Ok so now I am onto the second half of the book, so far this is really fun for me.

So right away I like how this opens it starts talking about how investors eagerly await when companies report the financial statements. I can’t argue with that, but I can say that I do not.

Very rarely do I wait in anticipation for one of my companies to report. There just is not that much that can happen in the span of 3 months at a company. Of course there are contradictions to this and sometimes I do await a report.

I Do Not Buy and Sell Often

But if that’s the case it’s because I want to see what management says rather than what they are reporting. Numbers just don’t change that much and the fact that people are waiting is really bad for their long term investing returns.

They are probably the type that buy and sell all the time, which could not be worse for their returns.

I buy companies or stocks just like if I was to buy the whole business, it’s no different to me. I’m not going to buy a subway franchise because I like the financials, open up my store and then every few months be on the lookout for how I can sell it and buy something else.

Investing is for the long term, like buying a house. That’s how I see it.

Also I could relate this to poker in that one should not be caught up in seeing what their results for the given week, it will just vary way too much to gain any insight or learn anything from such a report. Maybe up a little maybe down a little but most likely it means nothing.

Focus on the process not the very short term outcome.

Dual Impact System

Each debit has an associated credit that goes along with it. Company sells a product, that inventory is removed from the system, and then cash is added in.

Cash Based Accounting vs Accrual Based Accounting

Public companies use accrual method so that is what the book focuses on. I think this pretty much has to do with incrementally counting the cash as opposed to all at once for things like amortization or even service contacts that pay you up front. I think.

yea the next 2 paragraphs pretty much said that.

 

Chapter 6

First few pages are reading the income statement , well the basic stuff which I get, but hopefully it will get into some other stuff that on yahoo finance like net interest income.

Just as I typed that , the book literally talked about net interest income.

OK so I was just flying through the pages talking about the income statement because I have been very familiar with incomes statements from reading companies reports and also alot on yahoo finance.

But now we get to Interest Coverage Ratio, which is similar to Buffets principle of debt to equity, they give a picture of a companies ability to keep their head above water and alive in the worst times!

Interest Coverage Ratio = Operating Income / Interest Expense

this tells us how many times they can pay their interest expense from what they have in operating income. Anything above 10 is pretty safe I think.

Chapter 7 The Balance Sheet

Ok so I have been waiting for this. There are things I need to learn about like change in working capital and return on invested capital and I think much of this will be discussed in this chapter, I hope.

So 3  sections the assets, liabilities, and equity, which of course we know the relationship between those 3 from earlier chapter 2 I think.

Assets first

Starting with assets, these can be funded in one of two ways. Assets can be funded by owners equity, or what the company has in their bank accounts, or they can be funded with debt or liabilities.

As asset is something owned and expected to generate money for the company.

Current assets are things the company expects to turn into real cash within 1 year. Non current assets are longer than 1 year, like a building or vehicle.

When intangible assets like CocaCola spending money to develop a new flavor get depreciated over time, it’s called amortization.

Goodwill… or Badwill?

so often did the guys at the morning show talk about how often when one company acquires another they often pay too much and then later on have to write down the goodwill charge.

Goodwill is just the amount of money that they cannot tangibly account for in the acquired business. If they bought the business for 1 million but the valuation of the business was only $800k then $200k would go under the Goodwill amount.

This only happens during an acquisition it’s not something the company can create out of no where.

Liabilities Second

everything straight forward just like assets but in reverse

Shareholder Equity

First is Capital Stock

or common stock. It’s the amount of money the company puts into treasury to account for shares that they create or get rid of.

In the example it talks about the company having to reference the charter to figure out how many common shares they can create. I need to research this more because so many companies I follow seem to just keep issuing and issuing and issuing, and issuing,,, and issuing more and more shares. I will look into this charter thing.

additional paid in capital

related to creating shares and selling them for market value. The difference between the par value which normally is like 1 penny, and the amount the shares are actually sold for is the additional paid in capital.

Retained Earnings

sum of all the previous net incomes plus what was already in the retained earnings number. This number will decrease when a dividend is paid so you can account for it in the cash flow statement also.

Treasury Stock

This is the stock the company keeps after buying it back. It reduces the share  holder equity because it no longer owe that to the shareholders. This number needs to be accounted for when calculating the book value growth over time because a drastic raise in the treasuring number will affect the book value.

I think this is because the shares are decreasing and it should match up with the treasury number?

Total Equity

This is the sum of all of it and what the shareholders would own if the business stopped everything right then and there.

Total Liabilities

Sum of all liabilties!

Calculating Ratios

ROE

Return on Equity

Net Income / Shareholder Equity

15.56%

Ok but what does this actually mean. Ok so net income is how much profit came from the business, how much loot $$$ they made in that period.

Shareholder Equity is literally what the business is worth today if everything stopped on the balance sheet.  So the net income has a variable of Time, but the equity does not.

but you get a percentage that tells you information of how profitable % based the company is. 15% for that period is pretty good.

ROE – It tells us how much the company was able to grow the owners’ money during this period.

Good companies have a consistent ROE above 8%

but what if the equity was like apple then that % would be way way down and would not be great at all, so we can see how shareholder equity really plays into that.

Return on Investment or Return on Assets (this is not ROIC)

Return on Investment

Net Income / Total Assets

10.57%

Ok so this number is keeping with net income so to its the profit over all of the assets the business owns.

so the assets are everything that is there to produce money for the operations. So all of the assets are together able to pull in the net income or the profit.

So this % shows how effective the assets are at producing income or profit, in this case it is 10%.

a key point since this does not include any liabilities, if a company for example had no liabilities then the ROE and ROI would be the exact same because Assets = Equity

a good ROA would be above 6% for example, but more importantly you want your number to be better than your competitors over time.

 

Liquidity Ratios

current ratio

current assets / current liabilites

2.31

we like a current ratio above 1.0 which means more assets than liabilities, above water!

This means if its less than one that 1 of 2 things need to happen.  You need to take on debt or issue more shares so increase our assets.

So for this reason even a number around 1.5 is better and much safer than just 1.

Acid Test Ratio

or skeptic liquidity measure, much more conservative because it takes out inventory from the equation above

acid test

(Current assets – inventory) / current liabilities

1.68

so its just taking a worst case scenario and saying well what if we dont sell that inventory are we still above water aka >1

conservative and the book says if  you don’t know the company that well then this ratio is good.

I say if you dont know the damn company well enough , dont fucking invest a dime!

Efficiency Ratios

Inventory Turnover Ratio

Cost of Rev / Inventory

2.15

this tells us that the company was able to turn over the inventory 2.15 times in the given period

this makes sense for a product that has shelf life like a coke can but not so well for a fresh food company that turns over inventory much faster.

so for coke a better number would be 4 so turning over inventory 4 times during the period.

accounts receivable turnover ratio

turnover(rev) / accounts rec

3.41

= 365 / 3.41

107

so it takes on average the customers pay 107 days after they get the product. depends on the industry and product but this is quite long.

accounts payable turnover ratio

cost of rev / accounts pay

2.45

= 365/2.45

149

so on average it takes the business 149 days to pay its suppliers, kinda long!

Solvency Ratios

debt to equity ratio

(long term debt + notes payable )/ Equity

20%

this metric is used when risk comes into play probably during bad times. Buffett uses this and does not like above 50% debt to equity ratio

 

Chapter 8 Cash Flow Statement

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