Fundamentals 00: Definition of key terms used in the blog

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

While you don't need to be an accountant to understand my blog, there are some terms that I use throughout my analysis that are "technical jargon". Many terms come from different disciplines and may not be familiar even among accountants. That is why I have described them here.

As a person with a quantitative analysis background, I am very comfortable working with numbers. This has proven to be a blessing in my investing journey as I don't' get hung up on the numbers but instead see them as part of a company's story.

Along this line, I use many indicators and metrics that are computed based on information extracted from the company's' financial statements. The list below also provides an overview of the formula behind the various indicators and metrics.

This list is not meant to be exhaustive. I don't want to repeat what is readily available online so I have tried to keep the list short. However, if you think that there are things that I should add or even delete, feel free to comment.

Reading guide
If you are a first time visitor to this blog, you may not be familiar with some of the concepts that I have used in my analysis and valuation. I suggest that you check up the 3 Fundamentals series - Fundamentals 01, Fundamentals 02, and Fundamentals 03

It would enlighten you further on the points I made in the various case studies.

As part of the sharing of experience, at the end of most of the case studies, I have also pointed out some lessons that can be learned from the case presented. 

Revision date: 2 June 2020



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.

Altzman Z Score

This is an indicator by Professor Edward I. Altzman, 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

Asset-based value (AV)

This is the intrinsic value of a company based on the value of its assets

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.


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

Capital Asset Pricing model

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 risk-free return plus a risk premium, which is based on the Beta of that company. 

Clean Surplus accounting

An accounting concept where the changes in the shareholder equity which is not the consequence of transaction 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)

Earnings-based value (EV)

This is the intrinsic value of a company based on its discounted cash flow/earnings.  

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 sub-set of the EV

Free Cash Flow method of valuing companies

This approach is inspired by Professor Aswath Damodaran, Stern School of Business, New York University.  This is a method where the Intrinsic Value = 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)

Graham Net Net

Defined as the Total Current Assets Less Total Liabilities.  Many would consider this as a shorthand for the liquidation value

Gross profitability

This is a profitability indicator introduced by Professor Robert Novy-Marx, University of Rochester. It is computed by dividing sales minus the cost of goods sold by total assets.

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.

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 long-term growth. There are two key components to the formula: the winning probability factor and the win/loss ratio.

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 %

Net Net

Refer to Graham Net Net

Position sizing

This refers to the amount you allocate to each investment.  (Refer to Kelly formula)

Piotroski F Score

This is an indicator developed by Professor Joseph D. Piotroski of Stanford University that has a number between 0 to 9 which is used to assess the strength of a company’s financial position

Reproduction Value

This is an asset-based 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 the 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

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)

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 provider

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 non-controlled joint ventures from the TEV computation. 

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 issue.


The discount rate to be used in the discounted cash flow analysis and future described below

The discount rate refers to the rate you use in discounted cash flow analysis to determine the present value of all future cash flow. In the early days, I used a simple 10% as the discount rate for all the companies as this was my target returns. 

However, I later found out that according to finance theory the discount rate should account for both the time value of money as well as risk. The discount rate should thus be different for different companies. 

This led me to adopt Professor Aswath Damodaran's model where the risk is built into the discount rate. Damodaran derives the cost of equity using a Beta that accounts for the various company's business sectors and an Equity risk premium that accounts for where the revenue comes from.

Mathematically, the formula for the WACC is

Ke = the cost of equity. 

Kd = the cost of debt. 

T = marginal corporate tax rate. 

Ve = value of equity. 

Vd =market value of debt

The key parameters and assumptions of this model are:
  • The risk-free rate is derived as per Damodaran Local Currency Govt Bond Rate for the year and adjusted by a rating-based 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 free 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 un-levered beta of various sectors the Group is in. This is then levered based on the D/E ratio of the Group

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I am not an investment adviser, security analyst or stockbroker.  The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies.   Investments or strategies mentioned in this website may not be suitable to you and you should have your own independent decision regarding them. 

The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such. 

I may have equity interests in some of the companies featured.


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