October 20th, 2008 presentation:

ACCOUNTING BASICS AND CLUB

PORTFOLIO

Accounting Basics

"FASB stands for the Financial Accounting Standards Board. They are among the most useless people on the planet and they are standing in the way of patriotic American commerce. Imagine the lamest Star Trek-watching nerds hellbent on punishing the successful and cool kids with their nitpicky rules."

Needed for…

◦ Ability to accurately and properly interpret financial statement data

◦ Use in valuation modeling Discounted Cash Flow Model, etc.

◦ Understanding the health of a business

Why is Accounting important to (Value) Investors?

◦ Identifying past, current, and forecasting future performance Return on Equity, Free Cash Flow, other ratios

◦ How it affects the manner in which its components are reported Mark-to-market regulations, etc. This has become a major hotspot lately; if you’re

interested, do a Google search for “FAS 157”

Why is Accounting important to (Value) Investors?

These are what publicly traded companies issue through the SEC and GAAP to report quarterly and yearly performance

Many sites (Yahoo, Google Finance, etc.) report semi-accurate data◦ However, often times they are not the best source

for in-depth research Best to look at the actual filing

◦ Sources? investing.businessweek.com sec.edgar-online.com

Financial Statements

What are the three (primary) financial statements?

◦ Balance Sheet Also called Statement of Financial Position

◦ Income Statement Also called Statement of Earnings

◦ Statement of Cash Flows

Financial Statements

This statement lists all of the companies revenues, expenses, gains, and losses for a given period of time

◦ Example: Apple, Inc.

Revenue = Sale from an iPod, Macbook, etc.

Expense = Cost of goods sold (items needed to manufacture a product), salaries/wages, research & development, etc.

The Income Statement

Important to distinguish differences within each type of account

◦ Is that revenue part of our normal operations or from interest/investments?

◦ What type of expenses is the company incurring and in what volume?

◦ Is this gain or loss occurring frequently or once in a lifetime?

The Income Statement

What is depreciation/amortization?

◦ When a company purchases an asset, it has a limited useful life (5 years, 20 years, etc.)

◦ Depreciation is an annual expensing of the original purchase price of said asset

◦ There are many methods available, but the principle remains the same

◦ Key point: Depreciation in a NON-CASH expense

The Income Statement

Net Income and Earnings Per Share

◦ Ultimately, every company reports net income (or loss) for the given period It’s important to know everything to goes into

calculating this number

◦ Earnings Per Share (EPS) =

Allows comparison of company profitability regardless of overall size

The Income Statement

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

Here’s a shortened version of Apple’s:

The Income Statement

($'s in millions except EPS) 2007 2006Revenue 24,006.00$ 19,315.00$ Cost of Goods Sold (15,852.00) (13,717.00) Gross Profit 8,154.00 5,598.00 SG&A Expense (2,963.00) (2,433.00) Research and Development (782.00) (712.00) Depreciation/Amortization - - Operating Income 4,409.00 2,453.00 Non-operating Income (Expense) 599.00 365.00 Income Tax Provision (1,512.00) (828.00) Extraordinary Items - - Net Income 3,496.00$ 1,990.00$ Common Shares Outstanding 900.00 877.00Earnings Per Share 3.88$ 2.27$

Similar to the Income Statement, as it provides information about a company during a given period of time

However, the Statement of Cash Flows only deals with what the company did with their CASH

A company may be profitable according to their Income Statement, but they may have trouble generating cash

Statement of Cash Flows

The different components Cash flows from…

◦ Operating activities

◦ Investing activities

◦ Financing activities

Statement of Cash Flows

Useful for determining with the company did with its cash

◦ Are they collecting a reasonable amount from their normal operations?

◦ Are they spending a lot of their cash on new assets, prospects for expansion, etc.?

◦ If they have an excess amount sitting around, are they paying out a dividend?

Statement of Cash Flows

Free Cash Flow (FCF):

◦ Operating Cash Flow Inflow or outflow from everyday operations

◦ Capital Expenditures Outflow used to acquire or upgrade physical assets such as machinery, buildings, etc.

◦ Good indicator of whether or not the company is expanding and still has cash on hand to pay its current debt obligations

Statement of Cash Flows

𝐹𝐶𝐹= 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤− 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠

Here’s a shortened version of Apple’s:

Statement of Cash Flows

($'s in millions) 2007 2006Net Income 3,496.00$ 1,989.00$ Depreciation 317.00 225.00 Non-cash Items/Deferred Taxes 332.00 227.00 Changes in Working Capital 1,325.00 (221.00) Cash Flow from Operating Activities 5,470.00$ 2,220.00$ Capital Expenditures (986.00) (657.00) Other Investing Cash Flow Items (2,263.00) 1,014.00 Cash Flow from Investing Activities (3,249.00)$ 357.00$ Financing Cash Flow Items 377.00 361.00 Issuance of Stock (Retirement) 362.00 (37.00) Cash Dividends Paid - - Cash Flow From Financing Activities 739.00$ 324.00$

Net Change in Cash 2,960.00$ 2,901.00$

Reports a company’s assets, liabilities, and shareholder’s equity at an exact point in time

Differs from the previous two in this aspect; they cover a period of time whereas the Balance Sheet is a “snapshot”

Useful in determining the company’s structure

The Balance Sheet

The different components:

◦ Assets These represent future economic benefits Can be current and non-current Ranked on the Balance Sheet in order of their ease of

liquidity (how easy can you convert this asset into cash?)

The most liquid assets are listed at the top (cash, marketable securities, etc.)

The Balance Sheet

◦ Liabilities These represent future economic sacrifices Can be current and non-current Important to know how much debt the company is

obligated to pay in the next few years

◦ Shareholder’s Equity Represents the owner’s interest (that’s you!) in the

company Contains an important account: RETAINED

EARNINGS Takes a company’s net income and shows if they pay

it out as a dividend or re-invest it

The Balance Sheet

Important for analyzing the capital structure of the company

◦ Do they have a lot of cash relative to their debt? If not, do they have a lot of liquid assets?

◦ How do they finance their investments? Mainly through stock issuance or with bonds/borrowing?

◦ Do they have a lot of intangibles (goodwill, patents, etc.)?

The Balance Sheet

Let’s take a look at the handout

This is Apple’s condensed Balance Sheet for the years 2004-2007

What’s good about it? What might not be so good?

How might they be structured differently from a newly formed company?

The Balance Sheet

At a later date we will introduce more advanced concepts of accounting

◦ Financial Ratios Profitability, Leverage, Solvency, Liquidity, Efficiency Comparison to other companies in the same industry

◦ Valuation modeling Is the company’s equity more than its market cap?

◦ Anything else you guys would like to learn more about

Other

Questions?

Club Portfolio

Show by realistic example how to choose investments

Provide a sample portfolio of value investments for a college-aged investor

Learn about different stocks and companies and what makes them attractive investment opportunities

Goals

Encourage discussion and debate

Maintain records of the portfolio to learn from mistakes and successes

Goals

Start with $20,000 cash

Trades cost $7 (ScottTrade pricing)

Placing a trade requires a majority of present and voting members to approve

Provide rationale and analysis for each investment on the appropriate forum page

Parameters

Reason for buying?

Selling Strategy / Expected Duration?

Reason for Selling?

Analysis (What went well, what did not)

Analysis