Learning to understand annual reports is the first step in starting our investment journey. After getting over the first hurdle of looking at numbers, we also need to take a step further and interpret their meaning. For most investors, this can be a daunting task as financial formulas and jargon can be less than intuitive.
As with learning any new subject, the key to understanding is to be familiar with the relevant vocabulary. Apart from revenue, cost, and profit, here are 10 common financial jargons we wished someone explained to us when we were about to kickstart our investment journey.
Read Also: Guide To Value Investing In Singapore
#1 EBITDA: Earnings Before Interest, Tax, Depreciation And Amortisation
How to calculate it: Take net profit and add back interest paid, taxes, depreciation, and amortisation.
Formula: EBITDA = Net Profit + Interest Paid + Taxes + Depreciation + Amortisation
What is this: One of the most popular financial jargon, it is the quickest way to determine a company’s earning power. Interest, taxes, depreciation, and amortisation are not direct expenses involved in the day-to-day operations that keep the company functioning. Removing these indirect expenses allow us to see the actual cash-generating potential and hence signifying a company’s financial health.
#2 EV: Enterprise Value
How to calculate it: Add the company’s market capitalisation with total debt and minus out all the cash (including cash equivalents)
Formula: Enterprise value = Market Capitalisation + Total Debt – Cash (and Cash equivalents)
What is this: Technically, it is the base price required to acquire the company. Enterprise Value (EV) can be a better reflection of the company’s value compared to market capitalisation because a potential company’s buyer would be required to pay off its debt. The cash is deducted because it can be assumed the buyer would take the cash for their own.
Like EBITDA, EV is one of the most common financial terms and it is used in many investment and financial ratios.
#3 OPM: Operating Profit Margin
How to calculate it: Use gross profit and minus off all operating expenses, including variable and fixed cost, to get operating profit. Take operating profit and divide it against total revenue.
Formula: Operating Profit Margin (%) = (Gross Profit – Operating expenses)/Total Revenue
What is this: A popular financial metric, operating profit margin is used to determine the company’s ability to generate cash from its core operations.
A low OPM does not represent the full picture as we need to consider the nature of the business industry too. For example, the Food and Beverage industry generally have thinner margins compared to other industries. Regardless, OPM still does serves as a good comparative base across the industry against companies with similar business models.
#4 PATMI: Profits After Tax & Minority Interests
How to calculate it: Use net profit to deduct both taxes and the percentage of net profit allocated to minority stakeholders.
Formula: PATMI = Net Profit – Taxes – Net profit attributable to minority stakeholders
What is this: An important financial formula to note, this is a relevant term for listed holding companies that have consolidated financial results with multiple subsidiaries.
In essence, minority interests are minority stakeholders owning lesser than 50% of the company. Normally, all profits are attributable only to the listed companies and their shareholders. However, companies with consolidated financial statements will have to deduct off subsidiaries’ profits to the relevant minority stakeholders.
An example of an SGX listed company is CapitaLand. As a real estate developer, CapitaLand does go into joint ventures for development projects, especially for overseas developments. This has led to multiple subsidiaries being formed and consolidated into their financial statements. The profits from the subsidiaries would eventually split profits with its minority shareholders and CapitaLand would have to deduct minority interests deducted from the consolidated net profit.
#5 P/E Ratio: Price To Earnings Ratio
How to calculate it: Divide current share price against earnings per share
Formula: P/E ratio = Share Price / Earnings per Share
What is this: Price to Earnings Ratio (P/E) is a vital financial metric to determine if stock is priced reasonably. The metric reflects how much we are paying for every dollar the company earns. This means that the lower the P/E ratio is, the more undervalued it is. However, it is important to still delve into the earnings of the company as a lower P/E ratio for a particular year could be due to certain outsized earnings from a one-off investment.
Investors can use this metric to compare across the industry to determine if a company is relatively overpriced as compared to its peers.
Read Also: 3 Key Financial Ratios Investors Should Look At Before Investing In A Company
#6 PEG Ratio: Price To Earnings To Growth Ratio
How to calculate it: Use P/E ratio and divide it by the expected profit growth rate.
Formula: PEG Ratio = (Share price / Earnings per Share) / Rate Earnings Growth
What is this: Popularised by high growth companies, including tech unicorns, Price To Earnings To Growth Ratio is used to factor in the potential a company has in the future. For most growth stocks, their P/E ratio tends to be low as their earnings may not be high enough due to the unconquered market share.
One flaw of this metric is that the growth rate can differ from investor depending on how bullish or bearish they are on the company.
#7 P/B Ratio: Price To Book Ratio
How to calculate it: Divide market capitalisation against net value of assets on the balance sheet (total assets less total liability).
Formula: P/B Ratio = Market Capitalisation / Net Assets
What is this: Another metric to determine if a stock is priced reasonably. Having a P/B that is above 1 means that a company’s share is trading at a value that is higher than the book value of its assets. A P/B that is below 1 means that a company’s share is trading at a discount to its current net asset value.
However, a low P/B value doesn’t automatically mean that a company is undervalued. The metric should be used to compare the company across industry against similar companies. From comparison, it would be possible to tell if the company’s asset is overvalued or it is just an industry characteristic to be asset-heavy for operations.
#8 D/E Ratio: Debt To Equity Ratio
How to calculate it: Use total debt divided by total equity.
Formula: Debt to Equity Ratio = Total Debt / Total Equity
What is this: Also known as the net gearing ratio, the debt to equity ratio is a method used to determine if the company is borrowing at a healthy pace. As equity calculated as total assets less total liabilities, it is the total claim shareholders have on the company after the debtors first claim.
Having a high D/E ratio would mean that the company could be borrowing unsustainably. However, it is still necessary to compare the ratio across the industry and against similar companies as some capital-intensive industries will naturally have a higher D/E ratio.
#9 Current Ratio
How to calculate it: Divide current assets against current liabilities.
Formula: Current Ratio = Current Assets / Current Liabilities
What is this: Current ratio is a quick measure to determine the company’s ability to pay off its short-term debt with its liquid assets. Sometimes called the working capital ratio, a company with a low current ratio could be risky as it might not be able to fulfil its short-term obligations to keep operations going.
However, this ratio is relative within different industries. For industries that have practises of giving long credit days, having a lower current ratio is an industry characteristic.
#10 ESG: Environment, Social, And Governance
Currently, there is no formula to calculate the extent of how ESG friendly or active a company is. Except for a guideline metric from the United Nations on the 17 sustainable development goals.
What is this: There has been an increased focus on environmental, social and governance (ESG) issues for companies. Since 2016, it has been mandatory for all listed company on SGX to publish a sustainability report alongside their annual reports. Likewise, Bloomberg has also released a Gender Equality Index to identify listed companies with a dedication to gender equality around the globe.
Apart from profits and assets, reading a company’s sustainability report can provide a more holistic view of the company and its operations through its social practices.
Read Also: 4 Financial Ratios To Look Out For When Investing In Small & Mid-Cap Stocks
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