Episode II
Going Back to Basics: Coming to Terms
Neubert’s a pretty busy guy, what with running a magazine, sitting on various boards, promoting, writing articles… and of course, managing his portfolio, so right off I need to accept the fact that I cant just go running to him every time I have a question: I need to be self sufficient.
First and foremost will be the resources we use for vital information. For quotes we have Google Finance and Yahoo Finance. These sites will give current (though not in real time, they are behind by about 20 minutes for legal reasons) information on the basic statistics for a particular stock.
I forgot most of the lessons I learned in corporate finance five minutes after I took my final, but I still remember most of terms Professor K. drilled into my head, if not their definitions and how they apply to understanding the feasibility of an investment.
Rather than bug David (I’ll save that for the actual trades), I think it best if I break out the old Foundations of Finance textbook (Prentice Hall) and reacquaint myself with the broad strokes of valuation.
I may as well begin with the two terms I mentioned in Episode 1, market capitalization (market cap) and Price/Earnings Ratio (P/E).
David is pretty hyped on ‘market cap,’ so I’ll find out what that’s all about first.
Into the textbook and I find? Nada, zip, zilch!
Interesting. How important can market cap be if they don’t even bother to mention it in the textbook? In Nuebie I trust though, so I’m off to the web.
According to the wizards of Wikipedia, market cap is a measurement of corporate size. To find out what a company’s market capitalization is, you multiply the number of outstanding shares of common stock by the current price of the stock.
I head over to Yahoo Finance to try my hand at the equation and find that they have already done the math. This is a good thing, because this Greenhorn hates math!
I check out Google Finance, and they’ve done the math as well. Sweet.
In the illustration above (courtesy of Finance.Yahoo.com), we can see that Chevron Corp (CVX ) has a market cap of almost $158 billion. (More than I could ever spend, but wouldn’t mind the chance).
So now that I know what market cap is, I need to know what it means to me as an investor. I’ll ask David for a translation into lay terms for those less experienced (myself included).
David says market capitalization is an important baseline because “it allows an investor to compare the value of one company to another.” My obvious next question is how? David, now in his element showers me with a plethora of terms and examples that sends my head reeling.
After we talk a bit more, I begin to see that the market cap is like a price tag for a company. As the product of the number of shares and the price of those shares, it is, in the simplest terms, the number of dollars one would have to spend to buy the whole company.
I begin to see the point as David continues by showing me the ticker for Google (GOOG ).
“Okay, see how Google has a market cap of about $144 billion? Now consider this, there is only about a 10% difference between the price you would pay to buy Google versus Chevron in its entirety, so let’s call them about the same. With that in mind, we can consider other factors in valuation; Chevron has two million employees and capital in the form of factories, refineries, wells, land and so on. Google has no real physical assets, but carries zero debt compared to Chevron’s massive responsibilities, and Google only has a fraction of the drain on capital from staffing.”
I am a little confused because it is hard to distinguish between the two as to which is a better investment. David says, “Exactly. The market cap is only one aspect of the evaluation process. It is used in concert with many other factors in determining a course of action; buy, sell or hold. Nothing is definite. Nothing is guaranteed.”
I am beginning to think investing is like betting on horses. And analysts are like ‘handicappers.’
And the better you are at it, the more the odds are in your favor.
Next: Price/Earnings Ratios