Neat finance equations
If you don’t like math that’s okay, a lot of people don’t. If you are scared of equations and mathy-looking-stuff that’s okay as well as long as you don’t let it dictate your life. By that I mean wasting good opportunities like this because you don’t want to indulge on the following equations. The equations down below are some (basic) financial equations that are real handy and will enable you to get a better feel for potential investments.
Compounding interest of a finite amount
- Final amount: the amount of money you will get from your investment after it has ended
- Initial investment: the amount of money you invested at the start
- Interest rate: the interest rate of your investment e.g. 1% =0.01 for a bank account
- Timeframe: the timeframe over which you invest
Investing $1000 over 3 years with an interest of 4% leaves you with $1124.86 or an 12.5% increase.
Compounding interest with yearly contributions
The equation is usable if you have an (always equal) contribution. A fix interest over a given timeframe is needed to work out how much money you will have in the end.
Keeping the values from the formula above and using annual contributions= $1000 the final amount equals $3246.46 or an increase of 8.2% compared to $3000.
Rule of 72
The rule of 72 is a super quick estimate on how long it will take to double your money from an investment.
Keep in mind that you need to write the interest amount as an integer so basically for 4% one would calculate 72 by 4.
For an investment with 4% return per period the time to double your investment would be 18. The time period can be anything, a month or a year (or whatever). Also, this works as well for inflation (or negative interest). Assuming a inflation of 3% the time to half your investment equals 24 years.
Keep in mind that the rule of 72 is only an estimate and works fairly well for rates between 6% and 10%. However to get an estimate it works quite good. If you want to calculate the time it takes to double your money precisely use the compounding interest equation from above.
Earnings per Share (EPS)
If you want to know how much profit is allocated to a share you need to determine the EPS. It also gives inside if the company actually makes a profit (eps>0) and it makes it possible to evaluate the amount of profit a company made over a big timeframe. Normally one has to adjust for stock splits. That means that the company offers more shares and therefore “waters down” the share price of the company because now there are more shares available. However, as EPS uses the number of outstanding shares in its denominator this is not necessary.
Lets take the google stock (Alphabet) for example. The amount of shares outstanding is 703.9Mil. and the income is $26.13Bil. Therefore the EPS is 37.12.
That means the company is actually making roughly 37 dollars per share and therefore (highly) profitable. Comparable to that Snapchat has an EPS of -0.99 and is therefore not profitable. That means they actually lose more money than they make. Nowadays it is quite common for companies to start with a negative EPS and slowly make their path to profitability.
Price to Earnings Ratio
The price to earnings ratio is basically a multiplier that shows how much a company’s share price is valued above their actual value. Another point of view on the PE ratio would be that an investor is willing to pay the PE ratio of a stock to pay for $1 of current earnings. You can calculate it by dividing the share price by EPS.
For example @31.07.2018 the share price of google is roughly $1224. We calculated the EPS above (EPS=$37) and therefore we get a PE ratio of 33.08.
Obviously the numbers will have changed by the time someone looks at this post. That is the reason why I wrote down all the numbers. Snapchat has no PE ratio yet as the EPS is negative and therefore we don’t calculate the PE ratio.
The PE ratio is probably the most common evaluation metric for stocks. It makes it possible to compare company’s and especially from the industry. Normally company’s in the same industry share roughly the same PE ratio. If not there might something under the surface that needs you to dig deeper. Lets take the telecom services industry for example. AT&T and VERIZON are both listed as “Telecom Services” and they both share roughly the same PE ratios, namely 17.3 and 15.2. Each industry normally has their own PE ratio. For emerging stocks (who just went from non-profitable to profitable) the PE is often immensely high. After some time it often settles down to the industry standard. The PE ratio can be a sign that a company’s stock is overvalued (priced too high) or undervalued (too low). However this is only one metric. While it is definitely powerful do not make your decisions only by looking at the PE. By the way, the forward PE means the PE estimate for the current year as the data for the PE is derived from the last annual report.
Market capitalization or Market cap.
Another simple and powerful metric. By multiplying the share price of a stock times the outstanding share one gets the market capitalization and short market cap. Using the telecommunications industry AT&T and VERIZON have a market cap of $212Bil. and $228Bil. respectively.
The market cap equals the amount shareholders value a company by using the share price (market value). You can use it to estimate a company’s size. This can give you a feeling for how long a company has been around. A larger market cap can indicate that a company has existed for quite some time. Therefore they might be well established within their respective industry. As a rule of thumb company’s with a small market cap are seen as risky. Their small market cap makes it easier to influence the share price as you would need less money to acquire a certain percentage of their company.
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