Non-Cash Working Capital: A Critical Component of Valuation and FCF
Working capital is one of the engines that drives a business to profitability and growth. It is the combination of current assets and current liabilities that the company uses for short-term needs. But the combination includes cash items such as short-term cash, which is not working capital. Working capital is a critical component of valuation, […]
Sales to Capital Ratio: Measuring the Efficiency of a Company’s Reinvestments
One of Warren Buffett’s favorite metrics to measure a business’s efficiency to grow revenues is the metric, ROIC, or return on invested capital. When Buffett or Charlie Munger discuss potential investments, they mention that the best businesses can grow without investing much-invested capital. One way to measure how efficiently a company reinvests back into the […]
What is Net Book Value?
Net book value (NBV) is an accounting term which refers to the value of an asset as it can be seen on the balance sheet of the financial statements. The term carrying value is also commonly used to refer to NBV. The “net” in NBV signifies that the figure is the asset’s gross original cost […]
Two Examples of the Law of Large Numbers – How it Affects Valuations
Compound interest is the key to all investment returns, and it especially instrumental in its role for generating massive returns on the best growth stocks. But there’s a limit to compound interest called the law of large numbers, and we’ll talk about examples of this law applied on two very big businesses—Microsoft and Amazon. This […]
Enterprise Value Formula and Definition – CFA Level I & II Fundamentals
A company’s enterprise value (EV) is an important point of understanding for investors and is a fundamental learning point in many business schools, as well as CFA level I and II. The EV figure is an all-encompassing measure of the market value of all capital and other claims against the company. The detailed formula for […]
Levered Free Cash Flow Formula (FCFE) Explained
Free cash flow and a DCF go hand-in-hand in estimating valuation. But should levered free cash flow (also called FCFE) be used in a DCF? How does leverage affect a DCF, and future cash flows, and the value of a company? These are the questions I will be answering in this post. The way that […]
Degree of Total Leverage (DTL) – CFA Level 1
The term degree of total leverage (DTL) is a measure of a company’s overall sensitivity in bottom-line net income to a change in sales. The metric captures the degree of operating leverage (DOL) and the degree of financial leverage (DFL) to measure the total degree of leverage at the company, as can be seen in […]
Why Inventory Turns Are Key in Evaluating a Company’s Gross Margin
Business strategy is not binary. High gross margins are good, but just because they are higher doesn’t always mean a company has a better strategy. Other components of gross margin, such as inventory turns, can reveal business models with better profits and cash flows even while targeting lower margins. Before exploring the basics of inventory […]
Degree of Financial Leverage (DFL) – CFA Level 1
The degree of financial leverage (DFL) is not to be confused with the more popular balance sheet metric, financial leverage. While they have strong similarities both calculating risk (and reward!) from the use of debt, they go about measuring that risk in two different ways. Unlike the balance sheet metric financial leverage, the “degree” of […]
Degree of Operating Leverage (DOL) – CFA Level 1
The term degree of operating leverage (DOL) does not get as much attention as its more forthright cousin, financial leverage, but is just as important in determining the risk (and reward!) of a company. The degree of operating leverage is easy to calculate using only certain key line items on the income statement. The figure […]
