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Welcome to session 17 of the Investing for Beginners podcast. In today’s session, we will be discussing a very interesting topic that is near and dear to my heart, an in-depth analysis of the cash flow statement. If you are not an accountant, never fear because this will help explain some of the terms and give a better explanation of how they function.

In today’s session we will learn:

• What a cash flow statement is
• How it relates to the other financial statements included in the companies 10-k
• Breaking down the sections of the cash flow statement
• Highlighting some of the important line items to look for
• The differences between free cash flow and net cash

In this session, we are going to talk a little bit about Berkshire Hathaway, in honor of the recent annual meeting that they hold every year. We will look at how Warren Buffett, the master, lays out his cash flow statement.

Andrew: I think it’s important to understand where the cash flow statement lands when it comes to the financial statements in general. Every company needs to submit an annual report, and this is any company that is listed on any us stock exchange, they are all regulated by the SEC and are all required to submit what’s called a form 10-k. Which is an annual report, it shows the past three years of financial data on the income and the cash flow, and then the last two on the balance sheet.

When you hear these different statements that we are referring to. there are three major ones that are broken down into an income statement, which let me explain in a simple way what each of these three mean.

There is an income statement, balance sheet, and a cash flow statement. A great way to understand what happens on a business level is to compare to how it happens on a personal level because we all know how the personal level of finances work because we all live it. When you look at an income statement that’s the same as looking at someone’s tax return. What’s going to be on an income statement is how much money somebody makes as a salary from their job. Simple enough, really when you look at companies in the stock market, it’s the same way. It’s calculating how much they are earning every single year; it factors things like taxes, other accounting terms like depreciation and interest and all those types of things.

At the end of the day, you have this thing called the bottom line, and that’s the called the bottom line. Or another way to say profits, and it’s the bottom line on an income statement. That tells you how much a company earned, what their profits are and it’s the same way with you in your life. How much you bring home from your job, you can think of your gross income as what the revenue row is on the company’s income statement and then however much you pay in taxes. Then you have a net income, and that’s the same as the net income on the company’s income statement.

The next one would be the balance sheet if you think about a balance sheet for a company it is the same as a persn’s net worth. If you the person would add up everything you own minus all of your debts that gives you your net worth. Let’s say you have a spreadsheet; you have your house on there, the resale value of your car, and then maybe a couple of brokerage accounts, maybe a savings account or two, maybe a couple of retirement accounts. Then you have your debts, credit card, student loan, home equity line of credit and add all those things up on a spreadsheet they make your assets minus your liabilities which equals your net worth.

For a company it is the same way. They have a balance sheet, and there are all these different rows and columns, and all these different numbers. If you look closely enough, you will see it has the same concept as if you were making a spreadsheet at home. You have a row that’s called total assets, and then you have a row called total liabilities. Then when you subtract the total liabilities from the assets, you get what’s called shareholder’s equity. And that can be seen as the same as the net worth of a company.

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A return on any investment refers to the return of capital achieved over a certain period of time. In financial statement analysis, we are using many different ratios to understand how effectively a company is using its assets or its resources to generate a profit and create value for its shareholders. Yet, some of the most commonly used ratios are the return on equity (ROE) and the return on assets (ROA).

Understanding Return on Equity

Return on equity is a financial indicator that shows how efficiently a company uses the funds invested by its shareholders to generate additional earnings. Put simply, it shows the relationship between the firm’s net income to the funds available during a fiscal year to estimate the performance level of own funds.

ROE is expressed in percentage points, and it is calculated as:

ROE = Net Income / Shareholder’s equity

Given the fact that ROE is calculated for common shareholders, preferred dividends, if any, are excluded from the calculation of the net income. Therefore, if a company has a shareholder’s equity of $12 million, a net income of $1,25 million, and it pays $125,000 in dividends to preferred shareholders, the ROE calculation should be as follows:

Net income = $1,250,000 – $125,000 = $1,125,000.

ROE = $1,125,000 / $12,000,000 = 0.0937 = 9.38%.

Practically, this means that the company has achieved 9.38% return on equity from the funds invested by its shareholders. Hence, every dollar of common shareholder’s equity earned about $9.4 in this fiscal year.

What is a good ROE?

ROE is not the same for all industries. Capital-intensive industries like shipping, automobile, or airlines require substantial amounts of capital for expensive equipment and raw materials.

Conversely, labor-intensive intensive industries like insurance or banking require more human capital than physical assets to achieve a higher level of performance. Also, there are industries that require R&D, and their ROE should be adjusted for the R&D expenses.

Due to the particular nature of each industry and the different accounting practices used in each, ROE should be used for comparing firms that operate in the same sector or industry.  [click to continue…]

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Welcome to session 16 of the Investing for Beginners podcast. In today’s session, we are going to discuss IPOs and why you shouldn’t invest in them. We are going to use the recent Snapchat stock  IPO as well as their latest earnings reports to help us understand why Snapchat stock is not a good investment at this time, or if it will ever be a good investment.

• Snapchat had a recent IPO, and since then the company has been under siege.
• Yesterday’s earnings report was dismal, included were a drop in revenue as well as customer interactions.
• Buying a stock is risky enough, do you need to incur more risk by investing in an IPO.
• Remember that the ones making money from an IPO are the players, pitchers, team officials.
• Having a checklist to go over when investing is critical
• The Margin of Safety is a must, with a focus on the safety part of it.

Without any extra preamble let’s jump into the podcast and see what Andrew and Dave are cooking up.

Andrew: Yeah, let’s talk about IPOs and the most recent one everyone is talking about, Snapchat, the dirty pick app. A lot of people that I know use it, and it is obviously a very popular among millennials. We’ve mentioned before on the show, and I think it was you, Dave, that how a big percentage of users on Robin Hood had bought Snapchat stock, so we’ve riffed about it and maybe degraded it a little bit just for fun as one of our whipping boys.

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In the first article about 4 of the big players of the computer manufacturing industry, I looked at how these computer stocks performed since 2007.

By looking at growth histories spanning back to 1997, I sought out to determine whether such a long viewpoint could be a better indicator on stocks likely to outperform moving forward. You can read those conclusions in this article.

With this article here, I want to postulate whether an investor could combine the findings from the first article with some standard value investing metrics to improve results.

Recall that the first article showed that the two big computer stocks winners, AAPL and NICE, had high valuations in 2007. This is to be expected from companies growing and performing well during the peak of a bull market. The other interesting result was that the one company with favorable valuations in 2007, HPQ, ended up being the big loser. But upon further research, I’ve discovered a couple more interesting developments.

AAPL data by YCharts

What if we had put a simple criterion on these 4 computer stocks? Such as only buy their stock when the P/E is below 35…

A P/E below 25 is a general screen used by many investors as a starting point. I tend to be a little more flexible than the public when it comes to any one single metric, and I’ve been known to buy above 25 in the right situation.

Now IBM and HPQ would’ve qualified at all times because their P/E was never above this (neither have ever really been considered growth stocks).

Looking at AAPL’s chart above, the P/E below 35 criteria would have you buying after the bull craze of expensive stocks—right around mid to late 2008. Depending on your timing, you’d hit right during the crash or immediately after. Obviously after the crash would be more ideal for ROI, but today we have the benefit of hindsight. So, while this criterion could’ve been helpful had you gotten timing perfect, I don’t see it as particularly useful for AAPL.

NICE data by YCharts

Here’s where investors would be pickier, having to hold off on NICE until mid-2009 and mid-2013.

Buying in 2009 would’ve added to the overall performance, resulting in an over 200% return vs. 81%.

Buying in 2013 would have put the return at around 81% as well since the price had recovered to its 2007 high by then, but it also could’ve potentially saved buying in 2007 to put the capital elsewhere.

While this simple P/E criterion is nice, what gets especially interesting is when we combine it with net income growth. [click to continue…]