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Beta is the statistical measure of the risk of an investment. It measures the volatility of, say, a stock or a fund, in relation to the overall market. Beta is used by investors to assess risk in the stocks they buy or sell. The overall market has a beta of 1 and individual stocks are ranked according to how much they deviate from the market. A stock that swings more than the market over time has a beta above 1. And if a stock moves less than the overall market, its beta is less than 1. In a nutshell, a stock with a beta above 1 is more volatile than the market, while one with a beta below 1 is less volatile. Why is it important? High-beta stocks are supposed to be riskier but provide potential for higher returns. Examples of high-beta Singapore stocks are DBS Group Holdings, Keppel Corp and CapitaLand. Low-beta stocks pose less risk but also lower returns. Some examples are ComfortDelGro, ST Engineering and Singapore Post. So you want to use the term? Just say... 'I like stocks that have strong balance sheets and are low beta as they will be resilient even in the midst of uncertainty.'
What Does Leverage Mean? 1. The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. 2. The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged. Leverage is most commonly used in real estate transactions through the use of mortgages to purchase a home.
Leverageis a business term that refers to borrowing. If a business is "leveraged," it means that the business has borrowed money to finance the purchase of assets. The other way to purchase assets is through use of owner funds, or equity. One way to determine leverage is to calculate the Debt-to-Equity ratio, showing how much of the assets of the business are financed by debt and how much by equity(ownership).
Leverage is not necessarily a bad thing. Leverage is useful to fund company growth and development through the purchase of assets. But if the company has too much borrowing, it may not be able to pay back all of its debts. The degree to which an investor or business is utilizing borrowed money. Companies that are highly leveraged may be at risk of bankruptcy if they are unable to make payments on their debt; they may also be unable to find new lenders in the future. Leverage is not always bad, however; it can increase the shareholders' return on their investment and often there are tax advantages associated with borrowing. also called financial leverage. Free cash flow to equity:
This is a measure of how much cash can be paid to the equity shareholders of the company after all expenses, reinvestment and debt repayment. ...
Calculated as: FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt - Debt Repayment Investopedia explains Free Cash Flow to Equity - FCFE FCFE is often used by analysts in an attempt to determine the value of a company. This alternative method of valuation gained popularity as the dividend discount model's usefulness became increasingly questionable. What Does Free Cash Flow For The Firm - FCFF Mean? A measure of financial performance that expresses the net amount of cash that is generated for the firm, consisting of expenses, taxes and changes in net working capital and investments. Calculated as:
Investopedia explains Free Cash Flow For The Firm - FCFF This is a measurement of a company's profitability after all expenses and reinvestments. It's one of the many benchmarks used to compare and analyze financial health. A positive value would indicate that the firm has cash left after expenses. A negative value, on the other hand, would indicate that the firm has not generated enough revenue to cover its costs and investment activities. In that instance, an investor should dig deeper to assess why this is happening - it could be a sign that the company may have some deeper problems.
What Does Free Cash Flow Yield Mean? An overall return evaluation ratio of a stock, which standardizes the free cash flow per share a company is expected to earn against its market price per share. The ratio is calculated by taking the free cash flow per share divided by the share price. To illustrate:
Investopedia explains Free Cash Flow Yield Free cash flow yield is similar in nature to the earnings yield metric, which is usually meant to measure GAAP earnings per share divided by share price. Generally, the lower the ratio, the less attractive the investment is and vice versa. The logic behind this is that investors would like to pay as little price as possible for as many earnings as possible. Some investors regard free cash flow (which takes into account capital expenditures and other ongoing costs a business incurs to keep itself running) as a more accurate representation of the returns shareholders receive from owning a business, and thus prefer to free cash flow yield as a valuation metric over earnings yield. What Does Discount Cash Flow - DCF Mean? A valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one. Calculated as:
Also known as the Discounted Cash Flows Model. Investopedia explains Discounted Cash Flow - DCF There are many variations when it comes to what you can use for your cash flows and discount rate in a DCF analysis. Despite the complexity of the calculations involved, the purpose of DCF analysis is just to estimate the money you'd receive from an investment and to adjust for the time value of money. Discounted cash flow models are powerful, but they do have shortcomings. DCF is merely a mechanical valuation tool, which makes it subject to the axiom "garbage in, garbage out". Small changes in inputs can result in large changes in the value of a company. Instead of trying to project the cash flows to infinity, terminal value techniques are often used. A simple annuity is used to estimate the terminal value past 10 years, for example. This is done because it is harder to come to a realistic estimate of the cash flows as time goes on.
Weighted Average Cost Of Capital - WACC
What Does Weighted Average Cost Of Capital - WACC Mean? A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. All else help equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk. The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing:
Where: Re = cost of equity Rd = cost of debt E = market value of the firm's equity D = market value of the firm's debt V=E+D E/V = percentage of financing that is equity D/V = percentage of financing that is debt Tc = corporate tax rate Businesses often discount cash flows at WACC to determine the Net Present Value (NPV) of a project, using the formula: NPV = Present Value (PV) of the Cash Flows discounted at WACC. Investopedia explains Weighted Average Cost of Capital - WACC broadly speaking, a company’s assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances. A firm's WACC is the overall required return on the firm as a whole and, as such, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers. It is the appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm. What Does Cost Of Capital Mean? The required return necessary to make a capital budgeting project, such as building a new factory, worthwhile. Cost of capital includes the cost of debt and the cost of equity.
Investopedia explains Cost Of Capital The cost of capital determines how a company can raise money (through a stock issue, borrowing, or a mix of the two). This is the rate of return that a firm would receive if it invested in a different vehicle with similar risk. What Does Cost Of Debt Mean? The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; however, because interest expense is deductible, the after-tax cost is seen most often. This is one part of the company's capital structure, which also includes the cost of equity. Investopedia explains Cost Of Debt A company will use various bonds, loans and other forms of debt, so this measure is useful for giving an idea as to the overall rate being paid by the company to use debt financing. The measure can also give investors an idea as to the riskiness of the company compared to others, because riskier companies generally have a higher cost of debt. To get the after-tax rate, you simply multiply the before-tax rate by one minus the marginal tax rate (before-tax rate x (1-marginal tax)). If a company's only debt were a single bond in which it paid 5%, the before-tax cost of debt would simply be 5%. If, however, the company's marginal tax rate were 40%, the company's after-tax cost of debt would be only 3% (5% x (1-40%)). What Does Cost Of Equity Mean? In financial theory, the return that stockholders require for a company. The traditional formula for cost of equity (COE) is the dividend capitalization model:
A firm's cost of equity represents the compensation that the market demands in exchange for owning the asset and bearing the risk of ownership. Investopedia explains Cost Of Equity Let's look at a very simple example: let's say you require a rate of return of 10% on an investment in TSJ Sports. The stock is currently trading at $10 and will pay a dividend of $0.30. Through a combination of dividends and share appreciation you require a $1.00 return on your $10.00 investment. Therefore the stock will have to appreciate by $0.70, which, combined with the $0.30 from dividends, gives you your 10% cost of equity. The capital asset pricing model (CAPM) is another method used to determine cost of equity.
What Does Opportunity Cost Mean? 1. The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action. 2. The difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment - say, a riskfree government bond yielding 6%. In this situation, your opportunity costs are 4% (6% 2%). Investopedia explains Opportunity Cost 1. The opportunity cost of going to college is the money you would have earned if you worked instead. On the one hand, you lose four years of salary while getting your degree; on the other hand, you hope to earn more during your career, thanks to your education, to offset the lost wages. Here's another example: if a gardener decides to grow carrots, his or her opportunity cost is the alternative crop that might have been grown instead (potatoes, tomatoes, pumpkins, etc.). In both cases, a choice between two options must be made. It would be an easy decision if you knew the end outcome; however, the risk that you could achieve greater "benefits" (be they monetary or otherwise) with another option is the opportunity cost. What Does Discount Rate Mean? 1. The interest rate that an eligible depository institution is charged to borrow short-term funds directly from a Federal Reserve Bank. 2. The interest rate used in determining the present value of future cash flows. Investopedia explains Discount Rate 1. This type of borrowing from the Fed is fairly limited. Institutions will often seek other means of meeting short-term liquidity needs. The Federal funds discount rate is one of two interest rates the Fed sets, the other being the overnight lending rate, or the Fed funds rate. 2. For example, let's say you expect $1,000 dollars in one year's time. To determine the present value of this $1,000 (what it is worth to you today) you would need to discount it by a particular rate of interest (often the risk-free rate but not always). Assuming a discount rate of 10%, the $1,000 in a year's time would be the equivalent of $909.09 to you today (1000/[1.00 + 0.10]).
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