Intelligent investor Ch 12-14 Flashcards by leo Gottlieb

When looking at an income statement that has 4 different earnings numbers, which should be used?
Primary earnings. . $5.20
Net income (after special charges). $4.32
Fully diluted, before special charges $5.01
Fully diluted after special charges. $4.19

Fully diluted, before special charges. $5.01, less part of
the 82 cents they may be attributed to occurrences in 1970

ALCOA factored in charges from other years, to make their
Earnings look good for 1971

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2 pieces of advice to the investor about earnings

1 don’t take a single years earnings seriously

2 if you pay attention to short term earnings, look out for booby
Traps in per share figures

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4 factors an investor must factor into earnings

1 use of special charges (May never be reflected in eps)
2 reduction in normal income tax deduction for past loss
3 dilution from convertible securities or warrants
4 depreciation: accelerated vs. straight line

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Jason zweig’s: common financial risks today

1 unrealistic assumptions on pension returns
2 special purpose entities which hide risky assets or liabilities
From the balance sheet
3 treating expenses as assets

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Stock valuation are really dependable only in…

Exceptional cases

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Period average earnings should be calculated for a company?

7 to 10 years

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Using average earnings: Special charges and credits

Should be included in average earnings

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Calculation of past growth rate

Use the average of the last 3 years, with corresponding figures
10 years earlier

Ex. Avg. earnings of Alcoa 1968-1970 $4.95
Avg. earnings of Alcoa 1958-1960. 2.08
Growth. 141%
Annual rate compounded. 9.0%

(3/5 special charges in 1970 deducted)

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Despite its excellent performance over the past decade, how did Alcoa sell for in the market?

11.5 it’s average 3 year earnings

The Dow was at 15+ times it’s average earnings

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Earnings on capital funds

Return on book value = net income/company’s tangible assets

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High multipliers have only been maintained in the stock market…

Only if the company maintained better than average profitability

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Pro forms earnings enable companies…

To show how well they would have done if they hadn’t done

As badly as they did

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Aggressive revenue recognition

Sign of dangers to come in earnings

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Non recurring costs

Investors should be on the look out for if recurring costs continue
To occur

Ex. Inventory write offs

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When a company raises it’s expected rate of return from pension plan investments (ex. 8.5% to 9.5%), what happens?

This lowers the amount of money they need to set aside

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What was a reasonable rate of return for pension plan assets in 2003?

How much money should a company be able to set aside for pension plans?

6.5%

Set aside 5%, if more you should check out how it can meet
It’s future obligations

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Detecting accounting time bombs

1 Anything the company doesn’t want you to see will be in the
back of the report

2 read footnotes under summary of significant accounting policies

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In the footnotes: “capitalized”, “deferred” and “restructuring” indicate…

The company has altered its accounting practices

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What should you check over in the accounting notes

Revenue recognition, inventory records, treatment of installment/
Contract sales, expenses in marketing costs

Also: debt, stock options, loans to customers, reserves against
Losses, other risk factors

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Footnotes and company competitors

Compare footnotes with company’s close competitor to see

How aggressive the company’s accountants are

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3 books for the enterprising investor to help interperet financial
Statements

1 Martin Fridson and Fernando Alverez’s Financial Statement Analysis

2 Charles Mulford and Eugen Comiskey’s The Financial Numbers

3 Howard Schilit’s Financial Shenanigans

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What 5 types of items does graham find key ratios for when comparing companies in security analysis?

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1 capitalization
2 income items
3 balance sheet items
4 ratios 
5 price record

What capitalization items are looked at? 5 things

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1 current price of the common stock
2 number of shares of common
3 market value of common
4 bonds and preferred stock
5 total capitalization

Total capitalization

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Total capitalization =

market value of common + (bonds and preferred stock)

What income items are looked at?

``` 1 sales (current year, 1970) 2 net income (current year) 3 eps average (1968-1970) 4 eps average (1963-1965) 5 eps average (1958-1960) 6 current dividend ```

What balance sheet items are compared? 4

1 current assets 2 current liabilities 3 net assets for common stock 4 book value per share

How do you calculate book value per share?

Book value per share= | Net assets for commons stock/# of shares of common

What ratios does graham calculate for security analysis comparing the 4 companies?10

``` 1 PE 1970 2 PE 1968-1970 3 price/book value 4 net income/sales 1970 5 net income per share/book value 6 dividend yield 7 current ratio 8 working capital/debt 9 earnings growth per share from 1968-1970 vs 1963-1965 10 earnings growth per share from 1968-1970 vs 1958-1960 ```

Price record data for current year of 1971? 4

1 1936-1968 lowest price 2 1936-1968 highest price 3 1970 low 4 1971 high

It is striking when different companies current PE ratios vary widely even more than...

Their operating performance and financial condition

Profitability and PE ratios

Favorable companies that have a higher ratio of | net earnings per share/book value have higher PE ratios

A high rate of return on invested capital (higher net income per share/book value) often goes along with...

A high annual growth rate in earnings per share

What indicates comparative strength or weakness on profitability especially for manufacturing ? (2 ratios)

Profit margin and ratio of operating income to sales

Stability, how is it measured

Measured by the maximum decline in per share earnings in any One of the past 10 years against the average 3 proceeding years No decline translates into 100% stability, can measure decline In earnings compared to s&p or Dow

What 6 factors do you want to take into account when evaluating and comparing companies?

``` 1 profitability 2 stability 3 growth 4 financial position 5 dividends 6 price history ```

How should preferred shares be treated in earnings and financial position ratios ?

Treat preferred as if converted into common

It often proves most difficult for a company to grow at a high rate after...

After volumes and profits have already expanded to large totals

Emery Air Freight managed to grow its earnings apace in 1970, which was the worst year for the domestic air passenger industry, a remarkable Acheivement. What should the investor research in regard to future profits being vulnerable to adverse developments?

1 increased competition 2 pressure for new arrangements between forwarders and Airlines

2 reasons many analysts like company stocks? Which are valid in Graham's opinion?

1 positive price movement in stock market (only good for speculators) 2 faster recent growth of earnings (investor must research Whether continued growth is likely to continue)

7 statistical requirements for inclusion in investor's portfolio?

1 adequate size 2 sufficiently strong financial condition 3 continued dividends for past 20 years 4 no earnings deficit in past 10 years 5 10-year growth of at least one-third in eps 6 price of stock no more than 1.5 times net asset value 7 price no more than 15 times average earnings of past 3 years

Defensive investor: requirement for sufficiently strong financial condition for industrial companies (2 things)

1 have current ratio of at least = 2 2 long term debt should not exceed working capital

Defensive investor: strong financial condition for public utility companies

Debt should not exceed twice the stock equity (at book value)

Graham's 7 requirements for stock selection of the defensive investor

``` 1 adequate size of enterprise 2 sufficiently strong financial condition 3 earnings stability 4 dividend record 5 earnings growth 6 moderate PE ratio 7 moderate price to assets ```

Defensive investor: earnings growth

Minimum increase in per share earnings in past ten years using 3-year averages at beginning and end

Defensive investor: Moderate price to earnings ratio

Current price should not be more than 15 times average earnings Of past 3 years

Defensive investor: moderate ratio of price to assets

Current price should not be more than 1.5 times book value last reported, however a multiplier of earnings below 15 could justify Higher multiplier of assets A (product of the multiplier) x (PE ratio) is less than or equal to 22.5 (Ex. (PE = 9) and 2.5 times asset value = 22.5)

Defensive investor Recommendation of a stock portfolio: should have have overall earnings/price ratio (the reverse of PE ratio)...

At least as high as the current high-grade bond rate (look at The 10 year AA-rated corporate bonds)

What 2 aspects of a business does the qualitative approach evaluate?

1 company prospects 2 management

Quantitative statistical approach

Emphasizes measurable relationships between selling price, | Earnings, assets and dividends

Working capital equation

Working capital = current assets - current liabilities

Jason Zweig's opinion on Graham's requirement for 33% growth over the decade?

Feels graham set the bar too low, the defensive investor should Look for 50% of 4% annual compounded growth

Why are forward PE ratios unreliable

Earnings Estimates are off by a by a wide margin 59% of the time

Why is it harder to find companies that trade at 1.5 times their price to book value?

An increasing proportion of the value of companies comes from Intangible assets (franchises, brand names, patents, trademarks, Goodwill) These factors are excluded from the standard definition Of book value

When are stocks scarcely undiscovered and probably over owned

Anything over 60% institutional ownership

Intelligent investor Ch 12-14 Flashcards

(54 cards)