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VALUATION TUTOR:  Glossary

Accruals:   Accounts that represent liabilities and non-cash based assets used in accrual or non-cash based accounting systems. 

Altmans Z-Score:  A formula used for predicting the probability a firm will go into bankruptcy within two years.  It uses ratios derived from both the balance sheet and income statement to assess a firm’s financial health.

American Depository Receipts (ADR):   A negotiable certificate traded on US exchanges.  The certificate is issued by a US Bank and represents a specified number of shares in a foreign stock that is held by a US financial institution overseas.

Asset Turnover:   A measure of the efficiency of a company’s use of assets for generating revenue.  It is defined as Sales Revenue divided by Total Assets.

Balanced Scorecard (BSC):   A management tool that describes how a firm’s business strategy impacts upon performance, measured in terms of multiple dimensions such as financial, internal processes, customer, learning and growth.

Book to Market Ratio:  This is the inverse of the Price to Book Ratio.  It is convenient from a measurement perspective because market is positive and thus in this form the ratio preserves ranking order.

Capital Asset Pricing Model:   A model that describes a linear relationship between risk and expected return for all risky assets.

Capital Expenditures (CAPEX):  Expenditures made as part of the firm’s investment decision to create capacity for generating future benefits.

Comprehensive Income:   A measure of income that results from clean surplus accounting that results from all changes in shareholder equity not involving shareholders.

Consolidated Cash Flow Statement:   This accounting report measures the cash flows generated from the three major firm decisions (Investment, Financing and Dividend) over a specific accounting period for a set of corporations that are under the control of a single parent company. 

Consolidated Statement of Earnings (Income Statement)             :  This accounting report measures the net income for an accounting income over a specific accounting period for a set of corporations that are under the control of a single parent company.  It includes both operating and non-operating revenues and expenses. 

Consolidated Statement of Stockholders Equity:   This accounting report measures the changes in a company’s retained earnings over the reporting period for a set of corporations that are under the control of a single parent company.  It includes information from the income and other financial statements. 

Critical Accounting Policy:  A policy for a firm that has a significant subjective part to it and it has a material impact upon the firm’s financial statements.

Degree of Financial Leverage (DFL):  A measure of how growth in net income is related to growth earnings before interest and taxes.  DFL = % Change in Net Income/% Change in EBIT

Degree of Operating Leverage (DOL):  A measure of how growth in operating income is related to growth in revenue.  DOL = % Change in Earnings Before Interest and Taxes/% Change in Sales

Degree of Total Leverage (DTL):  A measure of how growth in net income is related to growth in revenue.  DTL = % Change in Net Income/ % Change in Sales.

DuPont Formula:  A performance measure that originated from the DuPont Corporation that breaks

ROE (Net Income (NI)/ Shareholders’ Equity (OE)) into three important determinants:  Operating Efficiency (NI/Sales), Asset Use Efficiency (Sales/Total Assets) and Financial Leverage (Total Assets/Shareholders Equity).

Earnings Per Share (EPS):  A company’s accounting net income divided by the number of outstanding shares.  This is often also measured using the weighted average number of shares outstanding over the accounting period.

EBITDA:  This stands for Earnings before interest, taxes, depreciation and amortizations.

EDGAR Database:  The SEC’s electronic filing system created to accelerate accessibility to corporate filings.

EM Model:  An alternative form of Altman’s Z-Score constructed by Altman, Hartzell and Peck (1995) for emerging markets.

Financial Leverage:  A general term that refers to using fixed costs to finance the firm.  As a component of a Du Pont decomposition it is defined as Total Assets/Shareholders’ Equity.

Financial Vehicle Corporation (FVC):  A special purpose entity in Ireland.               

Form 10-K:   The annual report required by the U.S. Securities and Exchange Commission (SEC) within 60-days after the end of the fiscal year from public companies.   This report contains among other things audited financial statement information.

Form 10-Q:   The annual report required by the U.S. Securities and Exchange Commission (SEC) within 35-days after each of the first three fiscal quarters.  This report contains unaudited financial statement information.

Form 20-F:   The annual report required by the U.S. Securities and Exchange Commission (SEC) within 6-months of the end of the company’s fiscal year by all foreign private issuers that have shares trading on US exchanges.

Form 8-K:  A report required by the U.S. Securities and Exchange Commission (SEC) of major events that shareholders should know about.

Forward Looking Statement:  Used in Item 1A Risk Factors and Item 7 Managements Discussion and Analysis sections of a 10-K.  These sections use the words such as “believe”, “expect”, “anticipate”, “estimate”, “project”, that is words that predict or describe future events and trends.

Gross Profit Margin:  Contribution to the business from sales revenue after accounting for the cost of goods sold.

Interest Burden:  This is defined as Earnings Before Tax (EBT) divided by Earnings Before Interest and Tax (EBIT).

International Accounting Standards (IAS):  A set of accounting standards issued by the International Accounting Standards Board (IASB).  These were replaced after 2001 by a net set of standards known as the International Financial Reporting Standards (IFRS).

Management Discussion and Analysis (MD&A):   A subsection of the 10-K report where the firm’s management provides an unbiased narrative explanation of how the entity has performed in the past, its current financial condition and its future.

Net Income (NI):  A company’s total earnings calculated under US GAAP (or IFRS if applicable).  These earnings can be distributed to common stockholders as an ordinary dividend or added to a firm’s retained earnings.

Operating Margin:  This is defined as Operating Income divided by Sales.   It measures the proportion of revenue leftover after paying for costs arising from the investment decision (e.g., fixed and variable production costs).  This is measured as Earnings Before Interest and Taxes divided by Sales.

Payout Ratio:  This is defined as the ratio of Earnings Per Share (EPS) paid to shareholders as Dividends Per Share (DPS).  That is EPS/DPS.

Price Earnings Growth Ratio (PEG Ratio):  The Price Earnings Ratio adjusted for growth.  PEG = Price Earnings Ratio/Growth in Earnings per Share

Price Earnings Ratio (P/E Ratio):  The number of years required to recover a firm’s spot price from it current earnings assuming zero growth.   P/E = Market Price per Share/Earnings per Share (EPS)

Price to Book Ratio:  A financial ratio that divides the stock’s current price by the book value of shareholder’s equity per share.

Price to Cash Flow:  A relative valuation metric that divides the stock’s current price by it’s operating cash per share.  Operating cash per share is usually computed from the trailing twelve months.

Price to Sales Ratio (PSR):  A relative valuation metric for stocks that divides the stock’s current price by it’s revenue.  Revenue is usually the trailing twelve months revenue.

Profit Attributable to Shareholders:  A term for net income used in the U.K.  see Net Income.

Profit Margin:  This is defined as Net Income divided by Total Revenue.  It is a measure of a firm’s profitability from sales.

Profitability Ratios:   These ratios measure how well a company is generating income typically net income and operating income.  The ratio relates some measure of income to some base such as total assets, equity or revenue.

Regulation FD (Fair Disclosure):  A regulation adopted by the SEC in August 2000, that prohibits selective disclosure of non-public market moving information to subsets of investors. 

Relative Valuation:  A valuation technique that compares the price of one asset to another asset in terms of some fundamental dimension such as earnings, sales or cash flows.

Retention Ratio:  This is defined as the ratio of Earnings Per Share (EPS) that are not paid out in

Dividends Per Share (DPS) but instead credited to retained earnings.  It is defined as (EPS – DPS)/DPS

Return On Assets (ROA):   A measure of earnings relative to the total assets under control.  It is defined as Net Income divided by Total Assets.

Return on Common Equity (ROCE):  The ratio of net income less preferred dividends to the shareholders’ equity.  See also Return on Equity (ROE).

Return on Equity (ROE):  The ratio of net income to the shareholders’ equity.  Shareholders equity does not include preferred shares.  See also Return on Common Equity (ROCE)

Sales:   Revenue that is generated from the firm’s day-to-day activities.               

Selling and General Administration Margin:  This is defined as the sum of direct and indirect selling and general administration costs divided by Sales.

Shareholders’ Equity:   A firm’s total assets minus total liabilities.              

Special Purpose Entity (SPE):  A legal entity (usually a limited company or partnership) created to serve some very specific objective.  They are often used to isolate risks or transfer sub components of the a firms balance sheet without putting the entire firm at risk.

Special Purpose Vehicle (SPV):  A special purpose entity in Europe.         

Tax Burden:  This is defined as Net Income (NI) divided by Earnings Before Tax (EBT).

Total Assets (TA):  The total assets reported in a firm’s consolidated balance sheet which presents Total Assets and the Total Equity claims against these assets.