Investing Tools for Investors Looking to Excel
10/21/02  

Investment terms defined that will equip you with professional investment jargon. 

 Glossary of Terms

Valuation Glossary

Amortization- When certain expenses are capitalized (added to assets), they are subsequently amortized or expensed over a period consistent with their economic life. Economic life is a period of time for which a capitalized asset can be expected to produce income which is fair in relation to its capitalized value.

Annualizing- The basic concept is to evaluate a company for a quarterly period and analyze what that performance would equate to on an annual basis by multiplying the result by four. Alternatively, if a company's margins or ROE improve and those improvements are sustainable, it would be useful to annualize results at the new higher margin levels to look at the full year possibilities. 

Book Value Per Share- Shareholder's Equity divided by the number of common shares outstanding.

Capitalization of Expenses- When an expenditure occurs where the asset acquired will be useful and generate or participate in the generation of income over a period exceeding one year. The related asset would then be expensed (depreciated or amortized) over its expected life.  Plant and equipment, software development costs, pre-opening expenses for restaurants and stores, drug development cost, etc. are examples of expenditures that are capitalized. Finally, goodwill is created from corporate acquisitions when there is an excess of cost over the fair value of net assets acquired. 

Cheap Stock- This is a vague concept that exists largely in the eye of the beholder. Cheap implies that based on popular ratios like P/E, Price to Cash Flow, etc the company's stock is cheap vis a vis it industry peers, the market in general, or the company's own historical valuation range. 

Depreciation- Fixed assets like property, plant and equipment require an immediate expenditure. But since these assets are productive and will generate income over a period of their useful economic life, the expenditures are capitalized (recorded as an asset) and expensed (depreciated) over a period consistent with their life.

EBITDA- Earnings before interest expense, taxes, depreciation, and amortization.

Free Cash Flow- Net Income plus non-cash charges to income, specifically depreciation and amortization less capital expenditures to sustain the basic business. This free cash flow is available to deleverage the business (pay down debt), buy back stock, or acquire other businesses for cash. Mature businesses generate free cash flow, while rapidly growing businesses often must reinvest to add assets to meet rapid demand growth. Frequently, the absence of free cash flow in a supposedly profitable business, may indicate that the company's products are in need of constant upgrade to stay competitive. This could imply profits are illusory. Technology must be carefully scrutinized for this profitless prosperity. 

GARP- Growth at a reasonable price. The P/E of the company in relation to the growth of the business as represented by the analyst's mean estimate of sustainable growth for the business looking out 3 to 5 years. A ratio of less than one is viewed as cheap while ratios well over 1 are viewed as expensive. If a company has a forecast growth of 15% over the next 3 to 5 years, but is selling at a P/E over 35, this might be viewed as a non-GARP. However, a growth rate of 30% with a P/E of 20 times, would, subject to further analysis, represent a possible GARP stock. 

High Margin Business- The relationhip between a dollar of expense and a dollar of income. In other words, a high margin business might only spend $.60 to generate $1.00 of income. Microsoft is a high margin business. 

Low Margin Business- A business that spends a high amount to generate revenues. For instance a company spending $1.00 to generate a $1.00  in revenues is a low margin business. Supermarkets are a low margin business.

Margins- The relationship between  the expenses of the businesses to revenues. The lower the expenses of the business in relation to income the higher the margins and the higher the expenses the thinner the margins.

Market Share- The company's sales in a product line versus total industry sales in that product category.

Price/Book Value per Share- Price of the Stock divided by the company's Book Value per Share.

Price/Cash Flow- Price of the Stock divided by number of shares of common stock outstanding.

Price/ Earnings Multiple- Price of the Stock divided by the Earnings per Share (EPS)

Price to Sales Ratio- Price of the Stock divided by Sales per Share of the company.

Relative P/E- It is not enough to know that a P/E is cheap or expensive vs the market. You must know the relationship between the current P/E, the company's industry group, the overall market, and the historical range of the company's P/E. Certain industry groups, like autos, look cheap on a P/E basis, but they have always had low P/E's because they are viewed as low growth and cyclical.

Return on Assets (ROA)- The company's net income divided by average assets for the annual period under consideration. Net Income, for purposes of this calculation, is after adding back interest expense on an after tax basis. 

Return on Equity (ROE)- The company's net income divided by Shareholder's Equity. Highly competitive businesses which have low margins and little value added generally have low ROE. If a company's ROA exceeds its after tax cost of debt, then the ROE will exceed ROA. If the company's after tax cost of debt exceeds ROA, then ROE will be less than ROA.

Rich Valuation- This is a concept suggesting a stock is fully valued or overvalued based on P/E, Price to Book Value, Price to Cash Flow, or Price to Sales vis a vis its peers in its industry group, or the market as a whole.

Turnaround- A situation where a troubled company with a troubled stock is or could pursue certain strategies to unlock value and move the stock price positively. These strategies could include closing money losing businesses, reengineering the business to cut expenses, developing new marketing or product strategies, or merging with a like business to create synergies or better economies of scale.

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