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Net non-operating income expense
Old 12-29-2009, 05:55 PM   #1
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Net non-operating income expense

I have picked up several of the books recommended for stock analysis. One is called "Warren Buffet and the Interpretation of Financial Statements". I'm using HD to research as I read the book. I am looking at the Income Statement for Q4 of 09 and I see a Net non-operating income expense of minus 168.000. My question is: what does it mean to have a minus number here?

Well, I see in the SEC filing that the number is plus 168. The minus 168 is on the Vanguard Fundamentals page. I guess I'll stick with the SEC.
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Old 12-30-2009, 06:24 AM   #2
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Stick with the SEC filings.

When I analyze a company, I usually back out this sort of thing when assessing the company's structural cash generation capabilities. Its usually non-recurring and not related to the core business. But if it is a big number you would want to find out what caused it.

If it is in the expense section of the income statement, a minus may indicate a gain.
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Old 12-31-2009, 07:18 PM   #3
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I am still reading and have another question. In the book I cited above it says:

On Income statement statement:
---net earnings should show an historical trend upwards of > 20%

% of net earnings = net earnings / total revenue

For Home Depot:
net income (689) / total revenue (16361) =4.2%


My questions:
Is net income the same as net earnings? If so, did I figure this correctly?
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Old 01-01-2010, 06:08 AM   #4
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A couple of things:

1) Net earnings should be equal to net income

2) I think you have misinterpreted the statement "historical upward trend." I think what this book is suggesting is that earnings for year 2 should be about 20% higher than year 1. This is highly subjective and not the way I look at the world. If I get some time this weekend, I will give you the thumbnail sketch on how I approach valuation.

But good on you for keeping at it. Keep up the good work!
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Old 01-01-2010, 09:37 AM   #5
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Thanks, Brewer. There are so many definitions in this book that I am confusing myself as to which ones are useful. A thumbnail sketch would be very helpful. And Happy New Year!
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Old 01-01-2010, 07:16 PM   #6
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How I look at valuation:

This is an admittedly crude way of doing things, but it is applicable to securities ranging from secured debt to bonds to preferred to common equity. It does not apply to financial institutions, which are another ball of wax entirely.

First I start with the financial statements for the last few years and year-to-date. What you want to do is get to a core EBITDA number for these periods as a starting point. So what is EBITDA? It is Earnings Before Income, Taxes and Depreciation & Amortization. It is an approximation of the unleverd (as if the company had no debt), tax free cash generation capabilities of a company, and it is relatively easy to calculate once you clean up a company's financial statements.

Before you calculate EBITDA, you will need to clean up a company's financial statements. What do I mean by this? Most companies have items appearing on their income statemnts from time to time that must be recognized but are not representative of a company's true earnings power. Examples might include gains on sales of assets/securities/businesses, losses on write-downs, derivatives gains or losses, restructuring charges, etc. There is a whole range of these things and what you take out and what you leave in is a judgement call. Mechanically, the way to do this is to take pre tax net income and add (for write ofs and other losses) or subtract (for gains) the "special" items that are in each period's financial statements. Then you will have a corrected earnings number that hopefully reflects underlying ability to generate cash.

How do we get to EBITDA? Start with your adjusted pre tax income and add back:

- Interest cost minus interest income
- depreciation and amortization

Interest expense and income you will usually see listed on the income statement. In a pinch, companies are required to report cash paid for interest either as part of the cash flow statement or in the notes to the financial statements. D & A may be presented on the income statement, but if they are not you will see them in the cash flow statement.

Now you have adjusted EBITDA numbers for your company for a few years andthe most recent YTD. What you can then do is compute some ratios:

- EBITDA minus Interest is the money a company has left over to invest, expand, pay dividends, pay down debt, etc. If this number is negative or declining without an obvious reason (and a reason could be as simple as we are in a recession and you have reason to think things will get better), this is a big red flag.
- EBITDA minus Interest minus Capital Expenditures (latter found in the cash flow statement) approximates free cash flow. This is what is left after a company has left after it has reinvested in the business. This can be a negative number if a company has found attractive investment opportunities worth going into debt to take advantage of.
- EDITDA/Operating Cash Flow, usually expressed as a %. This tells you how closely EBITDA (an approximation of cash flow) matches up with actual cash flow. If a company is expanding and using a lot of cash to invest in working capital (inventory and receivables, primarily), tthis might be well below 100%. If it is consistently below 100%, you would want to understand why this is the case.
- The big daddy of them all: EV/EBITDA. This is the valuation construct I usually use to keep me honest. EV stands for Enterprise Value. You calculate EV as follows: Short and long term debt minus cash plus preferred stock (if any) plus market cap. You then divide this by EBITDA to get EV/EBITDA. What does this tell us? The EV/EBITDA multiple gives us a nice yardstick to compare similar forms regardless of the amount of debt that they have because the formula puts them all on a level playing field (a dollar of market value of equity is considered the same as a dollar of debt). The best way to use EV/EBITDA is to 1) look at how it has changed over time for a company and industry and 2) compare companies within an industry. As a rule of thumb, not many public businesses trade for less 5 or 6 times EBITDA for any length of time unless something is seriously wring and (usually) EBITDA is expected to rapidly decline. Anything over 12 times EBITDA is either at a cyclical low point (and EBITDA is expected to recover sharply), is in a high growth mode, or is wildly overvalued.

A variant of EV/EBITDA is to look at total debt/EBITDA. This is a useful metric because you can compare how leveraged different companies in an industry are. You can also use it to evaluate a company's ability to take on leverage. Finally, you can also use it as a guide to knowing whether a company's bonds are an attractive investment even when there may be a lot of bad press, ratings downgrades, etc. On this last point, if you know that a company is levered to 3X EBITDA through the bonds and that EBITDA is probably not going to plunge even in the case of bankruptcy, the bonds might look very attractive at a double digit yield/fat dscount to par even if the company hasa non-trivial change of going bust.

I suspect this is a fair amount to absorb, so if I am being unclear go right ahead and ask questions or point out inconsistencies. The other important piece of analytical work you would need to do is building a forecast model for a company. If you are not scared off, I can go into how to do that on another thread.
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Old 01-01-2010, 07:48 PM   #7
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I REALLY appreciate all of this help, Brewer! As you said, it is a lot to absorb, so I am going to take a few days to analyze my HD example using this information. I am sure I'll have more questions. Thanks again!
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Old 01-01-2010, 09:08 PM   #8
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I would suggest stacking HD vs. Lowe's to get a comparative view. It will also show you the vagaries of two companies in the same business having financial statements that look a bit different.

And it is my pleasure. I would rather help educate someone up front than hear the sorry story later. The fact that you are willing to do the work bodes well,since most of this requires (at most) 5th grade math. Otherwise I never would have gotten very far in my profession since I have to ask DW for help on anything more than the most basic algebra.
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Old 01-02-2010, 08:09 AM   #9
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Questions already. I'm down to:

You calculate EV as follows: Short and long term debt minus cash plus preferred stock (if any) plus market cap.

I see long term debt. Is short term debt all other liabilities? Also, would you tell me where to find or calculate market cap?
Yes, my next plan is to look at Lowe's for comparison.
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Old 01-03-2010, 06:35 AM   #10
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Smooch, short term debt would be listed in current/short term liabilities. It might be called "short term debt" or "debt due within a year" or something similar. Generally it will be clearly labelled in the income statement.

Market cap is just diluted shares out times the stock price. If you are calculating this acriss time you would want to use the appropriate period end shares out and prices for different point in time.
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Old 01-03-2010, 12:56 PM   #11
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I am almost finished with the quarter ending 11/1/2009. I think I know the answer to this, but just to be sure:

I calculated EBITDA to be 1527. The next calculation is: EBITDA (1527) minus Interest (164) minus Capital Expenditures (568) = 795


For the rest of the calculations, should I use 1527 for EBITDA or is 795 the new EBITDA?
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Old 01-03-2010, 02:06 PM   #12
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You want to use EBITDA as your main measure. The EBITDA - Interest - CapEx just tells you how much cash a company has left over after paying the interest bill and reinvesting.
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Old 01-03-2010, 07:13 PM   #13
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Brewer, this is my analysis using your directions above. My final calculation, EV / EBITDA, doesn't look right. Do you see any obvious mistakes with my calculations?


Thanks again for all of your help. I'm also using the Warren Buffet book I'm reading to analyze HD, but I'll start a new thread with that.


Analysis of Home Depot for quarter ending 11/1/09

How do we get to EBITDA? Start with your adjusted pre tax income (1099) and add back:
- Interest cost (168) minus interest income (4) = 164
- depreciation and amortization (428)

EBITDA = 1099+164+428 = 1691

EBITDA minus Interest is the money a company has left over to invest, expand, pay dividends, pay down debt, etc. If this number is negative or declining without an obvious reason (and a reason could be as simple as we are in a recession and you have reason to think things will get better), this is a big red flag.

EBITDA (1691) minus Interest (164) = 1527

EBITDA minus Interest minus Capital Expenditures (latter found in the cash flow statement) approximates free cash flow. This is what is left after a company has reinvested in the business. This can be a negative number if a company has found attractive investment opportunities worth going into debt to take advantage of.

EBITDA (1527) minus Interest (164) minus Capital Expenditures (568) = 795 (free cash flow)

EDITDA/Operating Cash Flow, usually expressed as a %. This tells you how closely EBITDA (an approximation of cash flow) matches up with actual cash flow. If a company is expanding and using a lot of cash to invest in working capital (inventory and receivables, primarily), this might be well below 100%. If it is consistently below 100%, you would want to understand why this is the case.

EBITDA (1527) / Operating Cash Flow (4664) = 33%

EV stands for Enterprise Value. You calculate EV as follows: Short and long term debt minus cash plus preferred stock (if any) plus market cap. You then divide this by EBITDA to get EV/EBITDA.

EV (53184) = (Short and long term debt (8656) minus Operating Cash Flow (4664) + preferred stock (0) + market cap (49192))

EV (53194)/ EBITDA (1527) = 3482% -- this doesn’t look good!
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Old 01-04-2010, 07:50 AM   #14
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A few specifics:

It looks like EBITDA is 1691, not 1527, so the last two ratios you came up with are based on something less than EBITDA.

I screwed up the ratio for EBITDA versus cash flow. It should be Operating Cash Flow/EBITDA. In this case, it looks like Cash flow was something like 3X EBITDA. The most likely reason for this was that HD was probably liquidating inventory and/or receivables. This provides a boost to cash flow, but it isn't from an earnings stream, so if this is the case it is OK.

EV/EBITDA as calculated has two flaws. The first is that you are using 1527 rather than your calc of EBITDA (1691). The second is that you need to use annual/annualized EBITDA to get to this ratio. If a business does not have strong seasonal trends, you could just annualize the number you got to (in this case 1691 * 4 = 6764). If a business has a strong seasonal effect to its results (and HD may well exhibit such), you would want to calculate EBITDA over the last 4 quarters to get a realistic multiple. Simply using the annualized EBITDA number of 6764, I get EV/EBITDA of 53194/6764 = 7.86X. I would want to try calculating this ratio based on trailing twelve months, but under 8X EBITDA for a scale (albeit cyclical) business like this does not seem outlandish and likely warrants further research, comparison with Lowe's, etc.
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Old 01-04-2010, 12:59 PM   #15
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Here are the recalculations from the ones I had wrong. I'm looking at some of the definitions on "Investopedia" to understand what I just calculated. If these are now correct, I need to figure all these annualized and then do the same for Lowe's?

Also, one more question. "Investopedia" defines a low enterprise multiple as an indication that a company might be undervalued. Is that multiple only of value compared to other companies in the industry?

EBITDA minus Interest minus Capital Expenditures (latter found in the cash flow statement) approximates free cash flow. This is what is left after a company has reinvested in the business. This can be a negative number if a company has found attractive investment opportunities worth going into debt to take advantage of.

EBITDA (1691) minus Interest (164) minus Capital Expenditures (568) = 959 (free cash flow)

EDITDA/Operating Cash Flow, usually expressed as a %. This tells you how closely EBITDA (an approximation of cash flow) matches up with actual cash flow. If a company is expanding and using a lot of cash to invest in working capital (inventory and receivables, primarily), this might be well below 100%. If it is consistently below 100%, you would want to understand why this is the case.

Operating Cash Flow (4664) / EBITDA (1691) = 276%

EV stands for Enterprise Value. You calculate EV as follows: Short and long term debt minus cash plus preferred stock (if any) plus market cap. You then divide this by EBITDA to get EV/EBITDA.

EV (53184) = (Short and long term debt (8656) minus Operating Cash Flow (4664) + preferred stock (0) + market cap (49192))

EV (53194)/ EBITDA Annualized (6764) = 786%
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Old 01-04-2010, 03:06 PM   #16
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Looks like you have the calculations right. In this case, I would calculate EBITDA for the last 4 quarters for use in your valuation multiples, rather than simply annualizing a single quarter.

In some sense, EBITDA multiples are useful in isolation. just the same as the yield on a security is. A 15% yield is interesting to me regardless of he industry; a 1% yieldis not. But many industries tend to trade within a range of EBITDA multiples over time, so seeing an abnormally high or low multiple without a good explanation may help you identify high or low valuation.

I would pursue this exercise with Lowe's and compare the two. Then I would suggest you try to figure out why the two might trade at different multiples.

The next thing you should learn is how to build a forecast model that estimates EBITDA (among other things) in the future.
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Old 01-05-2010, 08:19 PM   #17
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Thanks again for all of your help. I have quite a bit of work to do now on this. I've picked up a book on forcasting models. I'm sure it will take me a while to understand this!
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Old 01-05-2010, 08:20 PM   #18
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Forecasting models can be really simple or really complex, depending on the purpose and the company. When you are ready, let me know.
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Old 01-06-2010, 04:16 AM   #19
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Nicely done Brewer, a finance course in one post.

My MBA was 20 years ago I sure had forgotten a lot.
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Old 01-06-2010, 06:08 PM   #20
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Today I went to Borders. Really the only book I found that addressed forcasting models in more than one page is "Building Financial Models with MS Excel" by Karen Proctor. It's $70 and was just published in 2010, so I'm sure the library won't have it. Can you recommend any books - I think I'll have to go with keeping it simple.


Also, I have started to analyze Lowe's. I know this is 5th grade math, but I have to see if this is correct before I continue. For the quarter ending 10/30/09, Lowe's has Interest expense of 81 and Interest/investment income of -4. Does this mean they had net interest income of minus 77?
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