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Durable Competitive Advantage > Intelligent Investor Ch. 17- 20 > Flashcards

Intelligent Investor Ch. 17- 20 Flashcards

0
Q

Taxes: a red flag

A

When taxes aren’t paid over a long period of time this is a red
Flag pertaining to validity of the company’s earnings

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1
Q

Recommended coverage of interest charges before taxes?

A

5 times earnings

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2
Q

Transportation ratio AKA operating ratio (for railroads)

A

Transportation ratio = (expenses of running its trains)/total revenues

The higher the ratio, the less efficient the railroad

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3
Q

Restructuring charges

A

Allow company to hide its true earnings, by placing these losses
In one bad year (kitchen sink accounting)

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4
Q

Goodwill, accounting rule

A

Can be written off over multiple years, minimizing the impact
Of goodwill charges on future earnings

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5
Q

Volume

A

Sales or revenues

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6
Q

Asset backing

A

Book value

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7
Q

What 2 things does a very low book value signify?

A

1 company is earning high return on its capital, a sign of strength
And prosperity

2 the investor at the current price would be especially vulnerable
To an important adverse change in company’s earnings situation

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8
Q

Showing profitability per dollar of capital, what is this measured by (ratio)?

A

Earnings/book value

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9
Q

Good will component

A

Refers to when price exceeds book value (determined from the

Price/book value ratio)

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10
Q

Shareholders are justified in raising questions as to the competence of management when results are. 3 things

A

1 unsatisfactory in themselves

2 poorer than those obtained by other companies similarly
Situated

3 have resulted in unsatisfactory market price for long duration

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11
Q

Valuation of dividend stocks vs. growth stocks (2 extremes, note that they don’t apply to all stocks)

A

Dividend stocks are valuated primarily on their dividend growth
Rate

Growth stocks are valuated on expected growth over the next
Decade and cash dividend is left out of the reckoning

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12
Q

2 demands shareholders should have of managements pertaining to earnings

A

1 managers should payout a normal share of earnings as dividends
Or
2 clearly demonstrated reinvested earnings have produced
Satisfactory increase in per share earnings

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13
Q

Rule 703 of the New York Stock Exchange governing stock splits and stock dividends

A

Designates stock dividends of greater than 25% and less than
100% as partial stock splits

These Splits trigger the NYSE’s accounting requirement That the amount of the dividend be capitalized from retained earnings

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14
Q

Why are special dividends not paid as often today?

A

Managers are afraid that investors may interpret special dividends
As a sign that future earnings of the company will decline

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15
Q

Subscription rights

A

Less common today, still prevalent among closed end funds,
Insurance companies and other holding companies

Give existing shareholder right to buy new shares, sometimes
At a discount of market price, to maintain % ownership of
company

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16
Q

2 basic questions investors should draw attention too regarding management

A

1 is management reasonably efficient?

2 are the interests of the average outside shareholder receiving
Proper recognition

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17
Q

How do you judge the efficiency of a company’s management? 3 things

A

Comparing each company’s
1 profitability
2 size
3 competitiveness against similar firms in the industry

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18
Q

Proxy material

A

Used to weigh arguments of management

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19
Q

In order to evaluate you company, it is important to know how…

A

It has been unsuccessful

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20
Q

Engineering firms

A

Assess when how a management has performed poorly, that
Shareholders higher and company must pay

Investors today can choose among consulting firms, restructuring
Advisers, and members of entities like risk management association

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21
Q

Detecting fraud at Enron

A

Read the proxy under the heading Certain Transactions

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22
Q

Proxy statement

A

Essential to evaluate conflicts of interest and detect fraud in the company you’re investing in

Has agenda for annual meeting, discloses details about
compensation and stock ownership of managers, shows
Transactions between insiders and company

23
Q

Voting on proxies

A

33% individual investors don’t vote

institutional investors including pension funds and insurance companies are required by law To vote

24
Q

If you see a proxy and it disturbs you: 3 actions you should take

A

1 vote against every director to let them know you disapprove

2 attend an annual meeting and speak up for your rights

3 find an online message board and rally other stockholders
For your cause

25
Q

The objective of efficient operation

A

Produce at low cost and find most profitable articles to sell

26
Q

The typical management will operate with more capital than necessary

A

This is bad for stock holders and often permitted by them

Instead of paying cash dividends some companies waste the
Money and others pile it up without putting it to use

27
Q

Mergers 1995-2001

A

61% ended up destroying wealth for shareholders of acquiring
Companies

Acquirers using stock rather than cash, underperformed
Competitors by 8%

28
Q

Acquisitions of private companies and subsidiaries of a public company

A

Have more often lead to positive returns

29
Q

When a company piles up cash and interest rates are low

A

Produces lousy returns for shareholders if the cash just sits
Around, better if company pays a dividend

30
Q

Higher dividends and dividend increases

A

Often lead to higher earnings growth

Dividend increases are associated with higher future profitability
For at least 4 years after dividend change

31
Q

Stock options granted by company

A

Give executives and employees the right to buy shares in the

Future at a discounted price

32
Q

Exercising the options

A

Conversion of options to shares

33
Q

Repurchase of shares

A

Good when stock price is low

Bad when it is merely done to offset dilution of stock options,
Because company is wasting its money

34
Q

Share repurchases in 2000

A

In 2000, companies were spending 41.8% of their net income

To repurchase their shares, up from 4.8% in 1980

35
Q

Option exercising: taxes and income statement

A

Companies get a tax break when executives and employees
Exercise stock options (IRS considers compensation expense)

Stock options are not counted as an expense on the income
Statement, but are counted as an expense on the tax return

36
Q

Stock options and dividends

A

Dividends decrease the volatility of a stock, which decreases
The value of stock options for managers

This is why managers prefer to buy back shares at high prices
Over paying dividends

37
Q

Earning power AKA earnings yield

A 
What a company can earn year after year if business conditions
Stayed unchanged (usually 5 years or more)
38
Q

Earning power calculation

A

Inverse of the PE ratio

Ex. PE of 11, has earning power of 9%

39
Q

Margin of safety for bonds and preferred stock

A

Total enterprise value - debt = margin of safety, also pretax
Earnings must be 5 times interest charges

Ex if a business owes $10 million and is fairly worth $30 million,
Theoretically there is room for shrinkage of 2/3s of value before
Bond holders suffer a loss

40
Q

When a company has outstanding only common stock, that in depression conditions is selling for less than the amount of bonds that could be safely issued against the property and earning power

A

In this case investor can obtain the margin of safety associated
With a bond and chances of larger income and principal
appreciation in common stock

41
Q

Why does the market have a stubborn habit of valuing earnings disbursed as dividends more generously than the portion retained in the business?

A

In many cases reinvested earnings fail to add commensurately
to the earning power and value of the stock

42
Q

Chief losses to investors come from buying…

A

Low quality securities in favorable market conditions

43
Q

Bargain issues worth buying

A

Have a margin of safety

Have prospects neither promising or unpromising

44
Q

Margin: in margin of safety

A

Margin guarantees a better chance for profit than for loss

45
Q

Diversification

A

Demonstrates investor’s acceptance of the margin of safety

Principle

46
Q

Business principles: know your business

A

You must know the business if you intend to make business

Profits in excess of normal interest and dividend income

47
Q

Business principle: don’t let anyone else run your business unless… 2 things

A

1 you can supervise his performance with adequate care and comprehension

2 you have unusually strong reasons for placing implicit
Confidence in his integrity and ability

48
Q

What business operations should the investor avoid?

A

Avoid ventures where you have little to gain and much to lose

Operations for profit should be based on arithmetic rather than
Enthusiasm

49
Q

Have courage of your knowledge and experience

A

If you have formed a conclusion from the facts and you know
Your judgement is sound, act on it

In the world of securities, courage becomes the supreme virtue
After adequate knowledge and tested judgement are at hand

50
Q

How must an investor limit their ambition

A

Investor must realistically assess what they have capacity in
And limit investment activity to those confines

51
Q

What 2 factors characterize good investment decisions according to psychologist Daniel kahneman

A

1 well calibrated confidence

2 correctly anticipated regret

52
Q

Well calibrated confidence

A

Do I understand the investment as well as I think I do?

53
Q

Correctly anticipated regret

A

How will I react if my analysis turns out to be wrong

54
Q

Probability

A

Before you invest, you must assess your probability of being right
And how you react to the consequences of being wrong

55
Q

Margin of safety equation

A

Margin of Safety = Actual Sales - Break Even Sales

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