Intelligent Investor Ch. 17- 20

Question 0

Taxes: a red flag

Answer 0

When taxes aren’t paid over a long period of time this is a red
Flag pertaining to validity of the company’s earnings

Question 1

Recommended coverage of interest charges before taxes?

Answer 1

5 times earnings

Question 2

Transportation ratio AKA operating ratio (for railroads)

Answer 2

Transportation ratio = (expenses of running its trains)/total revenues

The higher the ratio, the less efficient the railroad

Question 3

Restructuring charges

Answer 3

Allow company to hide its true earnings, by placing these losses
In one bad year (kitchen sink accounting)

Question 4

Goodwill, accounting rule

Answer 4

Can be written off over multiple years, minimizing the impact
Of goodwill charges on future earnings

Question 5

Volume

Answer 5

Sales or revenues

Question 6

Asset backing

Answer 6

Book value

Question 7

What 2 things does a very low book value signify?

Answer 7

1 company is earning high return on its capital, a sign of strength
And prosperity

2 the investor at the current price would be especially vulnerable
To an important adverse change in company’s earnings situation

Question 8

Showing profitability per dollar of capital, what is this measured by (ratio)?

Answer 8

Earnings/book value

Question 9

Good will component

Answer 9

Refers to when price exceeds book value (determined from the

Price/book value ratio)

Question 10

Shareholders are justified in raising questions as to the competence of management when results are. 3 things

Answer 10

1 unsatisfactory in themselves

2 poorer than those obtained by other companies similarly
Situated

3 have resulted in unsatisfactory market price for long duration

Question 11

Valuation of dividend stocks vs. growth stocks (2 extremes, note that they don’t apply to all stocks)

Answer 11

Dividend stocks are valuated primarily on their dividend growth
Rate

Growth stocks are valuated on expected growth over the next
Decade and cash dividend is left out of the reckoning

Question 12

2 demands shareholders should have of managements pertaining to earnings

Answer 12

1 managers should payout a normal share of earnings as dividends
Or
2 clearly demonstrated reinvested earnings have produced
Satisfactory increase in per share earnings

Question 13

Rule 703 of the New York Stock Exchange governing stock splits and stock dividends

Answer 13

Designates stock dividends of greater than 25% and less than
100% as partial stock splits

These Splits trigger the NYSE’s accounting requirement That the amount of the dividend be capitalized from retained earnings

Question 14

Why are special dividends not paid as often today?

Answer 14

Managers are afraid that investors may interpret special dividends
As a sign that future earnings of the company will decline

Question 15

Subscription rights

Answer 15

Less common today, still prevalent among closed end funds,
Insurance companies and other holding companies

Give existing shareholder right to buy new shares, sometimes
At a discount of market price, to maintain % ownership of
company

Question 16

2 basic questions investors should draw attention too regarding management

Answer 16

1 is management reasonably efficient?

2 are the interests of the average outside shareholder receiving
Proper recognition

Question 17

How do you judge the efficiency of a company’s management? 3 things

Answer 17

Comparing each company’s
1 profitability
2 size
3 competitiveness against similar firms in the industry

Question 18

Proxy material

Answer 18

Used to weigh arguments of management

Question 19

In order to evaluate you company, it is important to know how…

Answer 19

It has been unsuccessful

Question 20

Engineering firms

Answer 20

Assess when how a management has performed poorly, that
Shareholders higher and company must pay

Investors today can choose among consulting firms, restructuring
Advisers, and members of entities like risk management association

Question 21

Detecting fraud at Enron

Answer 21

Read the proxy under the heading Certain Transactions

Question 22

Proxy statement

Answer 22

Essential to evaluate conflicts of interest and detect fraud in the company you’re investing in

Has agenda for annual meeting, discloses details about
compensation and stock ownership of managers, shows
Transactions between insiders and company

Question 23

Voting on proxies

Answer 23

33% individual investors don’t vote

institutional investors including pension funds and insurance companies are required by law To vote

Question 24

If you see a proxy and it disturbs you: 3 actions you should take

Answer 24

1 vote against every director to let them know you disapprove 2 attend an annual meeting and speak up for your rights 3 find an online message board and rally other stockholders For your cause

Question 25

The objective of efficient operation

Answer 25

Produce at low cost and find most profitable articles to sell

Question 26

The typical management will operate with more capital than necessary

Answer 26

This is bad for stock holders and often permitted by them Instead of paying cash dividends some companies waste the Money and others pile it up without putting it to use

Question 27

Mergers 1995-2001

Answer 27

61% ended up destroying wealth for shareholders of acquiring Companies Acquirers using stock rather than cash, underperformed Competitors by 8%

Question 28

Acquisitions of private companies and subsidiaries of a public company

Answer 28

Have more often lead to positive returns

Question 29

When a company piles up cash and interest rates are low

Answer 29

Produces lousy returns for shareholders if the cash just sits Around, better if company pays a dividend

Question 30

Higher dividends and dividend increases

Answer 30

Often lead to higher earnings growth Dividend increases are associated with higher future profitability For at least 4 years after dividend change

Question 31

Stock options granted by company

Answer 31

Give executives and employees the right to buy shares in the | Future at a discounted price

Question 32

Exercising the options

Answer 32

Conversion of options to shares

Question 33

Repurchase of shares

Answer 33

Good when stock price is low Bad when it is merely done to offset dilution of stock options, Because company is wasting its money

Question 34

Share repurchases in 2000

Answer 34

In 2000, companies were spending 41.8% of their net income | To repurchase their shares, up from 4.8% in 1980

Question 35

Option exercising: taxes and income statement

Answer 35

Companies get a tax break when executives and employees Exercise stock options (IRS considers compensation expense) Stock options are not counted as an expense on the income Statement, but are counted as an expense on the tax return

Question 36

Stock options and dividends

Answer 36

Dividends decrease the volatility of a stock, which decreases The value of stock options for managers This is why managers prefer to buy back shares at high prices Over paying dividends

Question 37

Earning power AKA earnings yield

Answer 37

``` What a company can earn year after year if business conditions Stayed unchanged (usually 5 years or more) ```

Question 38

Earning power calculation

Answer 38

Inverse of the PE ratio Ex. PE of 11, has earning power of 9%

Question 39

Margin of safety for bonds and preferred stock

Answer 39

Total enterprise value - debt = margin of safety, also pretax Earnings must be 5 times interest charges Ex if a business owes $10 million and is fairly worth $30 million, Theoretically there is room for shrinkage of 2/3s of value before Bond holders suffer a loss

Question 40

When a company has outstanding only common stock, that in depression conditions is selling for less than the amount of bonds that could be safely issued against the property and earning power

Answer 40

In this case investor can obtain the margin of safety associated With a bond and chances of larger income and principal appreciation in common stock

Question 41

Why does the market have a stubborn habit of valuing earnings disbursed as dividends more generously than the portion retained in the business?

Answer 41

In many cases reinvested earnings fail to add commensurately to the earning power and value of the stock

Question 42

Chief losses to investors come from buying...

Answer 42

Low quality securities in favorable market conditions

Question 43

Bargain issues worth buying

Answer 43

Have a margin of safety Have prospects neither promising or unpromising

Question 44

Margin: in margin of safety

Answer 44

Margin guarantees a better chance for profit than for loss

Question 45

Diversification

Answer 45

Demonstrates investor's acceptance of the margin of safety | Principle

Question 46

Business principles: know your business

Answer 46

You must know the business if you intend to make business | Profits in excess of normal interest and dividend income

Question 47

Business principle: don't let anyone else run your business unless... 2 things

Answer 47

1 you can supervise his performance with adequate care and comprehension 2 you have unusually strong reasons for placing implicit Confidence in his integrity and ability

Question 48

What business operations should the investor avoid?

Answer 48

Avoid ventures where you have little to gain and much to lose Operations for profit should be based on arithmetic rather than Enthusiasm

Question 49

Have courage of your knowledge and experience

Answer 49

If you have formed a conclusion from the facts and you know Your judgement is sound, act on it In the world of securities, courage becomes the supreme virtue After adequate knowledge and tested judgement are at hand

Question 50

How must an investor limit their ambition

Answer 50

Investor must realistically assess what they have capacity in And limit investment activity to those confines

Question 51

What 2 factors characterize good investment decisions according to psychologist Daniel kahneman

Answer 51

1 well calibrated confidence 2 correctly anticipated regret

Question 52

Well calibrated confidence

Answer 52

Do I understand the investment as well as I think I do?

Question 53

Correctly anticipated regret

Answer 53

How will I react if my analysis turns out to be wrong

Question 54

Probability

Answer 54

Before you invest, you must assess your probability of being right And how you react to the consequences of being wrong

Question 55

Margin of safety equation

Answer 55

Margin of Safety = Actual Sales - Break Even Sales