Extracts from the ebook

Chapter 1: The concept of the book

"The aim of this book is to present the relatively complicated theoretical tools necessary to be a competent stock picker, and to transmit these tools so that the non-specialist can understand and apply them. This is done by first introducing the reader to the most important valuation tools for stock companies. Then the tools are applied on Coca-Cola, the American soft drink producer. Thus, the reader might find the first theoretical part somewhat difficult, but the practical case will show that the theories are in fact highly functional tools."

Chapter 2: What is a stock market?

"This chapter is somewhat banal, but it is always useful to state the basic facts before advancing towards new and more dangerous terrain. In addition to these fundamental facts, this chapter presents some philosophical perspectives on investing in the stock market. Different investors have different investment philosophies, and often the stock market seems less like science and more like religion. If you know the different “religions”, you will better comprehend the market dynamics."

Chapter 2.1: The function of the stock market

"To most people the stock market symbolises power and money. To others it is a place where speculative money is circulated without any purpose. However, the reality is that the stock market is a cornerstone of modern society. Without the stock market, raising new capital would be costly and difficult for the largest companies, which would mean less investments and less employment. It would also be impossible for small and medium sized savers to invest in high-quality companies. In addition, the stock market offers the opportunity to reallocate savings whenever necessary."

Chapter 2.2: The players in the stock market

"a stock market behaves in accordance with the sum of the acts of its players. In addition to the investor groups following different investment philosophies, the stock markets are made up of a great span of specialised players fulfilling different functional roles."

Chapter 2.3: Relationship with other financial markets

"Falling interest rates lower the alternative cost of capital, reduce the net financial cost for companies and increase economic growth."

"FX crises normally create temporary uncertainty in the stock market and usually represent a favourable time for investing."

Chapter 3: The theoretical framework for valuations

"stock picking is primarily about evaluating the potential of a share relative to the price in the stock market. If a company has more values per share than the share price indicates, this means that you get more than one euro per euro invested. If you pick the stocks with the highest value relative to price and put them into your investment portfolio, you are in the long run going to outperform the market."

Chapter 3.1: Identifying the investment case

"To identify the investment case you must find the value drivers for the company. The value drivers are the elements that influence the company’s capacity to generate future cash flows and to increase the value of the assets in the company."

Chapter 3.2: The required return on investment

"To put a value on the estimated cash flows or to use other valuation models, like P/E, we must define the required return on investment. This chapter is intellectually challenging, but also extremely important. Do not lose confidence just because you do not understand all the concepts immediately. The basis for calculating the return, which a representative investor requires on an investment, is the investor’s alternative cost. The investment needs to return more than you alternatively could have received from another investment."

Chapter 3.3: The discounted cash flow model (DCF)

"The DCF-model calculates the value of these cash flow and hence the value of the company. Hence, the discounted cash flow model is per definition the theoretically correct model. All other pricing models, discussed in the following chapters, are just proxy calculations for the discounted cash flow value."

Chapter 3.4: Absolute key figure analysis

"The key figures for a company might tell the investor about the economic development in the company. These would be key figures like operating margin and capital turnover. However, we also have key figures that tell the investor about the pricing of the shares."

Chapter 3.5: Relative key figure analysis

"In addition to calculating the fair P/E and fair EV/OPLAT, the key figures for several companies can be estimated and compared. Also, the current key figures relative to historic observations can be looked at. But, historic comparisons are very difficult because the interest rates, risk premiums, betas, taxes, and growth potential change over time. Still, calculating historical key figures for the total market, give the investor a feeling for the market’s willingness to price shares in different situations. We could compare the key figures for a specific company with the market averages, but an individual company tends to be very different from the market and not really comparable. Still it might improve your feeling for the pricing even further. Comparing companies in the same industry makes much more sense."

Chapter 3.6: Substance valuation

"In a substance valuation, we add up the values of all company assets, and deduct the debt to find the values that belong to the shareholders."

Chapter 4: Real world case: Coca-Cola

"With this required return on total capital (WACC) the model returns a fair value per share of USD 59 (Illustration 4.1.13), which means that given the current share price of USD 44 the company has a 34% upside to become correctly priced."

Chapter 5: Concluding remarks

"In this book you have been introduced to the most important concepts of the stock market, the best valuation tools in practise and some practical examples. Even though the practical applications have improved your understanding of the theories, some of the material is highly technical and can be difficult to grasp. You need to make many analyses to get complete control over the tools presented in this book. A professional analyst is usually not considered fully educated before he or she has 2-3 years of experience. Thus, be patient, make a lot of models and research and go back to the book when you are in doubt."