LECTURE 3 – COURSE STRUCTURE

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 COURSE STRUCTURE
 SECTION 2 – Key Considerations:
1. Lecture 4 – Key Considerations
2. Lecture 5 - The Pension Time Bomb
3. Lecture 6 - How to invest in Stocks
4. Lecture 7 - Trading vs Investing
5. Lecture 8 - Value vs Growth investing

 SECTION 3 – Company Financial Statements:

1. Lecture 9 - Financial Statements Intro
2. Lecture 10 – Financial Statements Outline
3. Lecture 11 – Income Statement
4. Lecture 12 – Balance Sheet
5. Lecture 13 – Cash Flow Statement
6. Lecture 14 - Other Financial Statement Items

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 COURSE STRUCTURE
 SECTION 4 – The Application:
1. Lecture 15 – The Application
2. Lecture 16 - Key Valuation Ratios
3. Lecture 17 – Valuation Approach

 SECTION 5 – Real World Application:

1. Lecture 18 – Real World Application
2. Lecture 19 - Case Study: Analysis on a listed company

 SECTION 6 – Final Thoughts:

1. Lecture 20 – Final Reflections & Extra Resources
2. Lecture 21 – Your Investment Future

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 LECTURE 5 - THE PENSION TIME BOMB

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PROSAIC INVEST 2
 TODAY’S PENSION OUTLOOK
 Defined Benefit vs Defined Contribution pension schemes:

1. Defined Benefit Pensions: they pay out a secure income for life. Your employer
contributes to the scheme and is responsible for ensuring there’s enough money at
the time you retire to pay your pension income. The amount you’re paid is based on
how many years you’ve worked for your employer and the salary you’ve earned.

2. Defined Contribution Pensions: requires that you build up a pot of money that you
can then use to provide an income in retirement. Unlike defined benefit schemes,
which promise a specific income, the income you might get from a defined
contribution scheme depends on factors including the amount you pay in, the fund’s
investment performance and the choices you make at retirement. If you’re a member
of the scheme through your workplace, then your employer usually deducts your
contributions from your salary before it is taxed.

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 TODAY’S PENSION OUTLOOK
 For most people working today, Defined Benefit Pension Schemes are
NOT an option:
1. They are rarely issued today by employers. Most workplace
pension schemes today are Defined Contribution schemes.
2. A significant percentage of existing Defined Benefit schemes are
‘under water’ - presenting huge liabilities to employers.

 According to PWC, the funding DEFICIT for the UK’s 5,800 corporate
defined benefit pension funds was £200Bn i.e. Total Assets of
£1,560Bn was significantly below the £1,760Bn needed to pay out
existing & former workers at the end of April 2018.

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 TODAY’S PENSION OUTLOOK
 The UK median disposable household income for the Financial Year
ending 2017 was £27,300.
 If you wanted an average salary post retirement of £27,000/year for
20 years after retirement, you would have to have accumulated
£540,000 in your retirement fund at retirement (& for £50,000/year
you would have to have £1,000,000)
 At an annual net interest rate of 5% and annual inflation at 2.5%, you
would need to save £725/month for 30 years to get to £540,000 i.e. if
earning the median UK income and relying solely on your pension for
retirement, you need to be saving 30% of your gross income for 30
years to be able to maintain your current income after retirement.

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 TODAY’S PENSION OUTLOOK
 The UK is NOT ALONE.
 In June 2013, the National Institute on Retirement Security (NIRS) in
the US released a report showing, 38 million working age households
in the US - 45% of the total households - had no retirement account
assets - i.e. neither an employee-sponsored 401(K) plan or an
Individual Retirement Account.
 What are the factors making matters worse?
1. Low Returns: Weak Pension fund industry return performance
2. Low interest rates: Historically low bond yields
3. Age: An ever aging population

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 TODAY’S PENSION OUTLOOK
 What are the SOLUTIONS to avoiding this pension time bomb?

1. SAVE REGULARLY: UK personal savings rate has averaged 8.50%

from 1955 to date – with rates dropping below 5% since January
2017.

2. INVEST INTELLIGENTLY: Take responsibility in learning to invest in a

diversified long-term and largely self-determined portfolio.

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 LECTURE 6 - HOW TO INVEST IN STOCKS

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 “Investing in the stock markets can provide better,
inflation-beating long-term returns if you have the time
and know-how to build and manage a well-diversified
portfolio. But who does? To the vast majority of UK
savers, investing is a murky, complicated world, riddled
with hidden costs and uncertainty.”

Michelle Pearce,
CIO Wealthify

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 HOW TO INVEST IN STOCKS
 The first key question requires a choice between extent of control and
influence you are willing to take. The two options available in
investing in stocks are:

1. Investing in Pooled investment funds

2. Investing and building your Individual stock portfolio

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 POOLED INVESTMENT FUNDS
 Pooled investment funds are funds available to retail investors that are meant to allow for easier
diversification and reduced risk by spreading your investment across multiple shares and other
investment securities e.g. bonds.

 There are several types of pooled investment funds that are MANAGED by fund managers that
you can invest through and purchase from brokers, banks and directly from some fund managers.
They include:
1. Unit Trusts
2. Open-Ended Investment Companies (OEICs)
3. Investment Trusts

 All funds and fund managers of pooled investment funds should be REGULATED and authorised
by local and/or international regulators e.g. the UK’s Financial Conduct Authority (FCA) and US
Securities and Exchange Commission (SEC).

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 POOLED INVESTMENT FUNDS
 Because they are managed, there are COSTS to consider. Although these
vary, the main types of costs to consider when evaluating investment funds
are:

1. Initial Charges: A large majority of pooled investment funds charge an

initial charge for investing in them. In many cases, this could be up to 5%
of your investment.

2. Annual Management Charge (Ongoing Charges Figure): You may have to

pay an annual management charge.

3. Exit Charge: This may be charged if you want to cash in your investment.

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 POOLED INVESTMENT FUNDS
 Are the COSTS worth it?

 According to a 2017 Morningstar dataset covering UK Equity Income funds

of ‘average risk’:
1. 10 Year annualized returns ranged from 4% - 8% (vs the UK’s FTSE 100
annualized return of around 5% over the last decade)
2. Initial Charges averaged about 5%, and annual ongoing charges
ranged between 1.5% - 3%.

 Therefore, in many cases retail investors were paying initial charges and
annual ongoing charges significantly more than the historic average returns
of average risk pooled investment funds.

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 INDIVIDUAL STOCK PORTFOLIOS
 WHY invest in individual stock portfolios?
1. Inflation hedge, particularly when compared vs saving money in a
bank account
2. Provides an avenue to invest in Growth and Income, depending on
your risk appetite and investment capital. Favourable in a LOW
YIELD world.
3. Allows part-ownership in companies
4. Intellectually stimulating, as requires a disciplined approach over a
longer time horizon, and a commitment to carefully studying
potential investments

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 INDIVIDUAL STOCK PORTFOLIOS
 HOW to invest in stocks?

1. Apart from investing via pooled investment funds, you can buy or sell
shares directly through authorised stockbrokers.
2. Most brokers offer an online execution-only platform, allowing clients
to buy and sell shares independently using apps or online without
offering advice.

 In addition to market access and online execution services, most online

platforms will also provide data or company information resources
including historic price charts, financial metrics, latest company news and
corporate events.

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 INDIVIDUAL STOCK PORTFOLIOS
 The main dealing cost categories to consider when buying or selling listed shares,
include:

1. Dealing Commission: Either a % of your traded amount, or a set amount for

more frequent dealing. This may reduce proportionally for more regular and
larger capital investing plans e.g. monthly investment.

2. Automatic Reinvestment charges: A reduced dealing fee is offered by most

online brokers on dividend amounts reinvested into purchasing stocks. This
varies but will usually be around 0.5% of the reinvested amount.

3. Other Fees & Tax: include Stamp Duty Levy, Panel of Takeovers and Mergers
(PTM) Levy, broker Admin Fees, Transfer In & Transfer Out fees

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 INDIVIDUAL STOCK PORTFOLIOS
 What to be AWARE of when investing in shares?
1. Always have a plan as to what you want to achieve by investing
stocks i.e. what are your investment goals and investment horizon?
2. Always understand the costs, charges and fees you have to pay in
transacting and maintaining your share account.
3. Reflect carefully on YOUR risk tolerance. This should be related to
how much work are you willing to put into research.
4. The Market will NOT always go in your favour, your investment may
drop as well as rise.
5. HOPE IS NOT AN INVESTMENT STRATEGY.

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 LECTURE 7 – TRADING VS INVESTING

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 TRADING VS INVESTING
 “Being an Intelligent Investor is more a matter of CHARACTER than of
brain” – Benjamin Graham
 “People who INVEST make money for themselves, people who
SPECULATE, make money for their brokers.” – Benjamin Graham
 Look back at the summary of costs presented above, if you are
constantly trading than you cannot expect to make any decent
returns.
 This has been the reason for the SAD DEMISE of investment fund
returns. Investment horizons have shrunk.

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 PROVEN INVESTMENT APPROACH
 The best and PROVEN investment approach when in investing in
company shares is one of:
1. A long-term investment horizon
2. Involves re-investing dividends
3. An approach that applies incremental investing rather than lump
sum

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 PROVEN INVESTMENT APPROACH
$1 invested in US stocks in 1900 worth $198 or
$16,797 in 2000?

 Dividends are the greatest force in stock investing.

1. “If you invested $1 in US stocks in 1900 & spent all your dividend
payments, it would have been worth $198 in 2000.
2. If you reinvested ALL your dividends it would be worth $16,797.”

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 LECTURE 8 – VALUE VS GROWTH INVESTING

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 VALUE VS GROWTH INVESTING
 Although both approaches are aimed at maximising profits from investments in
the stock market, their approach differs:

1. Growth investors focus on industries/companies with strong earnings

momentum and view higher price-to-earnings (P/E) and price-to-book (P/B)
ratios as indicative of confidence in continued above-average growth in
company earnings.

2. Value investors tend to focus on stocks with relatively lower P/B and P/E ratios
and identify those as the best bargains the market has to offer.

 This course and the philosophy of its instructor is one heavily skewed towards
VALUE INVESTING.

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 LECTURE 10 - FINANCIAL STATEMENTS
OUTLINE

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 FINANCIAL STATEMENTS OUTLINE
 There are 3 main sections of a company’s financial statement:

1. Income Statement: measure of a company’s profit (or loss) over a

specific PERIOD of time
2. Balance Sheet: measure of a company’s financial position at a
specific POINT in time
3. Cash Flow Statement: measure of how much cash a company has
produced or spent over a PERIOD of time

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 LECTURE 11 – INCOME STATEMENT

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 INCOME STATEMENT
 The Income Statement measures a company’s profit (or loss) over a specific
PERIOD of time.
 The major line items in an income statement include:
1. Revenue – Sales made during a specific operating period.
2. Cost of Goods Sold (COGS) – Direct costs attributable to the production
of goods sold by the company.
3. Gross Profit = Revenue - Cost of Goods Sold.
4. Operating Expenses – Expenses incurred by a company as a result of
performing its normal business operations, i.e. Salaries, Administrative,
Advertising and R&D expenses.

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 INCOME STATEMENT
5. Earnings Before Interest, Tax, Depreciation & Amortization: Typically
abbreviated as EBITDA and also known as Operating Income, it is
calculated as:
 EBITDA = Revenue – COGS – Operating Expenses
6. Depreciation – An accounting expense that factors in the aging and
depletion of fixed assets over a period of time.
7. Amortization – An accounting expense for the cost basis reduction of
intangible assets (intellectual property e.g. patents) over their useful life.
8. Interest – Composed of interest expense (cost incurred on debt
borrowed) and interest income (income received from cash held in
savings or investments).

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 INCOME STATEMENT
8. Taxes – This factors in financial charges imposed on earnings from
the company’s operations by the government.
9. Non-recurring & Extraordinary items – expenses or incomes that
are either one-off or not pertaining to everyday core operations.
10. Distributions – broadly defined as payments to equity holders, e.g.
in the form of dividends or non-controlling interest payments.

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 LECTURE 12 – BALANCE SHEET

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 BALANCE SHEET
 The Balance Sheet is a measure of a company’s financial position at a
specific POINT in time.
 The Balance Sheet is broken up into three major categories:
1. Assets
2. Liabilities
3. Shareholders’ Equity
 A company’s total value of assets MUST ALWAYS equal the sum of its
liabilities and shareholders’ equity
 ASSETS = LIABILITIES + SHAREHOLDERS’ EQUITY

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 BALANCE SHEET
 Assets can be split into Current and Non-Current:
1. Current Asset: An asset whose economic benefit is expected to
come within 1 year. Examples are Cash, Accounts Receivable,
Inventory, Prepaid Expense, etc.
2. Non-Current Asset: Assets not expected to be converted into cash
within 1 year. Examples are Property, Plant and Equipment (PP&E);
Intangible assets such as patents, trademarks, copyrights, goodwill,
brand recognition, etc.

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 BALANCE SHEET
 Liabilities which are debt or financial obligations, can also be split into
Current and Non-Current:
1. Current Liability: Company debts or obligations that are owed
within 1 year. Examples are Accounts Payable, Accrued Liabilities,
and Short Term Debts due within 1 year.
2. Non-Current Liability: Company debts or obligations due beyond 1
year. Examples are Long Term Debts due beyond 1 year; Deferred
Taxes resulting from timing differences between net income
recorded for GAAP and net income recorded for tax purposes.

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 LECTURE 13 – CASH FLOW STATEMENT

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 CASH FLOW STATEMENT
 The Cash Flow Statement is a measure of how much cash a company
has produced or spent over a PERIOD of time.
 The cash flow statement is broken out into three segments:
1. Cash from Operating Activities
2. Cash from Investing Activities
3. Cash from Financing Activities
 The sum of all cash generated or spent from operating activities, from
investing activities and from financing activities results in total
amount of cash spent or received in a given period.

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 CASH FLOW STATEMENT
 Cash from Operating Activities shows how much cash was ACTUALLY
generated from net income or profits.
 Adjustments are needed on the Net Income or Profit figure provided
for in the Income Statement, to ensure only cash figures are included.
 Cash from Operating Activities =
Net Income +
[Changes in Accounts Receivable(-) + Changes in Inventory(-) + Changes in Prepaid
Expense(-) + Changes in Accounts Payable(+) + Changes in Accrued Expenses(+)] +
Depreciation +
Deferred Taxes

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 CASH FLOW STATEMENT
 Cash from Investing Activities is cash generated or spent from buying
or selling assets, businesses, other investments or securities. This
includes categories such as Capital expenditures (investments in
Properties, Plant & Equipment); buying/selling assets;
investing/selling securities.
 Cash from Financing Activities is cash generated or spent from equity
or debt, i.e. raising or buying back equity; raising or paying back debt;
distributions to equity holders (e.g. dividends paid).

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 LECTURE 14 – OTHER FINANCIAL STATEMENT
ITEMS

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 OTHER FINANCIAL STATEMENT ITEMS
 Other important considerations when reviewing company financial
statements are:
1. Always read the Auditor’s opinion letter. This will bring to attention early
on any accounting issues.
2. Always review and analyse the figures with further information provided
in the Notes section.
3. Read the Chairman’s and CEO’s letters for an indication of management
approach, temperament and ability to make and achieve realistic targets.
4. If you can, have a final read of the Annual Report starting from the last
page. You are more likely to find hidden items e.g. significant contingent
liabilities, pension deficits, etc.

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 LECTURE 16 - KEY VALUATION RATIOS

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 KEY VALUATION RATIOS
 Key investment and valuation ratios we will review are:
1. Price Earnings Ratio
2. Price–To–Book Ratio
3. Net Current Asset Value
4. Earnings Yield
5. Dividend Yield
6. Return on Invested Capital
7. Return on Equity
8. Margin of Safety

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 PRICE EARNINGS RATIO
𝑆ℎ𝑎𝑟𝑒 𝑃𝑟𝑖𝑐𝑒
 Price/Earnings (P/E) Ratio =
𝐿𝑎𝑠𝑡 3 𝑦𝑒𝑎𝑟 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑜𝑓 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

 P/E is a measure of the amount of $s an investor would invest, in

order to receive $1 of earnings in the company.
 A high P/E is ‘perceived’ to indicate investors are expecting are a high
earnings growth amount compared to a company with a low P/E.
 Note above we refer to historic P/E NOT forward-looking P/E.

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 PRICE-TO-BOOK RATIO
𝑆ℎ𝑎𝑟𝑒 𝑃𝑟𝑖𝑐𝑒
 Price/Book (P/B) Ratio =
𝑁𝑒𝑡 𝐴𝑠𝑠𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

 What is Net Asset Value (NAV)?

1. NAV, also known as the Book Value, Balance Sheet Value or Tangible Asset Value, is a
measure the company’s net worth.

2. 𝑁𝐴𝑉 = 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 ′ 𝐸𝑞𝑢𝑖𝑡𝑦 − 𝐼𝑛𝑡𝑎𝑛𝑔𝑖𝑏𝑙𝑒 𝐴𝑠𝑠𝑒𝑡𝑠 𝑒. 𝑔. 𝐺𝑜𝑜𝑑𝑤𝑖𝑙𝑙

𝑁𝑒𝑡 𝐴𝑠𝑠𝑒𝑡 𝑉𝑎𝑙𝑢𝑒

3. 𝑁𝐴𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = 𝐹𝑢𝑙𝑙𝑦 𝑑𝑖𝑙𝑢𝑡𝑒𝑑 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

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 PRICE-TO-BOOK RATIO
 The P/B ratio gives a measure of whether you are paying too much for
what would be left were the company to go bankrupt immediately.

 A LOW P/B ratio may be a sign the company is undervalued.

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 NET CURRENT ASSET VALUE
 𝑁𝑒𝑡 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

 A RARE but IMPORTANT indicator of an undervalued stock, is a situation whereby

a company sells for less than its Net Current Asset Value:

𝑁𝑒𝑡 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡 𝑉𝑎𝑙𝑢𝑒

 𝑆ℎ𝑎𝑟𝑒 𝑃𝑟𝑖𝑐𝑒 <
𝐹𝑢𝑙𝑙𝑦 𝐷𝑖𝑙𝑢𝑡𝑒𝑑 𝑁𝑜. 𝑜𝑓 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

 This would mean the company’s shares are selling BELOW their net liquidation
value, and are therefore UNDERVALUED.
 Net Current Asset Value is also known as Net Working Capital, but NOT the same
as Working Capital (which equals Current Assets minus Current Liabilities)

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 EARNINGS YIELD
𝐿𝑎𝑠𝑡 3 𝑦𝑒𝑎𝑟 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑜𝑓 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
 Earnings Yield =
𝑆ℎ𝑎𝑟𝑒 𝑃𝑟𝑖𝑐𝑒

 Note that it is the inverse of the P/E Ratio

 A HIGHER Earnings Yield means you are gaining a higher percentage
of earnings for every $ invested in the stock, vs another company with
a lower Earnings Yield.
 The Earnings Yield is usually compared to the interest rates in
government bonds. It should reflect within it the necessary risk
premium.

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 DIVIDEND YIELD
𝑇𝑜𝑡𝑎𝑙 𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
 Dividend Yield =
𝑆ℎ𝑎𝑟𝑒 𝑃𝑟𝑖𝑐𝑒

 The Dividend Yield is a measure of how much cash flow you receive
for each $ you have invested in the company.
 Although not used as much when evaluating value proposition, it
does form an important metric when evaluating a company’s dividend
proposition.
 In the absence of any meaningful capital gain, the dividend yield is a
useful indicator of your Return on Capital.

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 RETURN ON INVESTED CAPITAL
𝑂𝑤𝑛𝑒𝑟𝑠 ′ 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠
 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 =
𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

 The Return on Invested Capital (ROIC) gives an indication of how

much you as an owner, are truly earning on the capital the company
deploys in its business.
 So what are Owners’ Earnings and Invested Capital?

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 RETURN ON INVESTED CAPITAL
 What are Owners’ Earnings?

 𝑂𝑤𝑛𝑒𝑟𝑠 ′ 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 = 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 + 𝐴𝑚𝑜𝑟𝑡𝑖𝑠𝑎𝑡𝑖𝑜𝑛 −

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆𝑡𝑜𝑐𝑘 𝑂𝑝𝑡𝑖𝑜𝑛𝑠 𝑖𝑠𝑠𝑢𝑎𝑛𝑐𝑒 − 𝐶𝐴𝑃𝐸𝑋 𝑠𝑝𝑒𝑛𝑑 −
𝑖𝑛𝑐𝑜𝑚𝑒 𝑔𝑒𝑛𝑒𝑟𝑎𝑡𝑒𝑑 𝑓𝑟𝑜𝑚 𝑜𝑣𝑒𝑟𝑝𝑒𝑟𝑓𝑜𝑟𝑚𝑖𝑛𝑔 𝑝𝑒𝑛𝑠𝑖𝑜𝑛 𝑟𝑎𝑡𝑒𝑠 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛

 The Owner’s Earnings give a more practical figure to the amount of cash
flow you would receive if you were the sole owner of the company.
 A conservative approach to stock evaluation, made more famous as an
approach used by Warren Buffet.

PROSAIC INVEST 10
 RETURN ON INVESTED CAPITAL
 What is Invested Capital?

 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑎𝑠ℎ +

𝑝𝑎𝑠𝑡 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑖𝑛𝑔 𝑐ℎ𝑎𝑟𝑔𝑒𝑠

 Invested Capital represents a conservative indicator of the value of

capital the company has deployed in its business.

PROSAIC INVEST 11
 RETURN ON INVESTED CAPITAL
𝑂𝑤𝑛𝑒𝑟𝑠′ 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠
 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 =
𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

 Efficient and well run business will deploy less capital in producing each
unit of earnings. Therefore a higher ROIC represents a better run business.
 Note that some industry’s e.g. Banks tend to have much higher capital
needs and therefore lower ROICs.
 The ROIC should also be compared to the interest rate on 10 year
government bond yields.
 The ROIC approach for comparison of various investment opportunities is
applicable in other forms of non stock investments e.g. property, etc.

PROSAIC INVEST 12
 RETURN ON EQUITY
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 =
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠′ 𝐸𝑞𝑢𝑖𝑡𝑦

 Return on Equity (ROE) is a useful guide in comparing the profitability

of a company with that of other companies e.g. in the same industry.
 It is a less conservative approach than ROIC, but can be modified by
using Owners’ Earnings (in place of Net Profit) to evaluate % of
owners earnings generated from invested equity.

PROSAIC INVEST 13
 MARGIN OF SAFETY PRINCIPLE
 𝑀𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑆𝑎𝑓𝑒𝑡𝑦 = 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑌𝑖𝑒𝑙𝑑 −
𝑅𝑖𝑠𝑘 𝑓𝑟𝑒𝑒 𝐺𝑜𝑣𝑒𝑟𝑛𝑚𝑒𝑛𝑡 𝐵𝑜𝑛𝑑𝑠 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒

 The Margin of Safety is the difference between the percentage rate of

earnings on the stock at the price you pay for it (i.e. your earnings
yield) and the rate of interest on risk free bonds.
 Benjamin Graham developed the Margin of Safety approach when
selecting stock investments, as a quantifiable margin which would
absorb ‘unsatisfactory developments’.

PROSAIC INVEST 14
 LECTURE 17 - VALUATION APPROACH

PROSAIC INVEST 1
 STEP BY STEP VALUATION APPROACH
1. Screen for adequate company size - using Market Capitalisation or
Revenues i.e. Large Caps or Mid-Cap companies.

2. Sufficiently strong financial condition:

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
Current Ratio >= 1.2x where 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 = ;
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Long-term debts <= Net Current Assets, where
𝑁𝑒𝑡 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠;
Total Debt < 2x Shareholders’ Equity

3. Earnings Stability - positive earnings per share in each of the past 10

years.

PROSAIC INVEST 2
 STEP BY STEP VALUATION APPROACH
4. Dividend Record - uninterrupted dividend payments for the past 10
years

5. Earnings Growth – Minimum increase of at least 33% in earnings

per share over the last 10 years (this represents a 3% annual rise
each year). Use 3-year averages at beginning and end of the 10 year
period.

PROSAIC INVEST 3
 STEP BY STEP VALUATION APPROACH
6. Moderate P/E Ratio – P/E ratio of 12x or below

7. Moderate P/B Ratio – P/B ratio of 1.5x or below

8. Margin of Safety – Selected stock should have an Earnings Yield at least

as HIGH as the current 10 year government bond yield.

9. Once the above screening steps are complete, further comparison of

selected stocks can be carried out based on Dividend Yield, Net Current
Asset Value, Return on Invested Capital and ROE metrics.

PROSAIC INVEST 4
 LECTURE 20 – FINAL REFLECTIONS & EXTRA
RESOURCES

PROSAIC INVEST 1
 THEORY OF DIVERSIFICATION
 “Even with a margin in the investor’s favour, an individual security
may work out badly. But as the number of such commitments is
increased, the more certain does it become that the aggregate of the
profits will exceed the aggregate of the losses” – Benjamin Graham

PROSAIC INVEST 2
 SAGE OF OMAHA APPROACH
 Looks for ‘franchise’ companies with strong consumer brands, easily
understandable businesses, robust financial health & near
monopolies in their markets.
 Prefers to buy stocks after ‘scandal’ or ‘big loss’.
 Wants to see managers who set and meet realistic goals and build
their businesses from within rather than through acquisitions; and
who don’t pay themselves multi-million stock option ‘jackpots’.
 Insists on steady and sustainable growth in earnings so the company
is worth more in future than today.

PROSAIC INVEST 3
 FINAL REFLECTIONS
 You are NOT ‘THE SPECIAL ONE’, there are millions of professional analysts
out there. A reliable investment strategy takes patience. 3-5 year horizons
at least.
 Stock performance depends on 3 factors:
1. Real Growth (rise in company’s earnings and dividends)
2. Inflationary Growth (general rise in prices in the economy)
3. Speculative Growth/Decline (increase or decrease in the investing
public’s appetite for stock)
 ‘In making decisions under conditions of uncertainty, the CONSEQUENCES
must dominate the PROBABILITIES.
 Always remember the Analogy of Mr Market.

PROSAIC INVEST 4
 RESOURCES & FURTHER STUDY

PROSAIC INVEST 5
 RESOURCES & FURTHER STUDY

PROSAIC INVEST 6