Definitions
Big Five Numbers
- definition by Phil Town, "Rule #1"
Big Five are the five numbers I use to help me determine whether a business can give me at least a
15-percent return a year. The Big Five are:
- Return on Investment Capital (ROIC) is the rate of return a business makes on the cash it
invests in itself every year.
- Equity Growth Rate. It tells us the business can accumulate surplus, and that in itself makes
it exceptional.
- Earnings per Share (EPS) Growth Rate. EPS tells us how much the business is profiting
per share of ownership.
- Sales Growth Rate. Sales are the total dollars the business took in from selling whatever widgets
and digits it sells.
- Cash Growth Rate. Cash growth tells us whether its cash is growing with its profits or
if the profits are only on paper.
Remember: All of these Big Five numbers ahould be equal to or greater than 10 percent per year for
the last 10 years. We must also look at the five-year and one-year numbers, and compare those to the
10-year numbers to make sure business isn't slowing down.
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Cash Flow
Cash flow is an accounting term that refers to the amounts of cash being received and spent
by a business during a defined period of time, sometimes tied to a specific project. Measurement
of cash flow can be used
- to evaluate the state or performance of a business or project
- to determine problems with liquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash, even while profitable
- to generate project rate of returns. The time of cash flows into and out of projects are used as inputs to financial models such as internal rate of return, and net present value
- to examine income or growth of a business when it is believed that accrual accounting concepts do not represent economic realities. Alternately, cash flow can be used to 'validate' the net income generated by accrual accounting
Cash flow as a generic term may be used differently depending on context, and certain cash
flow definitions may be adapted by analysts and users for their own uses. Common terms
(with relatively standardized definitions) include operating cash flow and free cash flow.
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Four Ms
- definition by Phil Town, "Rule #1"
In thinking about the process you will be undertaking in finding wonderful companies at attractive prices,
it helps to think of what I call "the Four Ms": Meaning, Moat, Management and Margin of Safety."
The trick to understanding the essence of the Four Ms is to turn them into questions you must answer in
evaluating a business and deciding whether it can be a good investment. If you can answer a big unconditional
YES to all four of these questions, you will know if this business is one you want to buy. The questions are:
- Does the business have Meaning to you?
- Does the business have a wide Moat?
- Does the business have great Management?
- Does the business have a big Margin of Safety?
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Free Cash Flow
- definition by Wikipedia
- how to compute: [Free Cash Flow] = [Cash Flow] - [Capital Expenditures]
In corporate finance, free cash flow (FCF) is a cash flow available for distribution among all
the security holders of a company. They include equity holders, debt holders, preferred stock
holders, convertibles holders, and so on. It is a cash that is left after financing all
the NPV-positive projects.
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Intrinsic Value
An intrinsic theory of value is any theory of value in economics which holds that the value of
an object, good or service, is intrinsic or contained in the item itself. Most such theories look
to the process of producing an item, and the costs involved in that process, as a measure of the
item's intrinsic value.
For instance, the labor theory of value - the most influential of the intrinsic theories -
holds that the value of an item comes from the amount of labor spent producing said item.
For example, if a chair is produced by two workers in 6 hours, then that chair is worth
2 x 6 = 12 man-hours (this is a simplified case; the labor theory of value takes into
consideration only the "necessary" amount of labor that must go into the production of an item,
which may be less than the actual expended labor due to inefficiency).
Value investors use a variety of analytical techniques to estimate the intrinsic value of
securities in the hope of finding where the "true value" exceeds current market value.
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MOS Price
- definition by Phil Town, "Rule #1"
- how to compute: [MOS Price] = [Sticker Price] / 2
MOS Price - Margin of Safety Price. Nice MOS is buying a dollar of value for fifty cents.
In other words, you'd better be able to buy this business cheap enough that you can sell it later without losing
money - even if you were wrong to buy it in the first place.
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Rate of Return
In finance, rate of return (ROR) or return on investment (ROI), or sometimes just return, is
the ratio of money gained or lost on an investment relative to the amount of money invested.
The amount of money gained or lost may be referred to as interest, profit/loss, gain/loss, or net
income/loss. The money invested may be referred to as the asset, capital, principal, or the cost
basis of the investment.
ROI is also known as rate of profit. Return can also refer to the monetary amount of gain or
loss. ROI is the return on a past or current investment, or the estimated return on a future
investment. ROI is usually given as a percent rather than decimal value.
ROI does not indicate how long an investment is held. However, ROI is most often stated as an
annual or annualized rate of return, and it is most often stated for a calendar or fiscal year.
ROI is used to compare returns on investments where the money gained or lost -- or the money
invested – are not easily compared using monetary values. For instance, a $1,000 investment
that earns $50 in interest obviously generates more cash than a $100 investment that earns $20 in
interest, but the $100 investment earns a higher return on investment.
- $50/$1,000 = 5% ROI
- $20/$100 = 20% ROI
Since rates of return are percentages, negative rates cannot be averaged with positive rates
for purposes of calculating monetary returns. However, it is common practice in finance to
estimate monetary returns by averaging periodic rates of return; these estimations are most useful
when the averaged periodic returns are all positive, all negative, or have low variances.
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The Rule on Debt
- definition by Phil Town, "Rule #1"
To determine whether a business's debt is reasonable, find out if it can pay off its debt within
three years by dividing total long-term debt by current free cash flow.
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Sticker Price
- definition by Phil Town, "Rule #1"
The Sticker Price of a business is determined by the kind of surplus cash it can produce for its owners in the future.
Rule #1 investors can look at a business and quickly figure out what kind of surplus it can produce in the future,
deriving from that the Sticker Price of the business.
Once you know how to calculate a company's Sticker Price, which is its value regardless of the price it is selling for
on the market, you are on your way to investing with certainty.
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