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Flashcards in Fundamental Analysis Deck (6)
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1

What is the opposite of an "excellent" business?

A "commodity type" business.

A commodity is:

- a product that is the same from manufacturer to manufacturer
- the primary consumer purchase motivation is price

2

What traits do commodity type businesses have in common?

- absence of brand loyalty: when brand loyalty exists, the company can charge a premium (which increases profit margin)

- multiple producers: too many companies making the same product, or supplying the same service, translates into intense price competition (they have to lower their prices)

- excess capacity: if there is the presence of excess production capacity throughout the industry, companies are usually forced to compete on price.

# These three traits translate into:

- low profit margins
- low returns on equity
(Two attributes of companies that investors like to avoid)

3

Profitability ratios

Metrics that measure the profit-generating ability of a company relative to sales, assets, and equity.

- you can't simply use one profitability ratio. You have to use many, over time.

- they're a good way to judge a company's performance.

They are used in fundamental analysis.

They are:

- gross profit margin (GPM)
- net profit margin (NPM)
- return on equity (ROE)
- return on investment (ROI)
- return on assets (ROA)

4

ROE

Return on equity

- profitability ratio that analyzes management's ability to earn a fair return on the shareholder's investment.

- Each company has "shareholders equity", the amount of cash received from shareholders in exchange for shares.

- each company also has "net income" (or "net profit") for the full fiscal year.

- you would divide net income by shareholders equity to get the percentage.

5

What are the two companies to consider buying?

1). Stocks of businesses that we understand.

2). Businesses that are "excellent" and have expanding value.

6

Intrinsic value

Examining a stock (which will carry risk) versus a benchmark (like a treasury) that offers a risk-free return.

If it can't beat the treasury, it isn't worth the investment.