Cumulative and Geometric returns

If you had invested $1 with Warren Buffett in 1965, it would have grown to $2078 in 2000. Given below are the returns extracted from his letter to the shareholders. How did he arrive at the average annual gain of 23.6% and an overall gain of 207,821%. Let us start with the calculations for overall gain.…

Measuring Portfolio Performance

We invest our hard earned money in stocks and bonds. Year 2013 is coming to an end and we want to know how our portfolio performed. But how do we measure the performance of a portfolio? In this post I will show you how. Given below is a simple portfolio. $1000 was invested on 1st Jan…

Dupont Ratio Analysis

BestBooks and GreatBooks are two retail companies selling all kinds of books. Given below are some of their financial data in 2011 and 2012 BestBooks 2011 2012 Total Assets 1000 1500 Debt 0 0 Equity 1000 1500 Sales 2000 2200 Interest Expense 0 0 Net Income 500 550 GreatBooks 2011 2012 Total Assets 1000 1250…

Manias, Panics, and Crashes

History is replete with episodes of manias, panics and crashes. People go crazy and chase assets that are hot and in turn bid up the price to stratospheric levels. All these manias end with a crash. But these crashes were obvious only in the hindsight. In this post I am writing about the crashes that I…

Owner Earnings

Imagine that you are the owner of a retail business. The earnings that you can take out of the business every year without affecting its competitive position is called as Owner Earnings. This is the excess cash that can be taken out without affecting the business. Warren Buffett introduced this term in the 1986 letter…

Earnings Yield

Earnings Yield is defined as Earnings Yield = EBIT / Enterprise Value EBIT = Earnings Before Interest and Taxes. Enterprise Value = Market Value of Equity + Net Interest Bearing Debt Let us understand this with an example. Imagine you purchased a building with the following terms. Purchase price = $100 Mortgage = $ 80…

Return on Invested Capital

Return on Invested Capital (ROIC) is used to measure the company’s efficiency to allocate capital. The formula for ROIC is ROIC = After Tax Operating Income / Invested capital Don’t worry if you did not understand the formula. I did not either. I started with the question Why do we need ROIC? We already have…