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10 - 10 Rule - A concept used when determining whether a business has Meaning (one of the Four Ms) to you as a Rule #1 investor. The rule states that you should not “Own a business for 10 seconds if you are not willing to own it for 10 years.”
A
Analyst Consensus Growth Rate - A 5 year forecasted earnings growth rate that is derived from the forecasts of all the professional analysts following a particular company.
Assets - Resources controlled by a company from which future economic benefits are expected to be generated. In a business, an asset is something the business owns that has a dollar value. (An asset in general is anything of value that can be traded.) An intangible asset is an asset that has a dollar value but may not be worth anything unless the business is successful. Typically this is an asset that was acquired through buying another business. The price paid in excess of that business’ net worth is often called “goodwill” and is treated as an asset for GAAP purposes
Assets Turnover - Calculated as Revenue / Average Total Assets
B
BAG - "Big Audacious Goal” — Coined by author Jim Collins in the book Good to Great, Rule #1 investors seek businesses led by CEOs driven by BAGs. These goals are bigger and more meaningful than mere mission statements in that BAGs are about passion and relentless drive to change the world in some small or big way"
Balance Sheet - The financial statement that presents a company’s current financial position by disclosing the assets, liabilities and equity claims as of a particular point in time.
Basic EPS - Net earnings that are available to common shareholders. This is calculated as net income minus preferred dividends, divided by the weighted average number of common shares outstanding.
Bearish - An investor who acts on the belief that a security or the market is falling or is expected to fall.
Beta - A standardized measure of risk.
Big Five - The five financial calculations help to confirm the existence of a Moat (see definition) in a business, which translates to the business being protected from competition and thereby having a predictable future. Rule #1 investors only invest in businesses if all five of the Big Five numbers are equal to or greater than 10 percent per year for the last 10 years. The Big Five numbers are:
1. Return on Investment Capital (ROIC)
2. Sales growth rate
3. Earnings per Share (EPS) growth rate
4. Equity, or Book Value per Share (BVPS), growth rate
5. Free Cash Flow (FCF or Cash) growth rate
Bond - A debt investment, as in your loaning money to the U.S. government, which borrows from you for a defined period of time at a specified interest rate. The government issues you a certificate, or bond, that states the interest rate (coupon rate) that will be paid and when the loaned funds are to be returned (maturity date). These are often called T-bonds or T-bills, short for treasury bonds or bills.
Book Value - The net asset value of a company, calculated by total assets minus intangible assets (patents, goodwill) and liabilities. It’s what the business is worth if you shut it down
Book Value Growth - A Scan For Stocks filter showing the 10 Year Compound Annualized Growth Rate of Book Value
Book Value Per Share - The amount of book value of common equity per share of common stock. This is calculated as book value of shareholders’ equity divided by the weighted average number of common shares outstanding.
Bullish - An investor who thinks the market or a specific security or industry will rise. A bull market is an extended period in which the market consistently rises
Buy Price - The highest on sale price of the three different valuation methods representing a 50% discount to the sticker price or fair value.
Buybacks Per Share - Calculated as Common Stock Payments divided by Basic Average Shares Outstanding
C
Call option - A contract that gives the holder the right to buy an underlying asset from another party at a fixed price over a specified period of time
Capital Gains Tax - A tax on the increase in the value of an asset; the difference in what you paid to purchase that asset and what you sell it for. (The gain is not realized until the asset is sold.) A capital gain may be short-term (one year or less) or long-term (more than one year). Long-term capital gains are usually taxed at a lower rate than regular income. So, if you sell stocks six months after you purchased them and take profits, you’ll be taxed at a higher rate than if you sell them one year and one day after you originally bought them (assuming you can still take profits).
Cash Conversion Cycle - Calculated as Days In Inventory + Days In Sales – Days In Payment
Cash Ratio - Indicates a company's short-term liquidity, defined as short term liquid investments (cash, cash equivalents, short term investments) divided by current liabilities. Calculated as (Cash and Cash Equivalents + Investments) / Current Liabilities
Commodity - A bulk good that’s traded on an exchange or in the cash market. Examples include grain, oats, coffee, fruit, gold, oil, beef, silver, and natural gas. A “commodity business,” on the other hand, is what we call any company that produces a product that anyone else can similarly produce, thus eliminating a Moat. If you own a strawberry patch, for example, chances are a neighboring strawberry patch can easily compete with you. A strawberry from your patch is not going to be all that different from a strawberry from your neighbor. It’s very difficult and expensive to create a Moat and protect it with a commodity business
Common Shares Outstanding (EOP) - A balance sheet item representing the shares outstanding as of the respective quarters period ending date.
Composite Growth Rate - Calculated as the average of the weighted average growth rates for the selected inputs.
Compounded Annual Growth Rate (CAGR) - The year-over-year growth rate of an investment over a specified period of time.
Covered Call - An option strategy where the holder of an asset sells a call option obligating themselves to sell shares of stock they currently own. The two potential scenarios at option expiration are to create cash flow equal to the option premium received or to effectively sell the stock at a price equal to the stated strike price plus the premium received. This is an alternative way to sell stocks especially when the stock is not currently trading in the red zone.
Credit Spread - A limited risk option strategy that is implemented by selling one naked option, which incurs an obligation to perform and offsetting that obligation by buying a second option at a different strike price that gives you the right to make someone else perform.
Current Liabilities - Short-term obligations that are expected to be settled within 12 months.
Current Ratio - Liquidity ratio calculated as current assets divided by current liabilities.
D
Days in Sales - Also known as Receivable Turnover. Calculated as Revenue divided by Average Accounts Receivables
Days in Inventory - Also known as Inventory Turnover. Calculated as Revenue divided by Average Accounts Receivables
Days in Payment - Also known as Payable Turnover. Calculated as Cost of Goods Sold / Average Accounts Payable
Debt to Total Capital Ratio - Refers to the ratio of Long Term Debt to Total Capital. Morningstar calculates the ratio by using the underlying data reported in the Balance Sheet within the company filings or reports: Long-Term Debt And Capital Lease Obligation divided by the sum of Long-Term Debt And Capital Lease Obligation and Total Shareholder’s Equity"
Depreciation - The systematic allocation of costs of long-lived assets to the period during which the assets are expected to generate economic benefits.
Diluted Earnings Growth - A Scan For Stocks filter showing the 10 Year Compound Annualized Growth Rate of Earnings
Diluted EPS - The EPS that would result if all dilutive securities were converted into common shares.
Dividend Yield - Calculated as Dividends Per Share over the trailing 12 months divided by Price
Dividends per Share - The dollar amount of cash dividends paid during a period per share of common stock.
Dollar Cost Averaging - A timing strategy of investing equal dollar amounts regularly and periodically over specific time periods in a particular investment or portfolio.
Dow Jones Industrial Average - A price-weighted average of 30 significant stocks traded on the NYSE and the Nasdaq. Examples of DJIA companies include General Electric, Disney, McDonald’s, and Coca-Cola. Invented by Charles Dow in 1896.
E
Earnings growth rate (EGR) - The compounded growth rate that is used to fore¬cast potential future earnings per share. This is used in connection with other valuation assumptions to forecast the future value of the business and calculate sticker price.
Earnings Per Share (EPS) - The amount of income earned during a period per share of common stock.
Earnings Yield - The income return that a full owner would receive from the earnings of the company if the company was purchased at the current market price. It is determined by dividing the current earnings per share by the current market price.
Equity - (1) Stock or any other security representing ownership (“equities” are stocks). (2) On the balance sheet, equity refers to the amount of the funds contributed by the owners (the stockholders) plus the retained earnings (or losses). Thus, equity is essentially ownership in an asset after all debts associated with that asset are paid off. The importance of equity to a Rule #1 investor is in its growth rate. The growth rate of equity represents the growing surpluses, which in turn increase the value of the business
Exchange - A market where securities, commodities, options, or futures are traded. Examples of exchanges include the NYSE, Nasdaq, and AMEX.
F
Financial Leverage Ratio - Refers to the ratio of Total Assets to Common Equity. Morningstar calculates the ratio by using the underlying data reported in the Balance Sheet within the company filings or reports: Total Assets / Common Equity.
[Note: Common Equity = Total Shareholder’s Equity – Preferred Stock]
Fixed Assets Turnover - Calculated as Revenue / Average PP&E
Free Cash Flow - The actual cash that would be available to the company’s investors after operational investments, calculated as Cash From Operating Activities minus the Purchase of Property Plant and Equipment
Free Cash Flow Growth - A Scan For Stocks filter showing the 10 Year Compound Annualized Growth Rate of Free Cash Flow
Free Cash Flow Ratio - The ratio of Free Cash Flow to Net Income Common Stockholders as used in determining Free Cash Flow Per Share for the Pay Back Time Valuation Methodology
G
Green Zone Price - Delineates the beginning of the potential purchase zone. Whenever a particular stock trades below the green zone price then it may be considered for purchase. The green zone price can be either the Margin of Safety Price, The Payback Time Price, the 10 Cap Price or the lesser of these three prices.
Gross Profit Margin - This is calculated as gross profit divided by revenue.
I
Index - An imaginary portfolio of securities (stocks and bonds) representing a particular market or a portion of it. The S&P 500 is one of the world’s best-known indexes, and is the most commonly used benchmark for the stock market. Technically, you can’t actually invest in an index. Rather, you invest in a security such as an index fund or ETF that attempts to track an index as closely as possible.
Index Fund - A portfolio of investments that are weighted the same as a stock-exchange index, such as the S&P 500, in order to mirror its performance
Industry - A group of companies that provides similar product and services.
Insider Trading - When corporate insiders—officers, directors, and employees—buy and sell stock in their own companies. When corporate insiders trade in their own securities, they must report their trades to the SEC.
Interest Coverage - Refers to the ratio of EBIT to Interest Expense. Morningstar calculates the ratio by using the underlying data reported in the Income Statement within the company filings or reports: EBIT / Interest Expense.
In-the-money - Options that if exercised would result in a profit.
Intrinsic Value - The current value of a business based on its future surplus cash flow. Also known as “Sticker Price”
Inventory Turnover - Also known as Days in Inventory.Calculated as Cost Of Goods Sold / Average Inventory
L
Large Cap - Stocks with large market capitalization, between $10 billion and $200 billion.
Last - The last actual price at which a stock was sold.
Long Term Debt to Earnings - Solvency ratio calculated as long term debt divided by net income common stockholders. The amount of years it would take a company to pay off its debt using its current annual earnings.
Long Term Debt to Equity - Solvency ratio calculated as long term debt divided by total shareholders’ equity gross minority interest.
Long Term Debt to Free Cash Flow - Solvency ratio calculated as long term debt divided by free cash flow. The amount of years it would take a company to pay off its debt using its current annual free cash flow.
M
MACD - The Moving Average Convergence Divergence is a trend-following momentum indicator that shows the relationship between two moving averages of price as part of the 3-Arrows strategy. To calculate the MACD, subtract the 26-day exponential moving average from the 12-day exponential moving average. A nine-day dotted exponential moving average called the signal line is then plotted on top of the MACD.
Management - One of the Rule #1 Four Ms that qualify a business you are considering investing in. Having good management means the business is led by skilled, experienced individuals that you respect
Management Score (0-100) - A component of the Rule One Score calculated using the 10, 7, 5, 3 year averages of ROE, ROIC, ROA and the current Net Debt to Earnings and Net Debt to Free Cash Flow. A high management score indicates that the company may have quality management. Those with the highest scores are those that have had consistently high returns over the last ten years.
Margin of Safety Price (MOS Price) - One of three measures of fair value. A potential purchase price for a particular stock that is determined by reducing the sticker price by the margin of safety.
Margin of Safety (MOS) - The difference between the sticker price and margin of safety price. This reduction in the sticker price helps to insulate investors from possible valuation mistakes.
Market Capitalization - Denotes the size of a company. It is calculated by multiplying the outstanding shares by the current market price.
Market Order - An order to buy or sell a security immediately at the best price available.
Mid Cap - Stocks with middle-range market capitalization, between $2 billion and $10 billion.
Minimum Acceptable Rate of Return (MARR) - The rate at which an investor should expect to earn on an investment. In the MOS system, this typically equals 15% annually.
MOAT - First coined by Warren Buffett, Moat refers to the competitive advantage a company has over other companies in the same industry. It is also one of the Rule #1 Four Ms that qualify a business you are considering investing in. Moat means that the business must meet certain criteria in terms of financial strength and predictability, creating a symbolic Moat to surround and protect it from competitors. The strength of a business’ Moat, or lack thereof, will surface in one of
The five types of Moats include:
- Brand – A product you’re willing to pay more for because you trust it. The company is consistent in high quality services.
- Secret – A business that has a patent or trade secret that makes direct competition illegal or very difficult. Commonly pharmaceutical and technology companies.
- Toll Bridge – A business with exclusive control of a market—giving it the ability to collect a “toll” from customers needing that service or product.
- Switching – A business that is so much a part of your life that switching is not worth the trouble.
- Price - Companies with prices so low no one else can compete."
Moat Score (0-100) - A component of the Rule One Score calculated using the 10, 7, 5, 3 year CAGR of Book Value, Earnings, Operating Cash Flow, Sales and Free Cash Flow. A company with a high moat score is one whose financial numbers indicate that it may have a sustainable and durable moat. Companies that have significantly grown their earnings, book value, sales, operating cash flow, and free cash flow at greater than 10% per year will have the highest score. The higher scores suggest that these companies have the highest probability of having a significant competitive advantage over their peers, which has allowed them to grow significantly over time.
Moving Average - One of the components of the 3 Arrows Strategy. Frequently used to show the average value of a security’s price over a period of time. A simple moving average is the average price of the stock over a specific period of time. An exponential moving average is weighted to give more emphasis on recent activity.
Mutual Fund - A financial entity that allows a group of investors to pool their money for investing in the market, usually with a predetermined investment objective. A fund manager is responsible for taking that pooled money—usually billions—and buying securities (usually stocks or bonds). When you invest in a mutual fund, you are buying shares (or portions) of the mutual fund and become a shareholder of the fund. The vast majority of mutual funds fail to beat the market, as well as broad indexes like the S&P 500.
N
Naked Puts - An option strategy where a put option is sold. The two possible outcomes at option expiration are an income return from receiving the option premium or the potential to purchase the stock at a price equal to the stated strike price minus the premium received. Selling naked puts is an alternate method for purchasing stock especially when the stock is not currently trading in the green zone.
Net Debt to Earnings - Solvency ratio calculated as long term debt minus Cash and Cash Equivalents divided by net income common stockholders. The amount of years it would take a company to pay off its debt using its current annual earnings.
Net Debt to Equity - Solvency ratio calculated as long term debt minus Cash and Cash Equivalents divided by total shareholders’ equity gross minority interest.
Net Debt to Free Cash Flow - Solvency ratio calculated as long term debt minus Cash and Cash Equivalents divided by free cash flow. The amount of years it would take a company to pay off its debt using its current annual free cash flow.
Net Income (or Net Loss) - The difference between revenues and expenses.
Net Profit Margin - This is calculated as Net Income divided by Revenue
Non-Current Assets - Assets that are expected to benefit the company over a period of time greater than a year.
Normalized EPS - Normalizing removes onetime and unusual items from EPS, to provide investors with a more accurate measure of the company’s true earnings.
O
Operating Cash Flow Growth - A Scan For Stocks filter showing the 10 Year Compound Annualized Growth Rate of Operating Cash Flow
Operating Cash Flow Per Share (OCPS) - Denotes the amount of usable cash from operations that is allocated to each share of a company’s stock. A component of the Moat Score
Operating Profit Margin - This is calculated as Operating Profit divided by Revenue
Option Chain - For each underlying security, the option chain tells investors the various strike prices, expiration dates, and whether they are calls or puts.
Options - The privilege to buy or sell an asset, such as a stock, at a specified price within a specified time. Options are typically for the advanced investor
Owners Earnings - The sum of actual cash that the owner of the business would collect in a year after accounting for certain expenses
P
Payable Turnover - Calculated as Cost of Goods Sold / Average Accounts Payable
Payback Time (PBT) - The amount in years it would take a full owner of a company to recoup the capital investment using the forecasted earnings stream of the company.
Payback Time Price (PBT Price) - One of three valuation methodologies. The price that can be paid for a particular stock to receive the forecasted Payback Time. The investor selects the amount of years that determines the price. The default is 8 years.
Peers - Other businesses that form a company’s competitive set, determined by Morningstar based on their Industry and Sector assignments (ISIC and NAICS codes)
PEG - Price to Earnings multiple divided by the forecaster growth rate. It denotes the amount of the PE multiple that the market is paying for every percentage of forecaster growth.
Phil's Gurus - Phil Town's hand picked selection of professional money managers who invest using the Rule One methodology of large position sizes relative to their Assets Under Management
Portfolio List - A list of businesses that you have bought and may wish to sell. Rule #1 investors use a portfolio list to track the MOS and the Tools
Price to book value (P/BV) ratio - The price of a share divided by the company’s book value of equity. This is calculated as price per share divided by book value per share.
Price to cash flow (P/CF) ratio - The price of a share divided by the company’s cash flow. This is calculated as price per share divided by cash flow per share.
Price to earnings (P/E) ratio - The price of a share divided by the company’s earnings. This is calculated as price per share divided by earnings.
Price to Free Cash - The price of a share divided by the company’s free cash flow.
Price to sales (P/S) ratio - The price of a share divided by the company’s sales. This is calculated as price per share divided by sales.
Q
Quick Ratio - A more stringent measure of liquidity than the Current Ratio. Calculated as Cash and Cash Equivalents / Current Liabilities. By excluding inventory, the ratio focuses on the company's more liquid assets
R
Real Estate Investment Trust - A security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. This is how you can invest in real estate, without actually buying a piece of property.
Receivable Turnover - Also known as Days in Sales. Calculated as Revenue divided by Average Accounts Receivables
Red Zone - Delineates the beginning of the potential sales zone. Whenever a particular stock trades above the red zone price, then it may be considered as a potential sales candidate. The red zone price is determined by multiplying the sticker price by 120%.
Return on Assets (ROA) - A component of the Management Score. Gives an idea as to how efficient management is at using its assets to generate earnings. This is calculated as Net Income / Average Assets.
Return on Capital - Calculated as EBIT divided by the sum of total equity, total debt and total deferred tax liabilities
Return on Equity (ROE) - A component of the Management Score. The amount of net income returned as a percentage of shareholders equity and a measure of management’s effectiveness in applying equity capital. Calculated as Net Income Common Stockholders / Stockholders Equity
Return on Invested Capital (ROIC) - A component of the Management Score. The return on invested capital measure gives a sense of how well a company is using its money to generate returns. Calculated as Net Income Common Stockholders / (Stockholders Equity + Long Term Debt).
Return on Investment (ROI) - The percentage return you’ve made on your investment. The ROI for a savings account is 2 percent a year. It’s the total you got back from your investment, less the investment itself, divided by the investment. If I got back $120 from selling lemonade and my investment was $100, to find my ROI, I subtract $100 from $120 to get $20. And $20 ÷ $100 = 20%."
Revenue - An income statement value specifying the amount a company makes for providing goods and services.
Rho - The sensitivity of the option price to the risk-free rate.
ROC Zone - Also known as Red Zone. Delineates the beginning of the potential sales zone. Whenever a particular stock trades above the red zone price, then it may be considered as a potential sales candidate. The red zone price is determined by multiplying the sticker price by 120%.
ROP Zone - Also known as Green Zone. Delineates the beginning of the potential purchase zone. Whenever a particular stock trades below the green zone price then it may be considered for purchase. The green zone price can be either the Margin of Safety Price, The Payback Time Price, the 10 Cap Price or the lesser of these three prices.
Rule #1 - "Don't Lose Money Attributed by Warren Buffett to his teacher, Benjamin Graham. The essence of Rule #1 is the idea of certainty and low risk from buying businesses, not stocks, that are wonderful and only at an attractive price—in other words, buy a dollar of value for fifty cents."
Rule #2 - Don't Forget Rule #1
Rule of 72 - A method for estimating an investment’s doubling time. The number in the title is divided by the interest percentage per period to obtain the approximate number of periods (usually years) required for doubling.
Rule One Per Share Method - A process of determining the historical Per Share value of an item using the current periods shares outstanding in an effort to remove the effect of share buybacks. This methodology allows the investor to view the historical per share performance of a variety of metrics through the lens of owning the whole business.
Rule One Scores - The Rule One Scores help you determine the companies that have a high probability of meeting your definition of a “wonderful company.” If this company has meaning for you, look to the other scores to help you identify companies that may meet your expectation for the three M’s: Moat, Management and Margin of Safety.
S
Sales Growth - A Scan For Stocks filter showing the 10 Year Compound Annualized Growth Rate of Sales (Revenue)
Sales per Share - The amount of a company’s sales allocated to each share of company stock.
Scan for Stocks - A screening method applying a set of criteria to reduce a set of potential investments to a smaller set having specified desired characteristics.
SEC Filings - A financial statement or other formal document submitted to the U.S. Securities and Exchange Commission (SEC). Public companies, certain insiders and broker-dealers are required to make regular SEC filings.
Sector - A group of related industries.
Sticker Price - The price for which a stock that the valuation analysis justifies the market should be selling as typically determined by the three different valuation methods.
Stochastic - An indicator that compares where a security’s price closed relative to its price range over a given time period as used in the Rule One Arrows strategy. In theory, prices tend to close near their high in an upwardly trending market and closer to their low in a downward trending market.
Sustainable Growth Rate - The rate of earnings and dividend growth that can be sustained over time for a given level of return on equity, assuming a constant capital structure and no common stock dilution.
T
Technical Analysis - A method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security’s intrinsic value. Technical analysts often use charts to identify patterns that can suggest future activity.
Technical Indicator - Used to predict future financial or economic trends. An indicator is a mathematical calculation based on a security’s price and/or volume.
Ten Cap Price - One of the three valuation methods. The price that can be paid for the whole company where the purchaser will receive a 10% yield in Owner Earnings in the first year of ownership.
Theta - The rate at which an option’s time value decays.
Ticker Symbol - Denotes a particular stock on an exchange. Ticker symbols for companies trading on the NYSE or Amex have three letters while companies trading on the NASDAQ have four.
Topic - Definition
Trailing Twelve Months (TTM) - Denotes that the number or metric being displayed is for a period that equals the previous twelve months of operation.
Treasury Shares - Shares that were issued and subsequently repurchased by the company who certificates have not been destroyed and thus are available for resale.
V
Vega - The relationship between option price and volatility.
W
Weighted Average Growth Rate - This value is calculated with a proprietary weighting system (emphasizing recent years over historical years) of each 3 year smoothed average growth rate for the respective line item. (see also Composite Growth Rate)
Withholding Percentage - The percentage amount of an investment that a broker will hold to insulate against potential losses.