Definitions
"Knowing what you don't know is more useful than being brilliant" Charlie Munger 

Item 
Description 
Acquirer’s Multiple 
This defined as TEV/EBITDA. Popularized by Tobias Carlisle, this is a valuation framework that aims to assess the true cost a third party
would pay to acquire the company’s cash flow or operating profits. This is the only relative valuation metric that I rely upon. My usual approach to triangulate the intrinsic value is to use this in conjunction with Asset Value, Earning Power Value, and Magic Formula. 
Altman Z Score 
This is an indicator by Professor Edward I. Altman, New York
University that is based on financial ratios calculated from data from the company’s Annual Report. It is used to predict whether a company has a
high likelihood of bankruptcy. I use this in conjunction with the Beneish M Score and Poitroski F Score to gauge the "quality" of a company. 
Assetbased value (AV) 
This is the intrinsic value of a company based on the value of its assets. There are several components of the AV ie non operating assets, Graham NetNet, NTA, and Reproduction Value. I normally breakdown the AV into the respective components to get a sense of the "quality" of the AV. 
Beneish M Score 
This is a statistical model by Professor Messod D. Beneish, of Indiana
University that uses a number of financial ratios calculated from accounting
data to see whether it is likely that the reported earnings of a company have
been manipulated. I use this in conjunction with the Altzman Z Score and Poitroski F Score to gauge the "quality" of a company. 
Beta 
Beta is used in the Capital Asset Pricing model as a measure of the
volatility or systematic risk of equity in comparison to the market as a
whole. My approach is to use the "buildup" approach as per Professor Damodaran to derive the Beta for a company. Damodaran has a dataset of the Beta based on industries that I rely upon. 
Capital Asset Pricing Model (CAPM) 
A model that describes the relationship between the expected return and risk in the company. It shows that the expected return is equal to
the riskfree return plus a risk premium, which is based on the Beta of that company. While I don't believe in volatility as a measure of risk, I agree with Professor Damodaran that the CAPM is presently the best model for determining the cost of equity. So I use the CAPM until a better model comes along. 
Clean Surplus accounting 
An accounting concept where the changes in the shareholder equity which is not the consequence of transactions with shareholders such as share repurchase, dividends, etc are shown in the income statement. We thus have a relatively "quick and dirty" method
to calculate the market value of a firm  which should be
(approximately) the same as a valuation based on discounted cash flows. (Refer to
Free Cash Flow method and Residual Income method). In practice, the comprehensive income in the P&L nowadays accounts for all the income sources. 
Earningsbased value (EV) 
This is the intrinsic value of a company based on its discounted cash
flow/earnings. My normal approach is to break down the EV into several components ie nonoperating assets, EPV, and Earning with growth. This provides a better understanding of the "quality" of the EV 
Earnings Power Value (EPV) 
This refers to the value of a company based on its discounted cash flow/earnings assuming that there is no growth. It can be considered a
subset of the EV. I get most excited if I find that the market price is less than the EPV as I consider this the most reliable Earningbased value. 
Free Cash Flow method of valuing companies 
The approach is inspired by Professor Aswath Damodaran, Stern School of Business,
New York University. This is a method where the Intrinsic Value = the discounted sum of the Free Cash Flow generated by the business where Free
Cash Flow is defined as earnings less Capex and working capital requirement but adding back depreciation/amortization. (Refer to Clean Surplus
Accounting and Residual Income method) I use two methods to determine the EV  the Free Cash Flow method and the Residual Income method. This is my way to handle the various accounting assumptions used in Financial statements. 
Graham Net Net 
Defined
as the Total Current Assets Less Total Liabilities. Many would
consider this as a shorthand for the liquidation value This is the gold standard for "cigarbutt" type on value investments. I have found that in certain sectors eg retailing, the Graham Net Net may not be a good proxy for liquidation values. 
Gross profitability 
This is a profitability indicator introduced by Professor Robert
NovyMarx, University of Rochester. It is computed by dividing sales minus the cost of goods sold by total assets. This is one of the key performance indicators I use to gauge the performance of a company. 
Intensity of Core Earnings 
This is based on the Paper “Extracting Sustainable Earnings from
Profit Margins, Tel Aviv University. The measure is positively associated with earnings persistence and better earnings predictability. I use this in conjunction with "accruals" to judge the quality of earnings. 
Kelly formula 
The formula was developed by
John L. Kelly Jr. while working at AT&T's Bell Laboratories. It is
currently used by gamblers and investors to determine what percentage of
their bankroll/capital should be used in each bet/trade to maximize longterm
growth. There are two key components to the formula: the winning probability
factor and the win/loss ratio. I don't use the actual formula in my investment process. However, I use the idea ie that you invest the most in those stocks with the highest conviction. 
Magic Formula 
Developed by Joel Greenblatt, an investor and Adjunct Professor,
Columbia Business School, this is a ranking approach to select the best
companies to invest based on a combination of earnings yield and
return. Earnings yield = EBIT/TEV and Return = EBIT/TCE. I
often use it as a screen to week out those with a Magic Formula value of <
25 % I use this together with the Acquirer's Multiple, AV, and EV to gauge whether there is a sufficient margin of safety. 
Net Net 
Refer to Graham Net Net 
Position sizing 
This refers to the amount you allocate to each investment.
(Refer to Kelly formula) There is a relationship between the position size, the number of stocks in the portfolio, and the total dollar amount allocated to the portfolio. Refer to my articles on asset allocation, portfolio construction, and management for more details. 
Piotroski F Score 
This is an indicator developed by Professor Joseph D. Piotroski of
Stanford University has a number between 0 to 9 which is used to assess
the strength of a company’s financial position. I use this in conjunction with the Altzman Z Score and Beneish M Score to gauge the "quality" of a company. 
Reproduction Value 
This is
an assetbased value that is favoured by Professor Greenwald in deriving the
Asset Value of a company. It considers all the current costs to
create the company. Apart from accounting for the physical
assets, this method also includes the cost to establish a business which
Professor Greenwald estimated as some multiple of the annual selling, general
and administration expenses. In practice, I have generally found the Reproduction Value to be much greater than the Book Value. So I place greater emphasis on EV than the Reproduction Value. 
Residual Earnings method of valuing companies 
This approach is inspired by Professor Stephen H Penman, Columbia Business School,
Columbia University, NY. Under this method, the Intrinsic Value = Total
Capital Employed plus discounted sum of the excess earnings where the excess earning is defined as earnings after deducting a capital charge. (Refer
to Clean Surplus Accounting and Free Cash Flow method) My EV is derived based on the average of the values using the Residual Earnings method and the Free Cash Flow method. In practice, I place greater emphasis on the Residual Earnings method compared to the Free Cash Flow method. 
Total Capital Employed (TCE) 
This represents the total funding for the company. It is defined as Shareholders funds + Minority Interests + Total Loan. Looking at the
Return of TCE (EBIT/TCE) provides a perspective of the returns to all the company’s capital providers. Since I looked at earnings from a company's perspective (rather than just the shareholders' perspective) most of my return metrics are based on TCE. 
Total Enterprise Value (TEV) 
TEV = Market capitalization + MI + Debt – Excess cash. This is a
valuation metric to compare companies with varying levels of debt. As I
am using the TEV in the context of the Acquirer’s Multiple where I have
excluded the contribution from associates and no controlled joint ventures,
I have excluded the value of associates and noncontrolled joint ventures from
the TEV computation. Be careful when you rely on other sources for the TEV as some do not subtract out the cash. 
Value trap 
This is an investment that is trading at a low price relative to its valuation that appears to be cheaply priced but is actually misleading. This low price is because the company is experiencing some insurmountable issues. If you are a value investor, this is the most important concept. I see a value trap and a bargain as the opposite sides of the value investment coin. You cannot talk about buying opportunities without thinking about value traps. 
WACC 
The discount rate to be used in the discounted cash flow analysis and
future described below. Since I use value companies based on the perspective of a firm, this is the most relevant cost of capital to consider. 
Kd = the cost of debt.
T = marginal corporate tax rate.
Ve = value of equity.
Vd =market value of debt
 The riskfree rate is derived as per Damodaran Local Currency Govt Bond Rate for the year and adjusted by a ratingbased default spread.
 The equity risk premium is derived via a weighted average of the respective country risk premiums. I use the Revenue for each country where the company does business as the weights. I use the risk premium without the additional adjustment for equity market volatility.
 The Cost of debt = risk ree rate + company default spread+ country default spread with the country default spread based on the location of operations.
 The company’s beta is built up based on the weighted average unlevered beta of various sectors the Group is in. This is then levered based on the D/E ratio of the Group
END
Books  Comments 
I actually learned valuation from the book "Investment Valuation" by Damodaran. It took me about a year to go through chapter by chapter as I also did the exercises. The "Little Book" serves as a refresher.  

This is a good "formulatype" book for a newbie. I still use the Magic Formula as part of my valuation metrics together with Asset Value, Earnings Value, and the Acquirer's Multiple. 
It has been simply incredibly generous with you to provide openly what exactly many individuals would’ve marketed for an eBook to end up making some cash for their end, primarily given that you could have tried it in the event you wanted.
ReplyDeleteContracts App
Thank you for your generous comment. I don't think people should be selling things that are readily available for free online. This is especially so for the items covered in the Definitions post. I may have pulled items from several different sources with considerable less effort than a newbie, but it does not hide the fact that they are freely available online.
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