Stocks

Question 1

Basic characteristics of common stocks:

Answer 1

• residual claim: stockholders have claim to firm’s cash and assets obligation
• limited liability: you can only lose your investment
• voting rights: entitled to vote / every common share is one vote

Question 2

Markets that companies can issue shares:

Answer 2

• Venture Capital: issues shares privately to investment partners
• IPO: initial public offering: issue shares to general public
• SEO: secondary offerings: issuing additional shares

Question 3

Key stock evaluation metrics:

Answer 3

1. Price to earnings ratio: is how the market is pricing a company
2. Equity to Debt ratio: more than anything else it is debt that determines which companies will survive and which will go bankrupt in a crisis
3. Free Cash Flow per Share: (cash-debt)/outstanding shares
4. (Annual growth rate + annual dividend yield) over p/e

Question 4

How is the p/e multiplier determined:

Answer 4

• Expected Future Dividends

- Discount Rate for Dividends

Question 5

What is growth rate in earnings?

Answer 5

• the percentage increase in earnings from one year to the next

Question 6

How is the growth rate in earnings connected to p/e?

Answer 6

• the p/e ratio of any company that is fairly priced will equal its growth rate, growth rate of earnings
• If the p/e ratio is less than the growth rate you may have found a bargain
• in general p/e that’s half the growth rate is very positive and if it is twice the growth rate is very negative

Question 7

What is the most important growth rate?

Answer 7

• The only growth rate that really counts is earnings

Question 8

What is the key to the big-baggers?

Answer 8

• strong annual earnings growth
• a p/e of 20 with 20% growth is a much stonger stock than a p/e of 10 with 10% growth
• it’s all based on compounding earnings

Question 9

Dividend stocks - what do you need to check?

Answer 9

• If you do buy a stock for its dividend find out if the company will be able to pay through recessions, a company with 20-30 year record of regularly raising the dividend is your best bet.
• Cyclicals are not always reliable dividend-payers

Question 10

Book Value - what is important to understand?

Answer 10

• When you buy a stock for its book value you have to have a detailed understanding of what those values really are.
• Hidden Assets: Accounting methods for “goodwill” – what is it? It is how a company should account for depreciated assets
• Hidden Assets: Look for companies owning shares of a separate company

Question 11

Definition of Cash Flow

Answer 11

-Cash flow is the amount of money a company takes in as a result of doing business. All companies take in cash, but some have to spend more than others to get it. Prefer to invest in companies that don’t depend too much on capital spending to remain relevant/efficient.

Question 12

What are the 2 main accounting principles to account for Inventories:

Answer 12

• There are two basic accounting principles to calculate the value of inventories: LIFO and FIFO

Question 13

What is the “bottom line”

Answer 13

• Profit after taxes

Question 14

What is Pre-Tax profit?

Answer 14

• profit before taxes (including depreciation and interest expenses)

Question 15

What is the relationship between profit margin and cost?

Answer 15

• The company with the highest profit margin is by definition the lowest cost-operator and the low-cost operator has a better chance surviving if business conditions deteriorate.