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How to Value a Stock, Step 2: Invested Capital

Wednesday, September 10th, 2014 11442367685_d06e2fcf5c_m

The second step to gauge the value of a company is to determine the sum of all cash that has been invested in a company over its life without regard to financing form or accounting name. We call this Invested Capital.

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30+ Accounting Adjustments To Get The Truth About Earnings & Valuation

Tuesday, October 1st, 2013 Accounts book

Reported earnings don’t tell the whole story of a company’s profits. They are frequently manipulated by companies to manage earnings.

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Discussing FASB’s Lease Proposal

Tuesday, September 10th, 2013 Discussing FASB’s Lease Proposal

On August 27th, I met with my fellow members of the FASB’s Investor Advisory Committee (IAC) to discuss the proposed treatment of operating leases on the balance sheet by the Financial Accounting Standards Board (FASB).

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Midyear Acquisitions – Invested Capital Adjustment

Thursday, September 5th, 2013 Acquisition_Fig1

When a company makes an acquisition, the entire purchase price is added to the company’s balance sheet in the year of the acquisition along with any assumed debts or other long-term liabilities. However, the only income added to the income statement is that which occurs after the acquisition closes. In other words, the balance sheet is charged with the full price of the acquisition while the income statement only gets partially impacted.

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Overfunded Pension Plan Assets – Invested Capital Adjustment

Monday, August 5th, 2013 OverfundedPensions

Overfunded pension assets are similar to excess cash, and should not be included in the calculation of return on invested capital (ROIC).

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Deferred Tax Assets and Liabilities – Invested Capital Adjustment

Friday, August 2nd, 2013 dtaal1

DTAs artificially raise reported assets and do not help generate operating profit while DTLs are like a source of interest-free financing. We remove the impact of DTAs and DTLs from our calculation of invested capital to ensure the more accurate measure of a firm’s return on invested capital (ROIC).

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Deferred Compensation Assets – Invested Capital Adjustment

Thursday, August 1st, 2013 DCAF1

Deferred compensation plans delay employee compensation until a later date. The assets held for these plans are used to compensate employees in the future, not to generate profits for the company. As such, they should not be factored into the calculation of a company’s return on invested capital (ROIC).

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FASB/IASB Considers Adopting Revised Rules for Operating Lease Accounting

Monday, July 15th, 2013 FASB/IASB Considers Adopting Revised Rules for Operating Lease Accounting

We applaud the Financial Accounting Standards Board’s (FASB) latest proposal to change the way leases are reported. The new rules would make only the shortest-term operating leases exempt from being recorded on the balance sheet.

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Accumulated Other Comprehensive Income Removed from Invested Capital – NOPAT Adjustment

Thursday, July 11th, 2013 OCI

Reported assets don’t tell the whole story of the capital invested in a business. Accounting rules provide numerous loopholes that companies can exploit to hide balance sheet issues and obscure the true amount of capital invested in a business.

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Discontinued Operations Removed from Invested Capital – Invested Capital Adjustment

Tuesday, July 9th, 2013 DiscontinuedOperations

Most investors would never know that discontinued operations distort GAAP numbers by over-stating assets on balance sheets and distorting the picture of a company’s ability to generate a return on that capital.

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Off-Balance Sheet Debt – Invested Capital Adjustment

Monday, July 8th, 2013 OBSD

Investors who ignore off-balance sheet debt are not holding companies accountable for all of the capital invested in their business. By adding back off-balance sheet debt to invested capital, one can get a true picture of the value that management is creating for shareholders. Diligence pays.

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Off-Balance Sheet Reserves – Invested Capital Adjustment

Wednesday, July 3rd, 2013 ICRES

Reported assets don’t tell the whole story of the capital invested in a business. Accounting rules provide numerous loopholes that companies can exploit to hide issues and obscure the true amount of capital invested in a business over its life.

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Footnotes Adjustments for Earnings & Valuation Diligence

Monday, July 1st, 2013 Footnotes Adjustments for Earnings & Valuation Diligence

This article details the uniquely rigorous diligence behind each of our ratings on 3000 stocks, 7000 mutual funds and 400 ETFs. It contains reports on all the adjustments we make to convert GAAP data to economic earnings and derive true shareholder value in a discounted cash flow model.

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Footnotes Adjustments for Earnings & Valuation Diligence

Thursday, June 6th, 2013 Footnotes Adjustments for Earnings & Valuation Diligence

This report summarizes our series of reports on how to convert GAAP data to economic earnings and derive true shareholder… Read more >>

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New Constructs’ Offerings: Stock valuation models

Thursday, March 22nd, 2012 New Constructs’ Offerings: Stock valuation models

Our Company Valuation models are very sophisticated discounted cash flow and earnings quality models.
An enormous amount of works goes into every model. I wish I could offer a short-cut (beyond our ratings and reports) for understanding our models.

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No Security In VirnetX Holding Corp’s (VHC) Stock

Tuesday, April 12th, 2011 No Security In VirnetX Holding Corp’s (VHC) Stock

Is VHC the next Google? The market’s current valuation seems to suggest it is that and much more.
Very few times in the last 15 years have I found a stock as expensive as VHC. The only comparable situation that comes to mind is Google (GOOG) at its IPO.

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Stock Pick of the Week: Buy Discover Financial Services (DFS)- Very Attractive Rating

Tuesday, February 15th, 2011 Stock Pick of the Week: Buy Discover Financial Services (DFS)- Very Attractive Rating

HIDDEN GEMS:
1. Our dis­counted cash flow analy­sis shows that DFS’s cur­rent val­u­a­tion (stock price of $21.80) implies that the company’s prof­its will decline by 40% and never grow again.
2. Eco­nomic earn­ings are growing faster that reported accounting earnings.
3. Free cash flow of $2.8bn or 24% of its enterprise value during the last fiscal year.

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For Ask Matt readers: Abbot Laboratories (ABT) – Attractive Rating

Friday, February 11th, 2011 For Ask Matt readers: Abbot Laboratories (ABT) – Attractive Rating

HIDDEN GEM: ABT’s current stock price (~$45 per share) implies the company’s profits will permanently decline by 20%. In other words, the market is not only giving no credit for future profit growth, it is predicting a significant (20%) decline in profits.

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Stock Pick of the Week: Buy Apollo Group Inc cl A (APOL)- Very Attractive Rating

Tuesday, January 18th, 2011 Stock Pick of the Week: Buy Apollo Group Inc cl A (APOL)- Very Attractive Rating

HIDDEN GEMS:
1. Our discounted cash flow analysis shows that APOL’s current valuation (stock price of $42.31) implies that the company’s profits will decline by 60% and never grow again.
2. Economic earnings are higher than reported accounting earnings.
3. Excess cash of $1,201mm or about 20% of its market cap

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Starbucks -Don’t Be Fooled Again: Stong Brand Does Not Equal Strong Stock

Thursday, January 6th, 2011 Starbucks -Don’t Be Fooled Again: Stong Brand Does Not Equal Strong Stock

We went on record that investors should short SBUX on 11/6/2006 when the stock was close to $38 per share. Click here to see the Fortune Article. The stock did not look attractive to us until 2 years (11/18 – 11/20/08) later when it was under $8, and that for only about 3 days. And ever since we have had a Neutral or Dangerous Rating on the stock.

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