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Module 7Continuing with the P/E

What is the S&P 500

The S&P 500,[6] or simply the S&P,[7][8] is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices, and many consider it to be one of the best representations of the U.S. stock market. [9] The average annual total return of the index, including dividends, since inception in 1926 has been 9.8%; however, there were several years where the index declined over 30%.[10] The index has posted annual increases 70% of the time.[11]

For a list of the components of the index, see list of S&P 500 companies. The components that have increased their dividends in 25 consecutive years are known as the S&P 500 Dividend Aristocrats.[12]:25

The S&P 500 is a capitalization-weighted index and the performance of the 10 largest companies in the index account for 21.8% of the performance of the index.[1]

Funds that track the index have been recommended as investments by Warren Buffett, Burton Malkiel and John C. Bogle for investors with long time horizons.[13] https://en.wikipedia.org/wiki/S%26P_500_Index

https://www.investopedia.com/terms/p/price-earningsratio.asp

Other adjustments (Occam’s Razor?)

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Date ValueTo Earn

Current Yield

Estimated Growth

from inception 9.8%

1-Jun-2021.84 estimate 4.58%

1-Jan-2023.50 estimate 4.26%

1-Jan-19 19.6 5.10%1-Jan-18 24.971-Jan-17 23.59

So for any company take the Current yield + __sustainable growth______ = ROI

Current Yield = 1/ PE

So the higher the P/E, the lower the current yield and the HIGHER the sustainable growth needs to be to hit a return target.

So what does the growth have to be?

To earn

General Motors

Apple

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Amazon

PEG Ratio

Price/Earnings-to-Growth – PEG Ratio DefinitionBy WILL KENTON Reviewed By MARGARET JAMES  Updated May 14, 2020

What Is the Price/Earnings-to-Growth – PEG Ratio?The price/earnings to growth ratio (PEG ratio) is a stock's price-to-earnings (P/E) ratio divided by the growth rate of its earnings for a specified time period. The PEG ratio is used to determine a stock's value while also factoring in the company's expected earnings growth, and is thought to provide a more complete picture than the more standard P/E ratio.

KEY TAKEAWAYS

The PEG ratio enhances the P/E ratio by adding in expected earnings growth into the calculation.

The PEG ratio is considered to be an indicator of a stock's true value, and similar to the P/E ratio, a lower PEG may indicate that a stock is undervalued.

The PEG for a given company may differ significantly from one reported source to another, depending on which growth estimate is used in the calculation, such as one-year or three-year projected growth. https://www.investopedia.com/terms/p/pegratio.asp

But the ROI assumes what time frame?

Bill Gates and Warren Buffett and Dr. K say, until the end of time.

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Hedge Funds: And the Winner Is …By DAVID FLOYD Updated Jun 25, 2019In 2008, Warren Buffett issued a challenge to the hedge fund industry, which in his view charged exorbitant fees that the funds' performances couldn't justify. Protégé Partners LLC accepted, and the two parties placed a million-dollar bet.

Buffett has won the bet, Ted Seides wrote in a Bloomberg op-ed in May. The Protégé co-founder, who left in the fund in 2015, conceded defeat ahead of the contest's scheduled wrap-up on December 31, 2017, writing, "for all intents and purposes, the game is over. I lost."

Buffett's ultimately successful contention was that, including fees, costs and expenses, an S&P 500 index fund would outperform a hand-picked portfolio of hedge funds over 10 years. The bet pit two basic investing philosophies against each other: passive and active investing.

A Wild RideBuffett may be the quintessential active investor himself, but clearly doesn't think anyone else should try. He said as much in his most recent letter to Berkshire Hathaway Inc. (BRK.A, BRK.B) shareholders, dated February 225, 2017. Buffett boasted that there was "no doubt" who would come out on top when the contest ends. (See also, The 'Next Warren Buffett' Curse Is Real.)

His victory didn't always seem so certain. Not long after the wager started on January 1, 2008, the market tanked, and the hedge funds were able to show off their strong suit: hedging. Buffett's index fund lost 37.0% of its value, compared to the hedge funds' 23.9%. Buffett then beat Protégé in every year from 2009 through 2014, but it took four years to pull ahead of the hedge funds in terms of cumulative return. (See also, Hedge Fund Fees: Exotic Expenses.)

In 2015, Buffett lagged his hedge fund rival for the first time since 2008, gaining 1.4% versus Protégé's 1.7%. But 2016 saw Buffett gain 11.9% to Protégé's 0.9%. Another downturn could conceivably have handed the advantage back to Protégé, but that didn't happen. At the end of 2016, Buffett's index fund bet had gained 7.1% per year, or $854,000 in total, compared to 2.2% per year for Protégé's picks – just $220,000 in total.

In his shareholder letter, Buffett said he believed the hedge fund managers involved in the bet were "honest and intelligent people," but added, "the results for their investors were dismal – really dismal." And he noted that the two-and-twenty fee structure generally adopted by hedge funds (2% management fee plus 20% of profits) means that managers were "showered with compensation" despite, often enough, providing only "esoteric gibberish" in return.

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In the end, Seides admitted the strength of Buffett's argument: "He is correct that hedge-fund fees are high, and his reasoning is convincing. Fees matter in investing, no doubt about it." The index fund Buffett chose (see below for details) charges an expense ratio of just 0.04%, according to Morningstar.

In his letter, Buffett estimated that the financial "elites" had wasted $100 billion or more over the past decade by refusing to settle for low-cost index funds, but pointed out that the harm was not limited to 1%-ers: state pension plans have invested with hedge funds, and "the resulting shortfalls in their assets will for decades have to be made up by local taxpayers."

Buffet also floated the idea of erecting a statue to the index fund's inventor, Vanguard Group Inc. founder Jack Bogle.

All About the Fees?Seides did push back against some of the Berkshire CEO's passive triumphalism. "Fees will always matter," he wrote, "but market risk sometimes matters more." The S&P 500's run-up following the financial crisis defied reasonable expectations, Seides argues, and "my guess is that doubling down on a bet with Warren Buffett for the next 10 years would hold greater-than-even odds of victory."

He also raises doubts that fees were the deciding factor, pointing out that the MSCI All Country World Index has performed almost exactly in line with the hedge funds in the bet. "It was global diversification that hurt hedge fund returns more than fees," Seides concludes.

The terms of the bet pit incomparable vehicles against each other – apples and oranges, or as Seides put it, the Chicago Bulls and the Chicago Bears: "hedge funds and the S&P 500 play different sports." Then again, Seides did take the bet on these basketball-v.-football terms, and he recognizes that Buffett came out on top: "Forget the Bulls and Bears; Warren picked the World Series Champion Chicago Cubs!"

What Exactly Is the Bet?A few details about Buffett and Protégé's wager. The money Buffett has put down is his own, not Berkshire's or its shareholders'. His chosen vehicle is Vanguard's S&P 500 Admiral fund (VFIAX). Protégé's is the average return of five funds of funds, meaning that the fund-of-fund managers who select the choicest hedge funds themselves take a cut. These funds-of-funds have not been disclosed, in line with SEC rules on hedge funds' marketing.

The million dollars will go Girls Incorporated of Omaha, since Buffett won. A win for Protégé would have seen Friends of Absolute Return for Kids win the pot. In an odd twist, the prize money – stashed away in the most boring and secure instruments available – has seen by far the best return. The sides initially put $640,000 (split evenly) into zero-coupon Treasury bonds that were structured to rise to $1 million over 10 years. But the financial crisis saw interest rates plunge and sent the bonds up to nearly $1 million in 2012. 

By mutual agreement, the bettors sold the bonds and bought (actively managed) Berkshire B-shares, which were worth $1.4 million as of mid-February 2015. That 119% return blew

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both the Vanguard fund and Protégé's funds of funds out of the water; the stock returned an additional 19.1% from the end of February 2015 to September 8, 2017. If the share price had dropped, the winning charity was guaranteed $1 million anyway; since the pot remained larger than the originally agreed amount, the charity will get the surplus.

The money has been held by the Long Now Foundation in San Francisco, a non-profit which holds parties to long-term bets accountable. To give a sense of how long-term they like to think, the site lists the bet's duration as: "10 years (02008-02017)." The site has not assigned victory to one party or the other yet, Seides' admission of defeat notwithstanding.

The Tortoise and the HareTo mere mortals, this may look like a bet between a handful of Masters of the Universe and the world's third-richest person, the Oracle of Omaha. But Buffett has characteristically hit on a humbler metaphor for the wager: Aesop's tortoise and hare. While the hedge funds and funds of funds – the hares – bound around between exotic asset classes and elaborate derivatives, charging high fees for their troubles, passive index investors – the tortoises – worry about other things while the market, significant short-term turbulence aside, gradually gains in value. 

Protégé sees things differently, writing before the bet started, "Hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment. They think very differently than do traditional 'relative-return' investors, whose primary goal is to beat the market, even when that only means losing less than the market when it falls" (by these standards, Protégé delivered exactly what it promised). Protégé argues that "there is a wide gap between the returns of the best hedge funds and the average ones," which justify the fees at the center of the argument. (See also, The Multiple Strategies of Hedge Funds.)

The Bottom LineEveryone and their mother has an opinion about low-fee, passive index investing versus actively managed investments. The Buffett-Protégé contest provides fodder for arguments on both sides. While Buffett won according to the terms of the bet, the hedge fund side showed the merits of a bit of extra tweaking and pruning following the 2008 crash, which put them ahead of Buffett's Vanguard fund until 2012. And Protégé did beat the market in the previous cycle: their flagship fund returned 95% from 2002 to 2007, net of fees, versus 64% for the S&P 500. If the period running from the beginning of 2008 though 2017 had seen a second swoon, Protégé's co-founder might be writing sassy declarations of victory rather whatboutist op-eds. While this battle has been won, the active-passive war will rage on. (See also, The   ETF Economy: Overpaid Execs and 'Absurd Valuations.'   )

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So why bother?

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Now back to the ratios

https://analystprep.com/Ratio_Sheet.pdf

What Dr. Stowe said

Not sure about ratios. Exam is going online next year.

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15.Gross profit margin

Gross Profit ÷ Total Revenue

2018 2019

59,549 ÷ 136,819 71,896 ÷ 161,857

43.52% 44.42

16. Operating Profit Margin

Operating Income ÷ Total Revenue

2018 2019

27,524 ÷ 136,819 34,231 ÷ 161,857

20.12% 21.15%

17.Pretax Margin Earnings before tax but after interest ÷ Total Revenue

2018 2019

34,913 ÷ 136,819 39,625 ÷ 161,857 25.52% 24.48%

18. Net profit marginNet Income ÷ Total Revenue

2018 2019

(how much of each dollar of revenue is available to the shareholders.)

Available to Common shareholders, would be above less the preferred dividends.)

30,736 ÷ 136,819 34,343 ÷ 161,857

22.47% 21.22%

19. Operating return on assets, Total Assets, 12/31/17, 197,295)

Operating Income ÷ Average total assets

2018 2019

27,524 ÷ ((197,295 + 232,793)/2) 34,231/((232,793 +275,909)/2)

27,524/215,044 34,231/254,351

12.80% 13.46%

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20. Return on assetsNet Income ÷ Average total assets (2017 Assets, 197,295)

2018 2019

30,736 34,343

197,295 + 232,792 232,792 + 275,909

2 2

30,736 34,343

215,044 254,351

14.29% 13.50%

Preliminary measure of management effectiveness

21. Return on equity

Net Income ÷ Average shareholders’ equity (Shareholders’ Equity, 2017= 152,502)Need to subtract any preferred dividends from Net Income

2018 2019

30,736 34,343 152,502 + 177,628 177,628 + 201,442

2 2 30,736 34,343 165,065 189,535

18.62% 18.125%

Tells me- How effectively the company is using other peoples’ money to make money!!!!

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22. Return on total capitalEarnings before interest and taxes ÷ (Interest bearing debt + Shareholders’ Equity)

2018 2019

23. Return on common equity(Net income – preferred dividends) ÷ Average shareholders’ equity

2018 2019

24. Tax burdenNet Income ÷ Earnings before tax

2018 2019

25. Interest burden

Earnings before tax ÷ Earnings before interest and taxes

2018 2019

26. EBIT margin

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Earnings before interest and taxes ÷ Total Revenue

2018 2019

27.Financial leverage ratio (equity multiplier) (2017 Assets, 197,295; 2017 Share Equity 152,502)

Average total assets ÷ Average shareholders’ equity

2018 2019

(197,295 + 232,792)/2 (232,792 + 275,909) / 2(152,502 + 177,628)/2 (177,628 + 201,442) / 2

215,044 254,351165,065 189,535

1.303 1.342

28. Total debtThe total of interest-bearing short-term and long-term debt excluding liabilities such as accrued expenses and accounts payable

2018 2019

29. Debt to assets ratio

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Total Debt ÷ Total assets

2018 2019

30. Debt to equity ratioTotal Debt ÷ Total shareholders’ Equity

2018 2019

31. Debt to capital ratio

2018 2019

32. Interest coverage ratio

2018 2019

33. Fixed charge coverage ratio

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2018 2019

34. Dividends payout ratio

2018 2019

35. Retention rate

2018 2019

36. Sustainable growth rate

2018 2019

37. Earnings per share

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Module 7, HomeworkUse of Leverage

You have decided to open a hot dog stand at the corner of Court and Union. The following is your opening balance sheet. You own the only 50,000 shares of stock outstanding for your company. You sell the dogs for $2.00 each. You pay your worker a fixed salary of $20,000 plus $.10 for each dog she sells.

AssetsCash 5,000 Sales $60,000Inventory 10,000 Cost of sales 12,000Cart 35,000 Gross Margin 48,000 Total 50,000 Operating Expenses

Wages 23,000 Liabilities Other 10,000

-0- Total Operating Expenses 33,000 Owners’ Equity

Common Stock ($1 par) 50,000 Operating Income 15,000Retained Earnings -0- Tax Expense 4,500 Total 50,000 Net Income 10,500

You paid all your income out as a dividend. You want to expand to Oxford. You will need to invest a total of $60,000. You expect your sales and cogs to double with the new operation. Your wage expense for Oxford will be based the same as it is in Athens. (You will also pay the worker there a fixed salary of $20,000 plus .10 for each dog sold.) Your other expenses will increase to $12,000. Your tax rate is 30%. You can either sell 60,000 shares of stock for $1 each or you can borrow the money from the bank. The bank will charge you 8% interest on the loan. Prepare the income statement for next year if you do the deal under each of the alternatives. Assume the deal is done on January 1st.

Expand using Expand using Current Stock Loan

For the First Year Sales 60,000 120,000 120,000 Cost of Sales 12,000 Gross Margin 48,000 Operating Expenses Wages 23,000 Other 10,000 Total Operating Expenses 33,000 Operating Income 15,000

Net Income Before Taxes 15,000 Tax Expense 4,500 Net Income 10,500 EPS . . .

ROA _______ _______ _______

ROE _______ _______ _______

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