Value Investing 101

[007]

Value Investing 101

Tips on "value investing" are seriously lacking on stock market message boards. So to help us all (myself included) better understand some fundamental analysis, I would like to write down some definitions, thoughts and notes on the subject of value investing.

As always, I'm crunched for time, so this post and thread will be edited several times. But the goal is the make some short, clear notes that can be used as an aid while perusing company financials.

The goal of Value Investing 101 is to:

*Indentify solid, growth-oriented companies whose stock is currently undervalued or out of favor.

Once such stocks are identified, we can analyze technical trends and external factors to figure buy and sell points and maximize profits.

This thread is designed to be a stark contrast to the sub-penny and OTC culture of investors.

[007]

EARNINGS PER SHARE (EPS):

A company's earnings will be reported as earnings per share (EPS)

EPS = Net income divided by the number of common shares outstanding

Example: In 2006, company XYZ has 25 million shares outstanding and a net income $5 million.

EPS = net income/common shares outstanding
EPS = $5,000,000/25,000,000 shares
XYZ's EPS for 2006 = $.20

DILUTED EARNINGS PER SHARE:

The diluted earnings per share takes into account shares not converted into the outstanding such as: convertible preferred shares, convertible debentures, stock options and warrants. This statistic has a negative impact on a company's value as if they were saying "This is what our EPS would have been if we fully diluted our stock.".

Example: In 2006, company XYZ has 25 million shares outstanding with 7 million shares of stock options that have not yet been excerised and the same net income of $5 million.

Diluted EPS = net income/(common shares outstanding + convertible stock)
Diluted EPS = $5,000,000/32,000,000 shares
XYZ's Diluted EPS for 2006 = $.16

So company XYZ's EPS would be reported as $.20 basic and $.16 fully diluted.

EPS tips:
*usually considered the most important factor of a company's success
*earnings may include one-time events (such as the selling of assets, lawsuit settlements or stock options) that will either positively or negatively affect the EPS
*can be manipulated by companies trying to embellish their income statements.

[BadThad]

Good general info for new investors. Thanks for the post and welcome to the forum!

[007]

THE VALUE OF A COMPANY:

There are two ways to measure a company's worth: book value and market value (market cap).

BOOK VALUE: BASED ON THE BALANCE SHEET

Say a company suddenly ceased operation, liquidated assets, settled debts and paid off the shareholders. You would subtract your liabilities from your assets and divide the rest among the shareholders. Company XYZ trades at $2.00, has 20,000,000 shares outstanding, has $12,000,000 in assets and $2,000,000 in liabilities.

Book value = Assets - liabilities
Book value = $12,000,000 - $2,000,000
Book value = $10,000,000

So you could say company XYZ is woth $10,000,000

BOOK VALUE PER SHARE:

Simply divide the book value by the ammount of outstanding shares

$10,000,000 / 20,000,000 shares = $.50 per share

So if company XYZ ceased operation and paid off the shareholders, XYZ's stock would be worth $.50, not very good if you paid $2.00. But most stocks trade well above book value because investors are looking at the future worth of the company and are not too worried about the above scenerio. So obviously we want to invest in companies who have a growth-oriented future.

PRICE TO BOOK RATIO:

The ratio between the daily close and the current quarter's book value per share.

Price to Book Ratio = Current price per share / book value per share
Price to Book Ratio = $2.00 / $.50
Price to Book Ratio = 4

High price to book ratios may indicate an overvalued situation. Low price to book ratios may indicate an undervalued situation.

Book value tips:
*Stocks trading between a Price to Book ratio between 1 and 2 are generally considered "fairly valued".
*Just because a stock trades under book value doesn't mean it's an automatic buy signal. In fact, it may mean the market anticipates a dismal future.
*Invest in companies that avoid dilution and consistantly add to the book value (ie; beautiful balance sheets)


Market Cap.....more to come.