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Archive for September, 2007

Financial Ratio Glossary

Posted by Yogesh Agrawal on Friday, 14 September, 2007

CAGR – Compound Annual Growth Rate

The year-over-year growth rate of an investment over a specified period of time.

The compound annual growth rate is calculated by taking the nth root of the total percentage growth rate, where n is the number of years in the period being considered.

This can be written as follows:

CAGR isn’t the actual return in reality. It’s an imaginary number that describes the rate at which an investment would have grown if it grew at a steady rate. You can think of CAGR as a way to smooth out the returns.

EV – Enterprise value

Enterprise value, attempts to measure the value of a company’s business rather than the company. It answers the question “what would it cost to buy this business free of its debt and other liabilities?”

EV is calculated by adding together:

  1. the market capitalisation of the company
  2. the value of its debt financing (bonds and bank loans, not items such as trade creditors)
  3. the value of other liabilities such as a deficit in the company pension fund

and subtracting the value of liquid assets such as cash and investments.

The calculation is made more complex where there are minority stakes in associates and subsidiaries:

EBITDA – Earning Before Interest Tax Depreciation and Amortization

An indicator of a company’s financial performance which is calculated as follows:


EBITDA can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. However, this is a non-GAAP measure that allows a greater amount of discretion as to what is (and is not) included in the calculation. This also means that companies often change the items included in their EBITDA calculation from one reporting period to the next.

A common misconception is that EBITDA represents cash earnings. EBITDA is a good metric to evaluate profitability, but not cash flow. EBITDA also leaves out the cash required to fund working capital and the replacement of old equipment, which can be significant. Consequently, EBITDA is often used as an accounting gimmick to dress up a company’s earnings. When using this metric, it’s key that investors also focus on other performance measures to make sure the company is not trying to hide something with EBITDA.

Amortization

1. The paying off of debt in regular installments over a period of time.

2. The deduction of capital expenses over a specific period of time (usually over the asset’s life). More specifically, this method measures the consumption of the value of intangible assets, such as a patent or a copyright.

Suppose XYZ Biotech spent $30 million dollars on a piece of medical equipment and that the patent on the equipment lasts 15 years, this would mean that $2 million would be recorded each year as an amortization expense.

While amortization and depreciation are often used interchangeably, technically this is an incorrect practice because amortization refers to intangible assets and depreciation refers to tangible assets.

EV/EBITDA

The main advantage of EV/EBITDA over the PE ratio ratio is that it is unaffected by a company’s capital structure. It compares the value of a business, free of debt, to earnings before interest.

If a business has debt, then a buyer of that business (which is what a potential shareholder is) clearly needs to take account of that in valuing the business. EV includes the cost of paying off debt. EBITDA measures profits before interest and before the non-cash costs of depreciation and amortisation.

EV/EBITDA is harder to calculate than PE. It does not take into account the cost of assets or the effects of tax. As it is used to look at the value of the business in EV terms it does not break this value down into the value of the debt and the value of the equity.

As EV/EBITDA is generally used to value shares it is assumed that debt (such as bonds) that has a verifiable market value is worth its market value. Other debt may be assumed to be worth its book value (the amount shown in the accounts). Alternatively, it is valued in line with the company’s traded debt (for example, with the same risk premium as the most similar traded debt).

Equity can then be assumed to be worth EV less the value of the debt.

The first advantage of EV/EBITDA is that it is not affected by the capital structure of a company, in accordance with capital structure irrelevance. This is something that it shares with EV/EBIT and EV/EBITA

Consider what happens if a company issues shares and uses the money it raises to pay off its debt. This usually means that the EPS falls and the PE looks higher (i.e. the shares look more expensive). The EV/EBITDA should be unchanged. What the “before” and “after” cases here show is that it allows fair comparison of companies with different capital structures.

EV/EBITDA also strips out the effect of depreciation and amortisation. These are non-cash items, and it is ultimately cash flows that matter to investors.

EPS

Earnings per share (EPS) is the profit attributable to shareholders (after interest, tax, minority interests and everything else) divided by the number of shares in issue. It is the amount of a company’s profits that belong to a single ordinary share.

PE

The price/earnings ratio (PE) is the most commonly used valuation measure. It compares the price of a share to the company’s EPS. It directly relates the price of a share to the proportion of the company’s profits that belong to the owner of that share.

One of the reasons for the popularity of the PE ratio is its simplicity. It is:

share price ÷EPS

A higher PE means that the same share of a company’s profits will cost a prospective shareholder more. There are usually reasons for a higher PE. It may reflect faster expected earnings growth, or lower risk earnings.

The PE/growth ratio (PEG) attempts to allow meaningful comparison of the prices of companies with different growth rates.

A faster growing company deserves a higher PE. The PEG ratio attempts to formalise this by dividing the PE ratio by the percentage annual growth in earnings per share.

The PEG ratio is:

PE ÷g

where PE is simply the PE ratio
and g is the annual percentage growth in EPS.

It is usual to use historical PE and the growth from that to the prospective PE. So, if the historical EPS is 200p and the prospective is 210p, then g will be (210 ÷200) ×100 = 5. The use of the prospective PE and the following year’s PE instead (i.e., all the numbers one year further forward) is also common.

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IPO

Posted by Yogesh Agrawal on Tuesday, 11 September, 2007

IPO Refunds
Public Issue FAQ

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Mutual Fund

Posted by Yogesh Agrawal on Sunday, 9 September, 2007

The best resource for evaluating a mutual fund is www.moneycontrol.com and you can find out the top performer fund over a period of last one year in all the different category of mutual’s fund by clicking this link.
Evaluate Mutual Fund

And here is my favorite equity diversified with best performing fund over a period of 5 years.
Equity Diversified

And finally the index returns

P.S. using a payday loan to combat other loans like old car loans or other unsecured loans is as bad as asking for bad credit loans.

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