What's up guys, if you're new here my name is Ben and I'm a former JPMorgan investment banker and today I'm going to be going through 15 essential finance terms every investor needs to know divided into three categories beginner, intermediate, and advanced. So this video should be helpful regardless of your level of experience. Now before getting started if like me you're fascinated by the world of investing you may want to check out the Applied Value Investing Certificate program being offered by Wall Street Prep and Wharton which is where I got my MBA. This program teaches you how to apply the principles of value investing with the sophistication of an institutional investor and is taught by Wharton professors and keynote speakers from real investors including Oak Tree's founder Howard Marks who is one of the most famous investors in the world. Through this eight week long program you'll learn about the core concepts behind value investing such as market efficiency, intrinsic value, process-driven value investing, and a whole lot more.
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And I'll leave information for everything I just discussed in this video's description. All right, let's now go into the 15 terms. first starting off with the beginner ones.
The first term is EBIT which stands for earnings before interest and taxes and is also called operating income. EBIT tells you how profitable the company's operations are without considering debt interest payments and taxes and this is really useful because companies have all kinds of different debt levels and tax rates and so EBIT is a really great way to compare the operations amongst different companies. Next on the list we have net income which is also known as the bottom line.
and this is what's left after interest and taxes are paid. You can think of this as your own take-home pay from your gross salary after you pay off things like your student loans and taxes. Third on the list we have assets which are resources owned by a company that hold economic value and can provide future benefits and so they serve as the foundation of a company's ability to generate value. Assets can be divided into current assets which are the ones that can be converted into cash within a year such as cash, accounts receivable, and inventory. and then there are non-current assets which are long-term resources like plant property and equipment or patents.
On the flip side, we have liabilities which are obligations or debts that need to be settled, typically with cash or other resources. Similar to assets, liabilities can be split into current and non-current. Current liabilities are short-term obligations due within a year, such as accounts payable, accrued expenses, and short-term loans, while non-current liabilities are longer-term like long-term debt and long-term leases.
Our last beginner term is a combo and they are growth rates and margins and I've combined them since they're kind of commonly looked at together and are percentages. Growth rates are critical indicators for investors because they show how quickly key financial metrics are increasing over time. The most commonly analyzed growth rate is revenue growth either year over year or quarter over quarter and also by product line but sometimes investors also look at EBIT, EBITDA, and net income growth as well.
Margins show how efficiently a company turns revenue into profit. Margins are crucial and provide insight into operational efficiency by expressing various financial metrics as a percentage of revenue with the most common ones including gross margin, operating margin, and profit margin. Both growth rates and margins are vital to investors because they allow them to compare a company's financial health and efficiency to its competitors.
Alright now that you have the beginner terms down let's go into the intermediate ones. The first one on the list is EBITDA which is similar to EBIT but adds back depreciation and amortization which are non-cash expenses that reduce net income but don't actually involve cash outflows and this is more of an accounting concept and I wouldn't worry too much about it if this is new to you. What is important to know though is that EBITDA is widely used by investors as a proxy for cash flow because it provides a simple way to assess operational profitability across different companies without being affected by financing and accounting decisions.
The next three terms are often kind of confused with each other but are very very different and they are shareholders equity, equity value, and enterprise value. Starting with shareholders equity, this is the value of a company belonging to shareholders after all liabilities have been subtracted from assets and so shareholders equity is a line item that can be found on the balance sheet and it's also referred to as the book value of equity. That said, the book value of equity is a historical cost and does not reflect current market value. So looking at shareholders'equity can be super misleading, which is why we have our next term, equity value, also known as market capitalization.
Equity value is what the market says the company's equity is worth, and you can calculate it by multiplying a company's share price by its total number of shares. And this- This provides investors a quick snapshot of a company's size, organized usually into small cap, mid cap, and large cap. The owners of a company aren't just equity holders though, and so that's why we have something called enterprise value, which is calculated with the formula equity value plus debt plus non-controlling interest plus preferred stock minus cash. To explain what enterprise value is, if you think about the value of an entire company as a pie chart, you have equity holders, which usually hold a majority, but you also have debt holders, preferred stockholders, and non-controlling interest holders. And so if you wanted to purchase the whole entire company, you would need to pay off all of these holders to fully own the company.
And so to explain how these three work together, imagine you bought a car for ten thousand dollars but you financed it with eight thousand in debt and paid with two thousand in cash. The two thousand dollars you personally paid towards owning the car would be your shareholders equity. Then let's say you get lucky and the car's market value jumps up to twenty thousand, That is your market capitalization.
And lastly, in order to fully own the car, a buyer will need to pay $20,000 for the market value plus pay off the $8,000 in debt, making the enterprise value $28,000. Last on our intermediate list are multiples, and these are valuation ratios used to compare a company's financial metrics to its peers to determine how expensive a company is trading in the market. The most common multiples include revenue, EBITDA, and PE multiples. and the higher the multiple, the more expensive a company.
So for example, if company A and B both have enterprise values of 100 million, but company A has EBITDA of 10 million and company B has 20 million, then company A is trading at 10 times EBITDA, while company B is trading at 5 times EBITDA. What this means is that investors are paying $10 for every $1 in EBITDA company A earns, while paying $5 for every $1 in EBITDA company B earns. Just like anything else you always want a discount when you buy and so you generally want to purchase companies trading at lower multiples but companies are usually trading at premiums or discounts for good reasons so you do have to be kind of careful just because a company has a low multiple doesn't mean that it's at a discount and a good value.
Alright now last up let's go into our advanced terms. First up we have beta which measures how much a stock's price fluctuates relative to the market index which typically is the S&P 500. A beta of 1 means the stock moves in line with the market. Greater than 1 means it's more volatile and less than 1 means it's less volatile. And so for example a beta of 1.5 means the stock moves 1.5 times more than the market and so if the market is up 10% then the stock would be up 15%. Similarly a beta of 0.5 means that the stock moves 0.5 times the market and so if the market is up 10% the stock would be up 5%.
Beta is particularly useful for measuring the riskiness of a stock compared to the broader market and is also a key input for calculating expected returns using the CAPM model which is our next term. CAPM stands for Capital Asset Pricing Model and this is a formula used to calculate the expected return of an investment based on its risk. The formula is the risk-free rate plus beta times the market risk premium and breaking this down the risk-free rate is the rate at which you can pretty much invest without taking on any risk and this is typically represented by the yield on 10-year US treasury bonds. Beta we talked about a bit earlier and the market risk premium is the difference between the expected return of the stock market and the risk-free rate. And so for example given that the 10-year treasury yield right now is at 4.6 percent and if beta is 1.2 and we assume that the stock market return is 10.1 percent then the expected return on this individual fake stock that we're looking at is 11.2%.
Our next term is WAC or the weighted average cost of capital which represents the average return required by a company's investors including both equity and debt holders. The formula for WAC is the percentage of equity times cost of equity which by the way can be calculated using CAPM plus the percentage of debt times the cost of debt times one minus the tax rate since interest payments are tax deductible. And so for example if a company has 100 million in equity 50 million in debt, a cost of equity of 11.2%, cost of debt of 5%, and a tax rate of 25%. WAC would equal 8.7% and this represents the return a company would need to generate on its assets to meet the expectations of both its equity and debt investors.
As a result, a lower WAC is generally seen as less risky and more efficient at raising capital, while a higher WAC is used for riskier companies like startups and I'd say a pretty high WAC would be something like 14%. average would be around 10% and a really low one would be around 7%. Next on our list we have return on invested capital or ROIC and this measures how well a company generates returns from its invested capital which includes equity and debt.
The formula for ROIC is NOPAT or net operating profit after taxes or EBIT times one minus your tax rate divided by invested capital which is the total amount of money raised to fund operations including equity and debt financing. ROIC is a great indicator of whether a company is creating or destroying value and a good rule of thumb is to compare your ROIC to your company or assets WACC. If your ROIC exceeds WACC then the company is adding value for its investors and then of course the opposite is true as well.
Alright you made it to the end last but not least we have the Sharpe ratio which measures the risk adjusted return of an investment by comparing the excess return to the investment's volatility. This ratio is calculated using the formula return minus risk-free rate, all divided by your standard deviation of your returns, and a higher Sharpe ratio indicates that an investment is providing more return per unit of risk, while a lower one indicates that the return is not sufficient to justify the risk. The Sharpe ratio is incredibly useful when comparing two potential investments or assessing the overall performance of a portfolio.
and is often used to measure the true performance of investors at private equity firms and hedge funds. Alright so that concludes the 15 terms. Let me know if there are any other ones that you want me to explain in the comments below and I'll reply. And before you leave, I also wanted to let you know that I've recently launched my investment banking community in case you're watching this video because you're interested in breaking into investment banking and you'll get access to the resume and cover letter that I used to apply to JPMorgan.
all my financial models, live Q&A sessions with me, and a whole lot more for just $29 a month for the first 100 users. So feel free to check this out in this video's description if you're interested. In the next screen, you're gonna see a video about how to value companies, which I think is a great follow-up to this video. That said, thank you all so much as always for watching and hope to catch you all in the next one.