FAQ for Stock/Business Words
This page should list all the common phrasings and ideas that will show in my analyses. Is your question not here? Comment below your question!
What is intrinsic value?
This is what an asset is actually worth. For a business (and its individual stocks), intrinsic value is the value of all the future cash that the business can deliver to its owners. If you buy a stock, that makes you a part owner in that business.
How do you calculate intrinsic value?
It depends on the assets, but you try to figure out the owner’s earnings. These are earnings that are actually left over for owners.
What is free cash flow?
Free cash flow (FCF) is the most common way to figure out owner’s earnings. On the cash flow statement of a business’s annual report, it will tell you the cash flow from operating activities. You take that number and then substract capital expenditures from it, and that gives you free cash flow. Positive free cash flow means that more money enters the business than goes out.
What are capital expenditures?
Capital expenditures (capex) has no official definition, but these are expenses made by the business in order to grow its earnings, and it depends on what the analyst believes should count as capex. They are separate from operating expenses. Most people will count Additions to Property, Plant, and Equipment as capex. Some will also count Acquisitions of Businesses (if cash is paid for them). Both of these items are found on the cash flow statement, under investing activities. Typically companies with low capex are great investments.
What is net income versus free cash flow?
Net Income is the officially reported earnings for that business’s year of operations. Because net income is reported based on regulation and tax codes, there are non-cash items that must be calculated (some positive, some negative). For some businesses, this means that the difference between net income as reported and free cash flow can be substantial. Jeff Bezos wrote a brief but succinct explanation on this question too.
What is a discount rate?
A discount rate is a way of pricing in the passage of time to ensure that the investor gets an adequate return. In all of my valuations, I use a 10% discount rate. This means if my intrinsic value is correct, buying the stock at that price would give a 10% return per year over the next decade.
What is leverage?
More generally, leverage is an advantage that a business exploits. More narrowly, leverage is taking on debt to finance business operations or investments. In this sense, they are exploiting the value of their assets to generate cash from a loan, while still using the assets. This can be risky if plans go awry, and the business is unable to repay its debts.