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77 Cards in this Set

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2 reasons why Return on Equity important.
It's about shareholder wealth and profit margin.
ROE =
[net income] / [stockholders' equity]
Book value per share =
[total stockholder equity] / [# of shares outstanding]
Dividends must be paid out of...
Retained Earnings
What are the 2 ways to make a buck in business?
Increase sales & decrease costs
ROE =
margin x turnover
why are decreasing costs not a sustainable profit margin advance?
because you can only decrease so much.
you will always have some fixed costs.
ROA brings what into play?
leverage
With ROA, what is substituted for with assets?
turnover
name the 2 types of risk involved in ROE
business risk and financial risk
what is business risk?
the variability of the sales dollar.
the more variable the dollar, the more risk you have
What does profit margin let you do?
squeeze out a higher incremental return
what 3 things is stockholders' equity made of?
retained earnings,
paid in capital (paid in surplus),
and par value
as we turn equity, we can get the highest possible ROE which leads to what?
the exponential price to book of equity value
name the 2 companies that exemplified the 2 ways to make a buck in busiess
the washington post
and
gilette
book value per share does not include what?
preferred stock
what is the goal of any corporation?
to maximize shareholder wealth
Buffett wants a high ROE but without what?
an excess use of debt
name the 3 key financial decisions in a corporation
1. propoer allocation of capital as an investment
2. secure capital
3. dividend decision
what issues are involved int eh proper allocation of capital as an investment?
marginal revenue
what the company is going to invest in

consider: using capital budgeting techniques and the present values of inflows versus the present values of outflows
a project should be accepted under which net present values?
when the NPV is zero or positive
What are the key issues in the dividend decision?
whether to retain or pay out the $$$

a decision made by the CEO, CFO, and board
payout of dividends tends to be a function of what?
an inability to make capital investments.

if you can't make capital investments that give you a high rate of return, the only way to save the value of the business is to pay out dividends.
in which part of the life cycle is a company that is paying out dividends?
the mature -> stabilize -> decline stages
what do you never do to a dividend?
cut it.

you do not have to increase a dividend and you never have to instate it, but you never cut it
what does cutting a dividend signal?
it signals the company is not doing well.

the higher the payout ratio, the more damning the cut becomes
in signaling theory, it is important to consider what 3 ideas?
communication
willingness to serve
common purpose
every manager needs to consider what?
how to plan, organize, staff, control, direct, and be safe
cash flow is extremely important because...
free cash flow with a large sales growth is always the objective
operating cash flow =
EBIT + depreciation - taxes
net income + a non cash outlay =
cash flow
owner's income is?
subtracting capital expenditures to maintaing growth rate g
owner's income includes what elements?
working capital, plant, and equipment
owner's income =
net income + non cash outlays = cash flow

cash flow - capital expenditures to maintain growth rate g = owner's income
free cash flow
owner's income - dividends
Why is Buffett concerned with owners’ income?
Because that’s what he uses to take over companies.
What 4 options does a company have to use free cash flow?
Buy back stock

Make strategic capital investments beyond making a strategic acquisition

Pay down debt, but not to the point of being debt free

Increase dividends
Do dividends create growth?
no
John Burr Williams published what book in 1938?
The Theory of Investment Value
What was The Theory of Investment Value about?
It was Williams trying to figure out what went wrong in the crash of 1929.

He wanted to answer:
What went wrong? What was the underlying tell tale sign?
Today’s stock market is mostly about what?
Speculation
What is the kingpin theory of finance?
We buy stock for the present value of its future stream of dividends
In time all companies will pay dividends. True or False?
True
With the Time Value of Money, almost all value is generated in the first how many years?
100 years
Classically speaking, the dividend discount model goes to how many years?
Infinity
Buffett says that the growth rate of a stock ceases after which year?
10
What happens to the capital expenditure ratio of a stock after year 10, according to Buffett?
It goes to 0
Dividends cannot be postponed. True or False?
False
Why does Buffett stop considering a stock’s growth after year 10?
Because he cannot predict it
Net cap rate =
k - g
At the end of year 10, what should the earnings equal?
The dividends
Where we would say it’s the present value of the dividends, Buffett would say it’s the present value of what?
The owners’ income
Should we consider investing in anything below an AAA bond rate?
no
Financial risk is represented by which ratio?
The debt to equity ratio
What is Buffett's recommended margin of safety?
20%
You should only buy a stock what percent below its intrinsic value?
20%
Financial markets perceive risk as what?
The risk of price variance
What do we use to account for price variance?
Beta (volatility)
How Graham and Buffett perceive risk?
As the risk of losing further money
Buffett considers the company doing what to be the true definition of risk?
Going bankrupt
What does Buffett say of systematic risk?
That the market is going to do what the market is going to do
What is the modern way of coming up with the discount rate?
CAPM
What does CAPM stand for?
Capital Asset Pricing Model
What is the CAPM equation?
**
When is Beta more risky than the market?
When Beta > 1
When is Beta less risky than the market?
When Beta < 1
Graham would tolerate a little more debt than financial variability would suggest if they had what?
A low earnings variability
15% is the magic number for what?
price to book
dividends have to be paid out of what?
retained earnings
Dupont System of Financial Analysis
3. If our Sales/ dollar of equity are faster, then our Turnover of equity will be higher and our Turnover of total assets is higher too.
what is financial risk?
increasing corporate value with debt
what is the goal of corporate value?
to Maximize shareholders’ wealth by increasing ROE
Define the Payoff ratio
percent of dividends paid as a percent of earnings.
Cash flow =
net income + noncash outlays (depletion, depreciation)
why is Free cash flow with a large growth rate always the objective?
because it gives us an indication of what is remaining in the company.
What 4 things can you do with free cash flows?
1.Buy back common stock (does contribute to excess abnormal returns)
2.Pay down debt (but not debt free because of the tax)
3.Increase dividends
4.Strategic acquisitions
should you invest in compaies that are paying dividends?
no