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what's up guys if you're new here my
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name is Ben and I'm a former JP Morgan
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investment banker and today I'm going to
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be going through 15 essential Finance
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terms every investor needs to know
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divided into three categories beginner
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intermediate and advanced so this video
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should be helpful regardless of your
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level of experience now before getting
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started if like me you're fascinated by
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discussed in this video's description
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all right let's now go into the 15 terms
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first starting off with the beginner
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ones the first term is ebit which stands
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for earnings before interest and taxes
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and it's also called operating income
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IIT tells you how profitable the
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company's operations are without
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considering debt interest payments and
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taxes and this is really useful because
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companies have all kinds of different
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debt levels and tax rates and so EIT is
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a really great way to compare the
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operations amongst different companies
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next on the list we have net income
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which is also known as the bottom line
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and this is what's left after interest
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and taxes are paid you can think of this
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as your own take-home pay from your grow
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salary after you pay off things like
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your student loans and taxes third on
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the list we have assets which are
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resources owned by a company that hold
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economic value and can provide future
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benefits and so they serve as the
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foundation of a company's ability to
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generate value assets can be divided
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into current assets which are the ones
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that can be converted into cash within a
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year such as cash accounts receivable
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and inventory and then there are
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non-current assets which are long-term
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resources like plant property and
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equipment or patents on the flip side we
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have liabilities which are obligations
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or debts that need to be settled
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typically with cash or other resources
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similar to assets liabilities can be
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split into current and non-current
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current liabilities are short-term
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obligations due within a year such as
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accounts payable accured expenses and
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short-term loans while non-current
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liabilities are longer term like
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long-term debt and long-term leases our
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last beginner term is a combo and they
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are growth rates and margins and I've
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combined them since they're kind of
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commonly looked at together and are
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percentages growth rates are critical
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indicators for investors because they
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show how quickly key financial metrics
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are increasing over time the most
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commonly analyzed growth rate is revenue
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growth either year over-year or quarter
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over quarter and also by product line
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but sometimes investors also look at
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ebit EA and net income growth as well
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margins show how efficiently a company
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turns Revenue into profit margins are
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crucial and provide insight into
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operational efficiency by expressing
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various Financial metrics as a
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percentage of Revenue with the most
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common ones including gross margin
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operating margin and profit margin both
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growth rates and margins are vital to
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investors because they allow them to
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compare a company's Financial Health and
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efficiency to its competitors all right
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now that you have the beginner terms
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down let's go into the intermediate ones
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the first one on the list is IA which is
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similar to EIT but adds back
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depreciation and amortization which are
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non-cash expenses that reduce net income
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but don't actually involve cash outflows
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and this is more of an accounting
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concept and I wouldn't worry too much
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about it if this is new to you what is
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important to know though is that IA is
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widely used by investors as a proxy for
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cash flow because it provides a simple
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way to assess operational profitability
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across different companies without being
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affected by financing and accounting
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decisions the next three terms are often
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kind of confused with each other but are
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very very different and they are
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shareholders Equity Equity value and
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Enterprise Value starting with
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shareholders Equity this is the value of
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a company belonging to shareholders
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after all liabilities have been
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subtracted from assets and so
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shareholders Equity is a line item that
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can be found on the balance sheet and
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it's also referred to as the book value
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of equity that said the book value of
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equity is a historical cost and does not
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reflect current market value so looking
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at shareholders Equity can be super
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misleading which is why we have our next
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term Equity value also known as market
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capitalization Equity value is what the
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market says the company's Equity is
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worth and you can calculate it by
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multiplying a company's share price by
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its total number of shares and this
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provides investors a quick snapshot of a
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company's size organized usually into
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small cap midcap and large cap the
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owners of a company aren't just Equity
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holders though and so that's why we have
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something called Enterprise Value which
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is calculated with the formula Equity
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Value Plus debt plus non-controlling
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interest plus preferred stock minus cash
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to explain what Enterprise Value is if
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you think about the value of an entire
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company as a pie chart you have Equity
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holders which usually hold a majority
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but you also have debt holders preferred
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stockholders and non-controlling
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interest holders and so if you wanted to
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purchase the whole entire company you
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would need to pay off all of these
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holders to fully own the company and so
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to explain how these three work together
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imagine you bought a car for $110,000
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but you financed it with 8,000 in debt
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and paid with 2,000 in cash the $22,000
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you personally paid towards owning the
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car would be your shareholders Equity
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then let's say you get lucky and the
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car's market value jumps up to 20,000
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that is is your market capitalization
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and lastly in order to fully own the car
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a buyer would need to pay 20,000 for the
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Market Value Plus pay off to 8,000 in
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debt making the Enterprise Value
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$28,000 last on our intermediate list
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are multiples and these are valuation
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ratios used to compare a company's
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Financial metrics to its peers to
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determine how expensive a company is
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trading in the market the most common
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multiples include Revenue Etha and PE
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multiples and the higher the multiple
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the more more expensive a company so for
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example if company A and B both have
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Enterprise values of 100 million but
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company a has IA of 10 million and
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Company B has 20 million then company a
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is trading at 10 times IA while Company
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B is trading at 5 times IA what this
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means is that investors are paying $10
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for every $1 in IA company a earns while
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paying $5 for every $1 in E Company B
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earns just like anything else you always
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want a discount when you buy and so you
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generally want to purchase companies
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trading at lower multiples but companies
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are usually trading at premiums or
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discounts for good reasons so you do
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have to be kind of careful just because
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a company has a low multiple doesn't
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mean that it's at a discount and a good
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value all right now last up let's go
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into our Advanced terms first up we have
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beta which measures how much a Stock's
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price fluctuates relative to the market
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index which typically is the S&P 500 a
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beta of one means the stock moves in
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line with the market greater than one
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means it's more volatile and less than
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one means it's less volatile and so for
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example a beta of 1.5 means the stock
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moves 1.5 times more than the market and
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so if the market is up 10% then the
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stock would be up 15% similarly a beta
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of 0.5 means that the stock moves 0.5
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times the market and so if the market is
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up 10% the stock would be up 5% beta is
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particularly useful for measuring the
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riskiness of a stock compared to the
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brought in market and is also a key
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input for calculating expected returns
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using the capm model which is our next
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term capm stands for Capital asset
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pricing model and this is a formula used
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to calculate the expected return of an
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investment based on its risk the formula
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is the risk-free rate plus beta times
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the market risk premium and breaking
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this down the risk-free rate is the rate
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at which you can pretty much invest
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without taking on any risk and this is
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typically represented by the yield on
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10-year US Treasury bonds beta we talked
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about a bit earlier and the market risk
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premium is the difference between the
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expected Return of the stock market and
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the risk-free rate and so for example
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given that the 10-year treasury yield
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right now is at 4.6% and a beta is 1.2
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and we assume that the stock market
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return is 10.1% then the expected return
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on this individual fake stock that we're
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looking at is 11.2% our next term is
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whack or the weighted average cost of
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capital which represents the average
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return required by a company's investors
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including both equity and debt holders
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the formula for whack is the percentage
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of equity times cost of equity which by
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the way can be calculated using capm
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plus the percentage of debt times the
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cost of debt times 1 minus the tax rate
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since interest payments are tax
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deductible and so for example if a
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company has 100 million in equity 50
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million in debt a cost of equity of
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11.2% cost of debt of 5% and a tax rate
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of 25% whack would equal 8.7% and this
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repres ents the return a company would
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need to generate on its assets to meet
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the expectations of both its equity and
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debt investors as a result a lower whack
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is generally seen as less risky and more
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efficient at raising Capital while a
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higher whack is used for riskier
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companies like startups and I'd say a
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pretty high whack would be something
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like 14% average would be around 10% and
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a really low one would be around 7% next
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on our list we have return on invested
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capital or RC and this measures how well
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a company generates returns from its
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invested Capital which includes equity
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and debt the formula for R is no Pat or
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net operating profit after taxes or ebit
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Time 1 minus your tax rate divided by
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invested Capital which is the total
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amount of money raised to fund
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operations including equity and debt
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financing R is a great indicator of
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whether a company is creating or
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destroying value and A good rule of
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thumb is to compare your Ro to your
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company or assets whack if your Ro
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exceeds whack then the company is adding
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value for its investors and then of
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course the opposite is true as well all
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right you made it to the end last but
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not least we have the sharp ratio which
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measures the risk adjusted return of an
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investment by comparing the excess
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return to the investment's volatility
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this ratio is calculated using the
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formula return minus risk-free rate all
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divided by your standard deviation of
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your returns and a higher sharp ratio
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indicates that an investment is
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providing more return per unit of risk
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while a lower one indicates that the
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return is not sufficient to justify the
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risk the sharp ratio is incredibly
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useful when comparing two potential
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Investments or assessing the overall
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performance of a portfolio and is often
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used to measure the True Performance of
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investors at private Equity firms and
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hedge funds all right so that concludes
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the 15 terms let me know if there are
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any other ones that you want me to
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explain in the comments below and I'll
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reply and before you leave I also wanted
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to let you know that I've recently
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free to check this out in this video's
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description if you're interested in the
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next screen you're going to see a video
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about how to Value companies which I
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think is a great follow-up to this video
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that said thank you all so much as
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always for watching and hope to catch
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you you all in the next one
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[Music]
