This is a concept championed by Warrent Buffet and is central to all analysis
on this website. Typically, companies report their Net income. Net income is
defined as the income that a firm has after subtracting costs and expenses from
the total revenue. Drawback with only looking at net income is that it does not
take into account the assets that were used to generate that net income. If a
company does not invest part of its earnings on buying new equipment or
building new plants, it won't be able to stay in business. Capital expenditures
should be considered as any other expense that company incurs.
Investors should consider owner earnings as a better measure of company's
performance. Think of owner earnings as the money that you will make if you
owned 100% of the business. You will take the net income, add depreciation, depletion
and amortization and subtract capital expense as well as working capital. The
money that you will be left with is your earnings i.e. owner earnings. This is
not an exact measure as no one can predict future capital expenditures of a
company.
Owner Earnings = (Net income + depreciation,depletion and amortization) - Capital expenses - working capital
To determine Owner Earnings of any publicly listed company for the latest
completed financial year , go to
finance.yahoo.com, type
the stock symbol of the company and click on "Get Quotes". Click on "Cash Flow"
on the left navigation bar and look at the column for the latest financial year.
Add the value that you see under "Net Income" with "Depreciation" and subtract
from it the value that you see under "Capital Expenditures".
Suppose you want to determine Owner Earnings of Google Inc. for 2006. Go to
finance.yahoo.com and
type symbol GOOG in the text box that states "Enter symbol(s)" and click on "Get
Quotes" to see data for Google Inc.. Click on "Cash Flow" on the left navigation
bar. Find the column that states "31-Dec-06" on the row "PERIOD ENDING". Find
the value that you see under "Net Income". In this case you will see $3,077,446.
Determine the value under "Depreciation" which is $571,939. Finally, the value
under "Capital Expenditures" is $1,902,798. Note that all values are in
thousands.
Owner earnings of Google Inc. for 2006 =
$3,077,446+$571,939-$1902,798=$1,746,587 i.e $1.7 billion
EPS stands for earnings per share. It is obtained by dividing Net Income by
Weighted Average Common Shares. Any preferred dividends are removed from net
income before calculating EPS.
As explained above, Owner Earnings is a better measure than Net Income.
Therefore on this site we recommend that you look at Owner Earnings Per Share,
which is calculated as:
Owner Earnings Per Share = Owner Earnings ÷ Shares Outstanding
To determine Owner Earnings Per Share of any publicly listed company for the
latest completed financial year , use steps outlined in
Owner Earnings section to determine
Owner Earnings. To find out Shares Outstanding, go to
finance.yahoo.com, type
the stock symbol of the company and click on "Get Quotes". Click on "Key
Statistics" on the left navigation bar and look at the section titled "Share
Statistics ". Look at the value under "Shares Outstanding". Divide Owner
Earnings by Shares Outstanding to determine Owners Earnings Per Share.
Suppose you want to determine Owner Earnings Per Share of Google Inc. for 2006.
Using the Owner Earnings
example above, we have determined that Owner Earnings of Google Inc. for
2006 is $1,746,587 thousand. To determine Shares Outstanding, go to
finance.yahoo.com and
type symbol GOOG in the text box that states "Enter symbol(s)" and click on "Get
Quotes" to see data for Google Inc.. Click on "Key Statistics" on the left
navigation bar. Find the section labeled "Share Statistics" and look at the
value under "Shares Outstanding". In this case you will see 312.14M.
Owner Earnings Per Share of Google Inc. for 2006 = $1,746,587 ÷ 312,140 =
$5.59
P/E ratio of a stock is determined by taking Price per share and dividing it
with Earnings per Share. According to Peter Lynch in his famous bestseller One
Up on Wall Street, the P/E ratio of any company that's fairly priced will equal
its growth rate. P/E ratio represents the number of years it will take to recoup
your investment in the stock, assuming earnings stay at current level. P/E ratio
should always be considered in conjunction with the growth rate, as explained in
the Growth Rate section.
As explained above, Owner Earnings is a better measure than Net Income.
Therefore on this site we recommend that you determine P/E ratio by dividing
Price per share with Owner Earnings Per Share:
P/E = Price Per Share ÷ Owner Earnings Per Share
To determine P/E ratio of any publicly listed company for the latest completed
financial year , use steps outlined in
Owner Earnings Per Share
section to determine Owner Earnings Per Share. To find out Price Per Share, go
to finance.yahoo.com,
type the stock symbol of the company and click on "Get Quotes". Look at the
value under "Last Trade". Divide Owner Earnings Per Share by Last Trade to
determine P/E ratio.
Suppose you want to determine P/E ratio of Google Inc.. Using the Owner Earnings
Per Share example
above, we have determined that Owner Earnings Per Share of Google Inc. for 2006
is $5.59. To determine Last Traded value of Google Inc., go to
finance.yahoo.com and
type symbol GOOG in the text box that states "Enter symbol(s)" and click on "Get
Quotes" to see data for Google Inc.. Look at the value under "Last Trade". In
this case assume you see $560.10.
P/E ratio of Google Inc. = $560.10 ÷ $5.59 = 100.19
Growth rate is the rate at which company can grow Owner Earnings.
It's easy to determine past growth rate. Just determine the
Owner Earnings for past years as explained above
and compute the rate at which it is growing. For example, if company's owner
earnings is growing at 20% and its owner earnings five years back was $100
million then the owner earnings for 5 years will be $100M, $120M, $144M,
$172.8M and $207.36M respectively.
If everything else is equal, a company with a P/E ratio of 20
and a growth rate of 20% is a better buy than a company with a
P/E ratio of 10 and a growth rate of 10%. Let's look at the previous
example. If this Company is selling at P/E ratio of 20 and there are 100M
outstanding shares of the company, then the share price of the company five
years back was $20. (Owner Earnings Per Share = Owner Earnings ÷ Shares
Outstanding = $100M ÷ 100M=$1.
P/E = 20, hence Price = 20 X $1 = $20.)
Owner Earnings after 5 years will be $207.36M. Owner Earnings Per Share = Owner
Earnings ÷ Shares Outstanding = $207.36M ÷ 100M = $2.07.
Since P/E = 20, Price = 20 X $2.07 = $41.4
Imagine another company whose P/E ratio is 10 and its share price is also $20
and there are 100M outstanding shares of this company as well. That would imply
that the owner earnings of this company is $200M. This company's owner earnings for
5 years at the rate of 10% will be $200M, $220M, $242M, $266.2M and
$292.82M respectively.
Owner Earnings after 5 years will be $292.82M. Owner Earnings Per Share = Owner
Earnings ÷ Shares Outstanding = 292.82M ÷ 100M = $2.92.
Since P/E = 10, Price = 10 X $2.92 = $29.2. So you can see that investing
in first company is a better investment decision than investing in the second
company although it may appear that second company is a better buy because its
owner earnings is $200M compared to first company whose owner earnings is $100M,
but the growth rate makes all the difference.
Future growth rate is difficult to predict and your guess is as good as mine.
According to Peter Lynch in his famous bestseller One Up on Wall Street, there
are five basic ways a company can increase earnings: reduce costs; raise prices;
expand into new markets; sell more of its product in the old markets; or
revitalize, close, or otherwise dispose of a losing operation.
Since future growth is difficult to predict, on this site we use Analysts'
estimates for next 5 years growth rate. Analysts' may have more insight and
research on the company than an individual investor.
To determine "Next 5 years Growth" of any publicly listed company go
to finance.yahoo.com,
type the stock symbol of the company and click on "Get Quotes". Click
on "Analyst Estimates" on the left navigation bar and look at the section titled
"Growth Est ". Look at the value under "Next 5 Years (per annum)".
One thing to note is that in this case we assume that Capital Expenses will grow
proportionately to earnings. You may have to make adjustments if that's not the
case.
Suppose you want to determine next 5 years growth rate of Google Inc.. Go to
finance.yahoo.com and
type symbol GOOG in the text box that states "Enter symbol(s)" and click on "Get
Quotes" to see data for Google Inc.. Click on "Analyst Estimates" on the
left navigation bar and look at the section titled "Growth Est ". Look at the
value under "Next 5 Years (per annum)". In this case you will see 33.65%.
Analyst estimates of next 5 year's growth rate for Google Inc. = 33.65%
Dividend is the money that the company pays to the shareholders. Please do
not confuse dividends with owner earnings.
Owner earnings is what the company
makes, as explained above. Dividend is what it pays out to shareholders. A
company may generate very handsome owner earnings and yet not pay any dividends.
In this case it will retain all of owner earnings for future growth. Warren
Buffet looks for the one-dollar premise, for every dollar of retained earning,
the Market Capitalization of the
company should increase by at least one dollar. It's all right for a company to
not pay dividend as long as it can effectively invest owner earnings to increase
its market capitalization.
To determine the dividend yield that a company is expected to pay in the current
fiscal year, go
to finance.yahoo.com,
type the stock symbol of the company and click on "Get Quotes". Click on "Key
Statistics" on the left navigation bar and look at the section titled "Dividends
& Splits". Look at the value under "Forward Annual Dividend Yield".
Suppose you want to determine Forward Annual Dividend Yield of Google Inc.. Go to
finance.yahoo.com and
type symbol GOOG in the text box that states "Enter symbol(s)" and click on
"Get Quotes" to see data for Google Inc.. Click on "Key Statistics" on the left
navigation bar and look at the section titled "Dividends & Splits". Look at the value under "Forward
Annual Dividend Yield". In this case you will see N/A.
Forward Annual Dividend Yield of Google Inc. = N/A
Growth rate to Earnings ratio is opposite of PEG ratio that you
will see on many sites. Peter Lynch recommends an improvement to this formula.
His suggestion is to add growth rate with dividend yield and divide that by P/E.
Therefore on this site, Growth to Earnings ratio is determined by taking
Growth rate
of the company, adding Dividend yield and dividing it by P/E ratio.
Growth Rate to Earnings ratio = (Growth Rate + Dividend yield) ÷ P/E ratio
As explained earlier, the P/E ratio of any company that's fairly priced will
equal its growth rate. This implies that Growth to Earnings ratio should be at
least 1 for you to invest in a stock. If it's 2 or 3 or a higher number, you
have found a winner.
Suppose you want to determine Growth Rate to Earnings ratio of Google
Inc.. Using the Growth Rate example
above, we have determined that next 5 years growth rate of Google Inc. is
33.65%. Using the Dividend yield example
above, we have determined that forward annual dividend yield of Google Inc. is
N/A i.e. 0. Using the P/E ratio example
above, we have determined that P/E ratio of Google Inc. is 100.19.
Growth Rate to Earnings ratio for Google Inc. = (33.65 + 0) ÷ 100.19 = 0.33
Return on Equity is determined by taking Operating Income of the company and
dividing it by the shareholder's equity. Good companies will have superior
return on equity without having too much debt. Warren Buffet considers Return on
Equity as the single best measure of management's economic performance.
Return on Equity = (Operating Income ÷ Shareholder's equity) X 100
For all calculations on this site, we use the standard formula as given above.
If you want, for operating income you can consider marketable securities at cost
and exclude capital gains or loss.
To determine Return on Equity of any publicly listed company go to
finance.yahoo.com, type
the stock symbol of the company and click on "Get Quotes". Click on
"Income Statement" on the left navigation bar and look at the value under "Operating
Income or Loss". Next click on "Balance Sheet" on the left navigation bar and look at the value under "Total
Stockholder Equity". Divide Operating Income by Shareholder's Equity to determine
Return on Equity.
Suppose you want to determine Return on Equity of Google Inc. for 2006. To determine
Operating Income, go to
finance.yahoo.com and
type symbol GOOG in the text box that states "Enter symbol(s)" and click on "Get
Quotes" to see data for Google Inc.. Click on "Income Statement" on the left
navigation bar and find the column that states "31-Dec-06" on the row "PERIOD
ENDING". Look at the
value under "Operating Income or Loss". In this case you will see
$3,549,996. Next click on "Balance Sheet" on the left navigation bar and look at the value under "Total
Stockholder Equity". In this case you will see $17,039,840 under the column
"31-Dec-06". Note that all values are in
thousands.
Return on Equity of Google Inc. for 2006 = ($3,549,996 ÷ $17,039,840) X 100 =
20.83%
Debt to Equity ratio is calculated by dividing company's Long term Debt with
Shareholder's Equity. A strong balance sheet will have low debt to equity ratio
where as a weak balance sheet will have high debt to equity ratio. Peter Lynch
recommends ignoring short-term debt in this calculation as it balances out with
cash and cash items. This ratio should be looked in conjunction with
Return on Equity ratio described above. Funded
debt is better than Bank debt. Bank debt is due on demand and can lead to
bankruptcy in times of trouble. Funded debt cannot be called as long as company
continues to pay the interest.
Debt to Equity ratio = (Long term debt ÷ Shareholder's equity) X 100
To determine Debt to Equity ratio of any publicly listed company go to
finance.yahoo.com, type
the stock symbol of the company and click on "Get Quotes". Click on "Balance
Sheet" on the left navigation bar and look at the column for the latest
financial year. Divide the value that you see under "Long Term Debt" with the value
that you see under "Total Stockholder Equity".
Suppose you want to determine Debt to Equity ratio of Google Inc. for 2006. Go to
finance.yahoo.com and
type symbol GOOG in the text box that states "Enter symbol(s)" and click on "Get
Quotes" to see data for Google Inc.. Click on "Balance Sheet" on the left
navigation bar and find the column that states "31-Dec-06" on the row "PERIOD
ENDING". Look at the
value under "Long Term Debt". In this case you will see
"-" i.e. $0. Next look at the value under "Total Stockholder Equity". In
this case you will see $17,039,840. Note that all values are in thousands.
Debt to Equity ratio of Google Inc. for 2006 = ($0 ÷ $17,039,840) X 100 = 0%
Profit Margin is determined by taking Net Income of the company and
dividing it by the Revenue. Profit margin is an indicator of a company's ability
to control costs and cut unnecessary expenses. Warren Buffet considers Profit
Margin as an indicator of management's effectiveness as managers of low-cost
operations are always finding ways to cut expenses.
Profit Margin = (Net Income ÷ Total Revenue) X 100
To determine Profit Margin of any publicly listed company go to
finance.yahoo.com, type
the stock symbol of the company and click on "Get Quotes". Click on "Income
Statement" on the left navigation bar and look at the column for the latest
financial year. Divide the value that you see under "Net Income" with the value
that you see under "Total Revenue".
Suppose you want to determine Profit Margin of Google Inc. for 2006. To determine
Operating Income, go to
finance.yahoo.com and
type symbol GOOG in the text box that states "Enter symbol(s)" and click on "Get
Quotes" to see data for Google Inc.. Click on "Income Statement" on the left
navigation bar and find the column that states "31-Dec-06" on the row "PERIOD
ENDING". Look at the
value under "Net Income". In this case you will see
$3,077,446. Next look at the value under "Total
Revenue". In this case you will see $10,604,917. Note that all values are in
thousands.
Profit Margin of Google Inc. for 2006 = ($3,077,446 ÷ $10,604,917) X 100 =
29.01%