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Durable Competitive Advantage > Intelligent investor Ch 12-14 > Flashcards

Intelligent investor Ch 12-14 Flashcards

0
Q

When looking at an income statement that has 4 different earnings numbers, which should be used?
Primary earnings. . $5.20
Net income (after special charges). $4.32
Fully diluted, before special charges $5.01
Fully diluted after special charges. $4.19

A

Fully diluted, before special charges. $5.01, less part of
the 82 cents they may be attributed to occurrences in 1970

ALCOA factored in charges from other years, to make their
Earnings look good for 1971

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1
Q

2 pieces of advice to the investor about earnings

A

1 don’t take a single years earnings seriously

2 if you pay attention to short term earnings, look out for booby
Traps in per share figures

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2
Q

4 factors an investor must factor into earnings

A

1 use of special charges (May never be reflected in eps)
2 reduction in normal income tax deduction for past loss
3 dilution from convertible securities or warrants
4 depreciation: accelerated vs. straight line

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3
Q

Jason zweig’s: common financial risks today

A

1 unrealistic assumptions on pension returns
2 special purpose entities which hide risky assets or liabilities
From the balance sheet
3 treating expenses as assets

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4
Q

Stock valuation are really dependable only in…

A

Exceptional cases

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5
Q

Period average earnings should be calculated for a company?

A

7 to 10 years

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6
Q

Using average earnings: Special charges and credits

A

Should be included in average earnings

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7
Q

Calculation of past growth rate

A

Use the average of the last 3 years, with corresponding figures
10 years earlier

Ex. Avg. earnings of Alcoa 1968-1970 $4.95
Avg. earnings of Alcoa 1958-1960. 2.08
Growth. 141%
Annual rate compounded. 9.0%

(3/5 special charges in 1970 deducted)

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8
Q

Despite its excellent performance over the past decade, how did Alcoa sell for in the market?

A

11.5 it’s average 3 year earnings

The Dow was at 15+ times it’s average earnings

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9
Q

Earnings on capital funds

A

Return on book value = net income/company’s tangible assets

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10
Q

High multipliers have only been maintained in the stock market…

A

Only if the company maintained better than average profitability

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11
Q

Pro forms earnings enable companies…

A

To show how well they would have done if they hadn’t done

As badly as they did

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12
Q

Aggressive revenue recognition

A

Sign of dangers to come in earnings

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13
Q

Non recurring costs

A

Investors should be on the look out for if recurring costs continue
To occur

Ex. Inventory write offs

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14
Q

When a company raises it’s expected rate of return from pension plan investments (ex. 8.5% to 9.5%), what happens?

A

This lowers the amount of money they need to set aside

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15
Q

What was a reasonable rate of return for pension plan assets in 2003?

How much money should a company be able to set aside for pension plans?

A

6.5%

Set aside 5%, if more you should check out how it can meet
It’s future obligations

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16
Q

Detecting accounting time bombs

A

1 Anything the company doesn’t want you to see will be in the
back of the report

2 read footnotes under summary of significant accounting policies

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17
Q

In the footnotes: “capitalized”, “deferred” and “restructuring” indicate…

A

The company has altered its accounting practices

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18
Q

What should you check over in the accounting notes

A

Revenue recognition, inventory records, treatment of installment/
Contract sales, expenses in marketing costs

Also: debt, stock options, loans to customers, reserves against
Losses, other risk factors

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19
Q

Footnotes and company competitors

A

Compare footnotes with company’s close competitor to see

How aggressive the company’s accountants are

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20
Q

3 books for the enterprising investor to help interperet financial
Statements

A

1 Martin Fridson and Fernando Alverez’s Financial Statement Analysis

2 Charles Mulford and Eugen Comiskey’s The Financial Numbers

3 Howard Schilit’s Financial Shenanigans

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21
Q

What 5 types of items does graham find key ratios for when comparing companies in security analysis?

A 
1 capitalization
2 income items
3 balance sheet items
4 ratios 
5 price record
22
Q

What capitalization items are looked at? 5 things

A 
1 current price of the common stock
2 number of shares of common
3 market value of common
4 bonds and preferred stock
5 total capitalization
23
Q

Total capitalization

A

Total capitalization =

market value of common + (bonds and preferred stock)

24
Q

What income items are looked at?

A 
1 sales (current year, 1970)
2 net income (current year)
3 eps average (1968-1970)
4 eps average (1963-1965)
5 eps average (1958-1960)
6 current dividend
25
Q

What balance sheet items are compared? 4

A

1 current assets
2 current liabilities
3 net assets for common stock
4 book value per share

26
Q

How do you calculate book value per share?

A

Book value per share=

Net assets for commons stock/# of shares of common

27
Q

What ratios does graham calculate for security analysis comparing the 4 companies?10

A 
1 PE 1970
2 PE 1968-1970
3 price/book value
4 net income/sales 1970
5 net income per share/book value
6 dividend yield
7 current ratio 
8 working capital/debt
9 earnings growth per share from 1968-1970 vs 1963-1965
10 earnings growth per share from 1968-1970 vs 1958-1960
28
Q

Price record data for current year of 1971? 4

A

1 1936-1968 lowest price
2 1936-1968 highest price
3 1970 low
4 1971 high

29
Q

It is striking when different companies current PE ratios vary widely even more than…

A

Their operating performance and financial condition

30
Q

Profitability and PE ratios

A

Favorable companies that have a higher ratio of

net earnings per share/book value have higher PE ratios

31
Q

A high rate of return on invested capital (higher net income per share/book value) often goes along with…

A

A high annual growth rate in earnings per share

32
Q

What indicates comparative strength or weakness on profitability especially for manufacturing ? (2 ratios)

A

Profit margin and ratio of operating income to sales

33
Q

Stability, how is it measured

A

Measured by the maximum decline in per share earnings in any
One of the past 10 years against the average 3 proceeding years

No decline translates into 100% stability, can measure decline
In earnings compared to s&p or Dow

34
Q

What 6 factors do you want to take into account when evaluating and comparing companies?

A 
1 profitability
2 stability
3 growth
4 financial position 
5 dividends
6 price history
35
Q

How should preferred shares be treated in earnings and financial position ratios ?

A

Treat preferred as if converted into common

36
Q

It often proves most difficult for a company to grow at a high rate after…

A

After volumes and profits have already expanded to large totals

37
Q

Emery Air Freight managed to grow its earnings apace in 1970, which was the worst year for the domestic air passenger industry, a remarkable Acheivement. What should the investor research in regard to future profits being vulnerable to adverse developments?

A

1 increased competition
2 pressure for new arrangements between forwarders and
Airlines

38
Q

2 reasons many analysts like company stocks?

Which are valid in Graham’s opinion?

A

1 positive price movement in stock market (only good for
speculators)

2 faster recent growth of earnings (investor must research
Whether continued growth is likely to continue)

39
Q

7 statistical requirements for inclusion in investor’s portfolio?

A

1 adequate size
2 sufficiently strong financial condition
3 continued dividends for past 20 years
4 no earnings deficit in past 10 years
5 10-year growth of at least one-third in eps
6 price of stock no more than 1.5 times net asset value
7 price no more than 15 times average earnings of past 3 years

40
Q

Defensive investor: requirement for sufficiently strong financial condition for industrial companies (2 things)

A

1 have current ratio of at least = 2

2 long term debt should not exceed working capital

41
Q

Defensive investor: strong financial condition for public utility companies

A

Debt should not exceed twice the stock equity (at book value)

42
Q

Graham’s 7 requirements for stock selection of the defensive investor

A 
1 adequate size of enterprise
2 sufficiently strong financial condition
3 earnings stability
4 dividend record
5 earnings growth
6 moderate PE ratio
7 moderate price to assets
43
Q

Defensive investor: earnings growth

A

Minimum increase in per share earnings in past ten years using
3-year averages at beginning and end

44
Q

Defensive investor: Moderate price to earnings ratio

A

Current price should not be more than 15 times average earnings
Of past 3 years

45
Q

Defensive investor: moderate ratio of price to assets

A

Current price should not be more than 1.5 times book value last reported, however a multiplier of earnings below 15 could justify
Higher multiplier of assets

A (product of the multiplier) x (PE ratio) is less than or equal to 22.5
(Ex. (PE = 9) and 2.5 times asset value = 22.5)

46
Q

Defensive investor Recommendation of a stock portfolio: should have have overall earnings/price ratio (the reverse of PE ratio)…

A

At least as high as the current high-grade bond rate (look at
The 10 year AA-rated corporate bonds)

47
Q

What 2 aspects of a business does the qualitative approach evaluate?

A

1 company prospects

2 management

48
Q

Quantitative statistical approach

A

Emphasizes measurable relationships between selling price,

Earnings, assets and dividends

49
Q

Working capital equation

A

Working capital = current assets - current liabilities

50
Q

Jason Zweig’s opinion on Graham’s requirement for 33% growth over the decade?

A

Feels graham set the bar too low, the defensive investor should
Look for 50% of 4% annual compounded growth

51
Q

Why are forward PE ratios unreliable

A

Earnings Estimates are off by a by a wide margin 59% of the time

52
Q

Why is it harder to find companies that trade at 1.5 times their price to book value?

A

An increasing proportion of the value of companies comes from
Intangible assets (franchises, brand names, patents, trademarks,
Goodwill)

These factors are excluded from the standard definition
Of book value

53
Q

When are stocks scarcely undiscovered and probably over owned

A

Anything over 60% institutional ownership

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