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9 key definitions to understand the valuation and earnings of companies

learning goggles - key valuation definitions

Valuation of Companies and 9 key definitions

After skimming through The Fast Forward MBA in Finance, Second Edition by John Tracy, a few key concepts (such as EPS, ROE, market capitalisation and P/E) kept coming up again and again when dealing with the value of companies. When read in combination with Joel Greenblatt’s book, The Little Book That Beats the Market which simplifies things to some degree, an understanding of these concepts is required to begin understanding whether a company is undervalued or overvalued on the stock exchange and hence whether you should invest in the company.

It is important to firstly recognise that the value of a company’s shares on the stock exchange is only a representation of what the public will pay at any particular time for a stake in the company and is not a direct representation of the company’s true value per se. This fact is actually why smart investors should always be able to make money investing the stock market. For example, if an investor is able to identify a under or overvalued company, they can make the appropriate decision to either buy the stock if it is undervalued or sell the stock (we’ll come to how you can sell stock you don’t have later) if it is overvalued. Over time, whether it is overnight or over 5 years, the market will correct itself and the investor will profit from his analysis of the companies true value compared with the market’s perception of its value.

In later posts, I will describe how Greenblatt’s book proposes a magic formula strategy for identifying undervalued companies based on a company having a high earnings yield and a high return on capital. Firstly, however, this post will aim to explain these concepts so that we can get familiar with them first. Some of the definitions below are drawn from Tracy’s glossary in The Fast Forward MBA in Finance, Second Edition.

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This website will share a range of financial information centering mainly around corporate finance, investing, share trading, the stock market, growing companies and business, Economics, Law, Random relevant news events, and generally making money (probably some poker thrown in).

I am writing this blog for three main reasons. Since finishing my law degree, I find myself reading many books on these subjects and so far i am finding them particularly interesting.

In addition to this, financial topics are traditionally very hard to ‘get into’ or learn about and there seems to be a certain and somewhat intentional cloud of secrecy around their understanding. The number of times I have searched “learn share market” or “what is an option?” into Google and arrived at a page telling me to go to seminar or pay for an ebook (that is likely to tell me to go to a seminar) has led me to believe someone should be providing this information for free.

Finally, understanding these things is interesting even on the face of it but can obviously allow you to have a much greater chance of success in a variety of important facets of life no matter what you do and who you are. You don’t have to be a capitalist or investment banker to enjoy finance and regardless of your political and moral inclinations, understanding these topics are likely to increase your ability to live in what is obviously a capitalist society.

I am not a finance expert, I have a sound business sense in development and a legal background, but i am by no means going to write like so many money magazines or guides where you need a cipher to understand the majority of an article. Ideally, this blog will be simple, straight to the point and introductory to a wide range of financial topics.

This blog will hopefully demystify some of the concepts that seem so foreign to most people and provide a less than 400 page insight into the financial world from the perspective of an financial novice as I begin to truly understand alot of the concepts myself.

I look forward to writing this blog and i hope someone out there will enjoy reading it.

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