Equity Investment test 1 equations

FV =

RATE, NPER, PMT (REQUIRED) 

• PV IS OPTIONAL. 

• TYPE OPTIONAL. 

PMT =

RATE, PV, NPER (REQUIRED)

it represents payments over time

• FV OPTIONAL

• TYPE OPTIONAL

NPER =

(RATE, PMT, PV (REQUIRED)

• FV OPTIONAL

• TYPE OPTIONAL

RATE =

NPER, PMT, PV (REQUIRED)

• FV OPTIONAL

• TYPE OPTIONAL

• WHEN PUTTING PAYMENT IN, YOU HAVE TO MAKE IT NEGATIVE (when putting it in excel, make sure it has a negative if leaving the subject, or positive if going to subject.)

NPV =

RATE, VALUE 1, VALUE 2

basic formula
= R_t / (1+i)^t
R_t = net cash flows

i = discount rate
t = time of cashflows

RRI =

NPER, PV, FV (REQUIRED)

• FOR CAGR, USE RRI

IRR

VALUES REQUIRED

RFR — Risk-Free Rate

The baseline return you can earn with (almost) no risk.

Usually proxied by US Treasury yields.

RFR is the starting point for discount rates

When RFR rises

• bonds get more attractive

• stocks must offer higher returns

• valuations fall

ERP =

Expected Stock Return − RFR

The extra return investors demand for owning stocks instead of risk-free bonds.

ERP directly increases

the discount rate: r = RFR + ERP

r =

RFR + ERP

P/E - Price to Earnings =

Price / Earnings per share.

price of stock divided by earnings per share

P/FCF — Price to Free Cash Flow

P/FCF = Price / FCF per share

Price of stock divided by free cash flow per share

What is P/FCF trying to say?

“How much am I paying for real cash?”

EV/EBITDA =

Enterprise Value / EBITDA

Enterprise Value divided by Earnings before interest, taxes and depreciation

EV/EBITDA adjusts for:

• debt

• capital structure differences

Why do investors love EV/EBITDA

• Comparable across firms

• Useful for leveraged companies

• Common in private equity

How does EBITDA lie?

ignores:

• CapEx

• interest

• taxes

It does not ≠ cash

how can EV/EBITDA be a dealy trap?

Capital-intensive companies look cheap using this formula
Reality: planes, factories, and rigs still cost real money

When does P/FCF works?

• Cash-generative businesses

• Accounting-heavy industries

• Companies with heavy depreciation

how does P/FCF lie?

• can be temporarily high if:

  • CapEx is deferred

  • working capital is released

• Short-term spikes can be unsustainable

How does P/FCF trap you?

Thinking high FCF = permanent
Reality: CapEx always comes back eventually

What is P/E - Price to earnings saying?

“How much am I paying for current earnings?”

It’s the most famous ratio for a reason: it’s simple.

When or who does P/E work best?

• Stable businesses

• Normal margins

• Low accounting distortions

• Mature industries

How does P/E lie to you sometimes?

Earnings can be:

• cyclical

• temporarily inflated

• temporarily depressed

it also

Doesn’t account for:

• debt

• capital intensity

• reinvestment needs

What are some classic traps for P/E ?

Low P/E = cheap
Reality: low P/E can mean earnings are peaking

what is the ERP saying or what is it?

The extra return investors demand for owning stocks instead of risk-free bonds.

it represents

Compensation for uncertainty, volatility, and pain.

it is s fear + uncertainty + human psychology.

Why does ERP Matter?

• Higher ERP = investors are scared

• Lower ERP = investors are confident (or complacent)

how can ERP be misleading

• is not observable

• It’s inferred from markets

• It swings emotionally

what is the ERP trap?

Assuming it is constant
Reality: expands in crises and compresses in bubbles

What is RFR - Risk free rate?

The base line return you can earn with almost no risk.

What does RFR represent?

“What return can I earn without taking business risk?”

This is the floor under all asset pricing

Why does RFR matter?

is the starting point for discount rates

When RFR rises:

• bonds get more attractive

• stocks must offer higher returns

• valuations fall

Why can RFR mislead?

• It’s macro-driven, not company-driven

• A great business can look “overvalued” when rates spike

• RFR moves faster than fundamentals

classic RFR traps?

Thinking “stocks are bad” when rates rise
Reality: the discounting environment changed

Market Cap =

Price x shares

Dividend Yield

= Dividend / Price

dividend per share divided by stock price

What is Dividend Yield trying to say?

“What cash am I getting paid just for holding this?”
This is actual cash, not accounting.

When does Dividend Yield actually work?

It works for

• Mature companies

• Stable cash flows

• Disciplined capital allocators

How does Dividend Yield Lie?

• High yield can signal:

  • distress

  • unsustainable payout

• Dividends can be cut overnight

How can Dividend Yield lead to a trap?

Chasing yield
Reality: yield is only safe if FCF covers it comfortably

PEG - Price/earnings to growth

= P/E Ratio / Growth rate

Price/earnings to growth divided by growth rate

What is PEG - Price / earnings to growth trying to say?

“Am I paying too much for growth?”
It attempts to normalize valuation.

When does PEG - Price / earnings to growth work?

it works when there is

• Predictable growth

• Long growth runways

• Clean accounting

when does PEG lie?

• Growth estimates are guesses: they are forecasted growth, not guaranteed growth

• Growth slows faster than people expect: it assumes that growth is smooth, linear, and durable but doesnt take into account competition, compressed margins, market saturation.

• Doesn’t account for capital intensity

PEG trap

low peg = bargin

reality: growth can vanish, margins can compress.

FCF Yield

= FCF/ Market Cap

Free cash Flow divided by stock price

Discount Rate

Critical Variable

Risk free rate + equity risk premium

ERP is expected return on stocks above risk free rate

Federal Reserve impacts both

EV = Enterprise Value

Number of shares multiplied by price per share + total debt – Cash

EPS - Earnings Per Share =

Net Profit divided by number of shares outstanding.

FCF per share – free cash flow per share

(Net profit + depreciation – capex) Divided by number of shares outstanding

6 Major Stock Reports

1. Screen for ideas

2. Pick one you are interested in

3. Do overview research, including listening to last conference call,

company presentation

4. Put historical numbers into first model, then forecast 5 years in

future

5. Produce a comp sheet with competitor with key financial statistics

and ratios

6. Determine intrinsic value, and writeup one page summary

Time Value of Money

Albert Einstein once described compound interest as the

“eighth wonder of the world,” saying, “he who understands it, earns it; he

who doesn’t, pays for it.”

Time Value of Money

Money has value

• Money can be leased or rented

• The payment is called interest

• If you put $100 in a bank at 9% interest for one time period you will

receive back your original $100 plus $9

Original amount to be returned = $100

Interest to be returned = $100 x .09 = $9

Compound Interest

Interest that is computed on the original unpaid debt and the

unpaid interest

• Total interest earned = I_n = P (1+i)^n - P

• Where

• P – present sum of money

• i – interest rate

• n – number of periods (years)

I_2 = $100 x (1+.09)^2 - $100 = $18.81

Total Interest earned =

I_n = P (1+i)^n - P

• Where

• P – present sum of money

• i – interest rate

Future Value of a Loan with

Compound Interest

• Amount of money due at the end of a loan

• F = P(1+i)_1(1+i)_2…..(1+i)_n or F = P (1 + i)^n

• Where

• F = future value

F = $100 (1 + .09)^2 = $118.81

F = $100 (1 + .09)^20 = $560.44

Net Present Value

Present value of cash flows minus initial investments

Opportunity Cost of Capital

Expected rate of return given up by investing in a project

NPV = C_0 + C_t / (1 + r) ^ t

C = Cash Flow

t = time period of the investment

r = “opportunity cost of capital”

Net Present Value Example:

If the building is being offered for sale at a price of

$350,000, would you buy the building and what is the added

value generated by your purchase and management of the

building?

Internal Rate of Return
Rate of Return Rule

= Invest in any project offering a rate of return that is higher than the opportunity cost

of capital.

Rate of Return

= C_1-investment /investment

Internal Rate of Return

An average discount rate at which NPV = 0.

Internal Rate of Return Example

You can purchase a building for $350,000. The investment will generate

$16,000 in cash flows (i.e. rent) during the first three years. At the end

of three years you will sell the building for $450,000. What is the IRR

on this investment?

NPV for a Stock

when finding monthly values, what do you have to do to the NPER?

multiply by 12

when finding monthly values, what do you have to do to the Rate??

Divide by 12

When working with payments what sign is it?

if it is going away from subject, Negative if towards, positive.

When a problem is asking for CAGR, what function do you use?

RRI

when accounting for NPV

always add year 0 separately at the end

NPV FUNCTION EXCLUDES YEAR 0

IF NPV is a huge percentage

its a format error, right click and ask it to be. NUMBER.

Operating Income

= revenue x operating margin

Enterprise Value

≈ Market Cap + Total Debt − Cash

FCF

= Operating cash flow - Capital expenditures