Wednesday March 26 2014

Community colleges only address proprietorships in their accounting classes. As a result the corporate form of the balance sheet is new to students. We are at a unique point in stock market history. Several of the indexes are at all time highs. This is the polar opposite, in terms of valuation and social mood, from where we were in March 2009. But I am getting ahead of myself.

Over the next few days, I am going to introduce some basic concepts of equity to you. Then we will examine different companies to show you how the market values the company, and just how wildly different such valuations can be.

Okay we start with the basic equation

Assets = LIabilities + Equity

or re formulated

A – L = OE

In this case Owner Equity, OE, would bebook value. Recall that once stock is sold to the public, the equity section reflects that original price for the stock. It is NOT adjusted to reflect market prices.  It will only change if the company buys or sells more of its own stock.

Recall that common stock with par value gets credited for par value. Any amount paid in excess of this is paid in capital, example

We sell one share of commmon $1 Par for $10.

Cash           $10

    Common Stock            $1

    Paid In Capital            $9

There are several ratios presented in your textbook to reflect the valuations of the copany once the stock begins trading.

Price Earnings Ratio = Price of one common share/Earnings Per Share

Simply put, how many dollars is the public willing to pay for one dollar of this company's earnings. THis can vary wildly. Slow growth companies with stable earnings will sport a low p/e. Not surprisingly, in fits of irrational exhuberance, a company can  have a sky high p/e, a high stock price with little earnings or no p/e as the stock has no earnings. This occured with the dot.com bubble of 1999. Hundreds of stocks went public claiming they would make a bundle selling on the internet. It tuned out this was little more than the original Sears Catalog brought up to date with an electronic scree. But even at that, most folks elected to buy a washing machine locally, bye bye applicances.com.

 

Earnings Per Share = Earnings Available to Common/Avg Weighted # of Shares outstanding

Market Capitalization = # shares outstanding x Price per share, this literally reflects the total market value of the stock

Now let's look at some examples. Since Warren Buffet is pretty much  a household name these days, let's start with his Company, Berkshire Hathaway or BRK. Oh, stocks trade by symbol Stocks on the New York or American Exchange have no more than three letters in a symbol. Stocks on the NASD have four letters, like Microsoft or MSFT or Apple APPL.

This information is available for all public companies at finance.yahoo.com. I wil be using this for our root information.

We can learn a lot here. Finance.yahoo has sumarized a lot of information for us. Notice that the market cap is $306.4 billion. You could determine the number of shares outstanding by dividng the market cap by the price per share. Why?

Because, see above, market cap equals price times number of shares so

$306,400,000,000 / $186,000 = 1,647,312 shares outstanding

Now most stocks trade for less than $100. If theprice gets to $100, companies will split the stock, meaning you might now have four times as many shares at one fourth the price, say now you own 400 shares at $25 instead of 100 shares at $100.

Okay why would Warren want the stock priced so high?  The price earnings is fairly modest at 15.7. But notice that the stock only traded 117 shares yesterday and averages a paltry 441 shares a day over the last three months. The answer is that Warren does not want people speculating in BRK, he wants long term shareholders. Also notice he pays no dividend. The profit comes in long term growth.

Remember Warren likes traditional companies that as he says, have a large moat around them. That means other companies would be hard pressed to generate the same business model or capture the same audience. He also tends to buy the entire company resulting in a consolidation, he literally owns the income as with his railroad or Dairy Queen. By the way, how is Dairy Queen different from say McDonald's?  My experience is that DQ is mostly in small towns where there is no large chain competition, they have all the burger business. He likes boring companies that throw off lots of cash.

By the way, if you have never read a Letter to the Shareholder by Warren,  this would be a good time to start. Yes you should at least read the latest letter for 2013.

750 words is a typical newspaper column. So it is probably time to start another post. But grant me a bit more space here, let's look at the opposite end of the spectrum, yep, Facebook or FB.

By the say, have you thought about why FB is so popular. The answer is found via Dale Carnegie's How to Win Friends and Influence People. FB allows everyone to have their ow personal magazine, think O for Oprah. Who is on the cover of O every month, think hard now.

Yep, O is Oprah's ideal image of herself. And FB allows every person to do the same thing, Think Daffy Duck, it's all about me me me.

 

 

 

 

Okay let's take a look at FB.

FB sports a p/e of 101.8 or 6.7 x BRK. Hmm, are investors 6.7 times more confident in Zuckerburg than in Buffet, apparently so. Interestingly the market cap is at 156 ia bout half what BRK is valued. So FB must be making lots of money, right?

Uh wrong, E/S is 61 cents. No that is not a misprint. Rounded BRK is making

$11,850. per share, again not a misprint.

What is going on here? Well, the p/e is an expectation ratio. Expectations for FB are remarkably high. And FB is on a buying spree.