The Tiny Book On Basic Stock Valuation

The Tiny Book
of Basic Stock
Valuation
A Basic Value Investing
Guide for the Beginner
Investor in the Philippine
Stock Market
The Investing Engineer PH

www.investingengineer.com
Page 1
2 The Tiny Book of Basic Stock Valuation
Table of Contents
Introduction .................................................4
Why Should You Read This Book .......................6
What is Value Investing ...................................7
How to Value a Business ................................ 10
Knowing How a Business Works ................... 10
Determining the Right Price ........................ 15
The Stock Price and Its Relation to the Companys
Value .................................................... 17
How to Value Stocks Using the Price to Earnings
Valuation Method ........................................ 20
Finding the Intrinsic Value........................... 21
What is a Discount Rate ............................. 22
Using a Margin of Safety ............................. 24
How to Value a Stock Using Return on Equity
Valuation Method ........................................ 26
What is Return on Equity............................ 26
Using Return on Equity to Value a Stock ......... 28
Copyright www.investingengineer.com
All Rights Reserved 2016
Constructing the Return on Equity Valuation

Model ................................................... 29
Warren Buffetts Durable Competitive Advantage . 32
My Final Message ......................................... 35
Glossary of Terms ........................................ 38
Ebook Disclaimer......................................... 49
Introduction
Hi! Im Mark, an Electrical Engineer by profession
and the creator of the Philippine Value Investing Blog
www.investingengineer.com!
When I first started investing, it took me a while to

learn the most common mistakes and failures that
every investor makes. Learning from the mistakes and
experiences of others has led me to understand what
Value Investing is all about.
Most investors fail to realize the importance of a

value-based approach strategy once they start making
huge losses. These mistakes came simply because
most of them lack the ability to make accurate
estimates of the stocks intrinsic values.
When I started, I dont have any idea how to make

stock valuations. No one taught me what to do and I
had to figure this out on my own. Eventually, after
reading a lot of books about Value Investing, I learned
what to do and started investing based on my own
analysis.
After I started learning the basics, I applied these

principles and the right mindset in my investment
decisions. I invested heavily during the 2015 market
selloff which started on the 2nd week of August.
During those times, the PSEI tanked but that didnt
stop me from continuing my investing activities. After
a year, I managed to make a 20% return. I realized
that a value-based approach strategy really pays off.
Today, the personal challenge I want to achieve is to

make consistent returns of 20% or more every year. I
hope I make it!
I hope that the basic techniques that I will teach in this

book will help you consistently earn above average
returns in the stock market.
Happy investing!
Mark
The Investing Engineer PH
www.investingengineer.com
Why Should You Read This Book

Value Investing is a pretty cool thing to do especially
if you love crunching numbers. If youre pretty
confused and overwhelmed of the plethora of
information out there, then this book is right for you.
This book aims to teach you how to invest using a

value-based approach strategy. I have transformed
many of the complex ideas Ive learned from all the
value investing resources out there into a simple and
easy to understand book thats easy for a beginner to
comprehend.
Now, if you dont have any clue how to invest in the

stock market, I recommend you get started now. Ive
written a separate guide just for that in my blog and
heres the link that you can use to get there.
LINK: GET STARTED!
I hope that youll learn a lot from this book and I hope
that this book will serve you well.
Thank you and good luck!
What is Value Investing

Value Investing is an investing strategy wherein you
seek and buy stocks that trade below its intrinsic value
and have a huge upside potential.
To quickly understand this definition, Ill introduce

you to Juan. Juan is a value investor. He only invests
in undervalued businesses that have high growth. One
day, he saw a business named Pedros Buko Stand
listed in the Philippine Stock Exchange. He wanted to
know if the business is undervalued so he went on to
the companys website and downloaded the financial
statements. He started studying them digging out all
the vital information he could find. Based on the
financials, he found out that the companys stock is
worth P10 per share. Now, he looked at the stocks
market price and saw that its trading at around P5
per share. He realized that this is a bargain. He knows
that the business is doing great and earnings are
increasing year on year. So he decided to buy 10,000
shares worth P50,000 (lets exclude taxes and
commissions for now to simplify the math). After a
year, the stock rose to P15 per share. After seeing
this, Juan realized that the stock is now overvalued
and decided to sell his position making him P150,000

including the initial P50,000 he initially invested.
Pablo on the other hand, has also P50,000 that hes

willing to invest. Unlike Juan, he saw this other
business, Marias Isaw Stand. He also found out
that the value of the business is P10 per share and the
stock is trading at P5; same as Pedros Buko Stand. He
decided to buy 10,000 shares just like what Juan did.
But after the 1st half of the year, the stock fell to
P2.50 per share. Although this was the case, Pablo
didnt panic. Pablo thinks that if he liked the stock at
P5, he should like it even more at P2.50. So instead of
cutting losses, he bought another 10,000 shares worth
P25,000 bringing his total investment up to P75,000.
This purchase lowered his average price to P3.75 per
share but increased his shares to 20,000. Pablo
believes that the business is strong, stable and that the
stock will rise back. And he was right! After a year,
the stock now trades at P15 per share. Upon seeing
this, Pablo thought that the business is now
overvalued so he sold his shares making P300,000
including his initial investment of P75,000.
This is what Value Investing is all about. You buy

stocks that you believe that is less than its true worth
then wait a couple of years for the market to realize
that value so that youll make money from it.
Value Investing is pretty simple right? You really

dont need an extensive background on finance and
you dont need to study charts all day long. What
youll need to be successful in this strategy is a lot of
patience, money and willingness to learn the very
basic principles and fundamental concepts which I will
discuss in the next chapter.
How to Value a Business

Knowing How a Business Works
What most investors fail to realize is that when you
buy a stock, you are simply buying a portion of the
business itself. So let me explain this simple concept
in detail.
Mina wants to start a Halo-Halo business. Lets call

this business Minas Halo-Halo Stand. But Mina
doesnt want to get physically involved in the day-to-
day operations of the business so he hires Jason to run
it for her. Jasons job is to make sure to sell a lot of
Halo-Halo every day, monitor and replenish
inventories, account all the income and expenses,
keep the store clean and orderly and all other things
required to ensure the smooth operations of the
business. So the business opened and operations
started.
On the first day, a customer bought a glass of Halo-

Halo for P50. This is what we call Revenue.
To make a glass of Halo-Halo, Mina needs crushed

ice, milk, sugar and a lot of toppings which costs
around P10. This expense is what we call Cost of

Revenue. Some books call this Cost of Sales or
Cost of Goods Sold.
Besides the cost of revenue, Mina needs to pay Jasons

salary. She also needs to pay rent for the shops
location. Theres also the utility bills that needs to be
paid. So for every glass of Halo-Halo, Mina pays P5 to
Jason and P10 for the rent and P5 for the utility bills
for a total of P20. This is what we call Operating
Expenses.
So lets recap. Mina made P50 revenue. Subtract the

cost of revenue from the revenue and we get P40
Gross Profit. Subtract the operating expenses worth
from the gross profit and we get an Operating
Income of P20.
Let us also not forget that Mina needs to pay her

taxes. Im going to assume that she pays P10 taxes for
every glass of Halo-Halo she sells. Doing the math we
arrive at a Net Income of P10. This is the number
that we see at the bottom of an Income Statement.
From here, Mina has two choices. She can choose to

pay herself a Dividend of P5 and the other half to be
reinvested back into the business as Retained

Earnings to buy more inventories, hire more people
or improve the shop; or she can reinvest all the
earnings back into the company to speed up the
growth of her business.
Now, lets assume that for one year, her business

made P100,000. She decides to pay herself a nice
P50,000 of dividends. The other half, she then puts
back into the business. So lets see what happens to
the business Balance Sheet.
The balance sheet consists of all the Total Assets and

the Total Liabilities of the business. Subtracting the
two, you get the Equity of the business. To
understand this in the simplest way as possible,
consider this example.
Minas Halo-Halo business has total assets of

P100,000. This consists of the following below;
Cash - P5,000
Halo-Halo Stand - P65,000
Refrigerator - P20,000
Inventories - P10,000
Total Assets - P100,000
Minas business has a bank account and that account

contains the P5,000 cash. Lets assume that the Halo-
Halo stand and the refrigerator is worth P65,000 and
P20,000 respectively. Then she keeps an inventory
worth P10,000. Adding all that up, we get the total
assets amounting to P100,000.
Her business has total liabilities of P80,000 which

consists of the following;

Salary - P10,000
Total Liabilities - P80,000
Mina took out a loan to buy the Halo-Halo stand.

From what we see here, it seems that Mina has only
paid P10,000 out of the P65,000 which explains why
the liability is listed at P55,000. Same is true with the
refrigerator. She has only paid out P5,000 out of the
P20,000 loans. She also hasnt paid Jason yet his salary
amounting to P10,000. Adding all that up, we get the
total liabilities amounting to P80,000.
Subtracting both of these figures, we get the total

equity of the business which is P20,000.
So what do all these figures mean? You can see that

the business is making P100,000 a year in profits but
the equity in the business is only P20,000. If Mina fails
to find a buyer and decides to liquidate her business,
she would only get P20,000. Why? Its because she
has to sell all her assets to pay all her debts.
Now think about this, if she decides to sell her

business to you that earns P100,000 a year but is only
worth P20,000 in equity at P250,000, would you buy
it?
Before you answer that question, lets go back to

again to Mina. She said that she will reinvest the other
half of the earnings back into the business. She decides
to pay her loans and keep some of the cash. Her
balance sheet would now look like this
Cash - P15,000
Inventories - P10,000
Total Assets - P110,000

Salary - P10,000
Total Liabilities - P40,000
Total Equity - P70,000
So what we have here is that she paid her loans

amounting to P30,000 for the Halo-Halo stand and
P10,000 for the refrigerator bringing down her
liabilities to P40,000. She also added P10,000 to her
business bank account bringing up her assets at P110,
000. Her equity now is worth P70,000 compared to
the previous P40,000.
Now she again decides to sell her business but this

time, shes selling it for P500,000. Would you buy it?
Determining the Right Price

At this point, you now know that her business makes
P100,000 a year with P70,000 of equity in it.
Assuming the business has little to no risk, how much
are you willing to pay for it assuming that you dont
need to do anything just like what Mina is doing?
Are you willing to buy it for P250,000? What about

P500,000? How about P1,000,000?
This is where everything starts to become confusing.

But dont worry. Ill explain it in detail below.
Based on the income, if you buy the company at

P250,000, you would expect a one year return of
40%. If you buy it at P500,000, you would expect a
return of 20%. And when you buy it at P1,000,000,
you would expect a return of 10%.
Based on equity, if you buy the company at P250,

000, you risk losing P180,000 if the company
becomes unprofitable and liquidates. If you buy it at
P500,000, you risk losing P430,000. If you buy it at
P1,000,000, you risk losing P930,000.
If youll notice, the higher you buy the company, the

lower your expected returns will become and the
riskier it gets. It will also take a longer time to make a
return on investment. In the first example, it would
take you 2 years to gain back your initial
investment. In the second example it increased to 5
years. In the third example, it will take you 10 years.
Now what does this tells us? If you overpay for the
business, your returns diminishes, risk of losing
money becomes higher and it will take you a longer
time to gain back your initial investment. In

conclusion, the price you pay for the business
determines how much money you are willing to
make, the amount of risk you are willing to take and
the time it will take to get back your initial
investment.
The Stock Price and Its Relation to the

Companys Value
Mina has decided to sell her company for P500,000.
But the problem is that shes having a hard time
selling it to just one person. Although thats the case,
she knows that there are a lot of buyers out there that
are willing to buy her business but dont have the full
amount upfront. In order to solve this problem, she
decided to split her company into 100,000 small
pieces. These small chunks of her business are what
we call Shares of Stock. These 100,000 shares are
what we call Shares Outstanding.
Mina values her business at P500,000. If you divide it

by 100,000 shares, youll get P5 per share. We call
this the Market Price. This means that if you buy
one share of her business, it will cost you P5. Buy all
the shares and itll cost you P500,000.
The best way to understand this is to look at that one

share as a miniature sized business. Think of it as a
tiny Minas Halo-Halo Stand that sells tiny glasses of
Halo-Halo to tiny people to make tiny little profits.
If you divide the net income to the number of shares

outstanding (P100,000 / 100,000 shares), youll get
P1 per share. We call this the Earnings per Share
(EpS). Now lets take a look at the equity of the
business. Awhile ago, we determined that Minas
business has P70,000 worth of equity in it. If you
divide that equity into the number of shares
outstanding (P70,000 / 100,000 shares), youll get
P0.70 per share. We call this the Book Value per
Share (BVpS).
As you can see from here, the market price is directly

proportional to one share of stock. If you own the
whole business, you own all the P100,000 earnings
and P70,000 worth of equity. If you only own 1 share
of Minas business, you own a tiny P1 of the earnings
and P0.70 book value of the business.
This is the fundamental concept of why buying a stock

is the same as buying a business. By knowing how
much a company is worth, youll know how much a

stock is worth because all of these things are
proportional to each other.
In the next chapter, Ill discus some simple techniques

on how to value stocks so that you can now start
making educated estimates. Keep in mind that there is
no magic formula in calculating intrinsic values.
With that said, lets proceed.
How to Value Stocks Using the Price

to Earnings Valuation Method
The P/E Ratio is one of the most used ratios in
finding undervalued stocks. To get the P/E ratio, all
you have to do is to divide the market price of the
stock to the recent earnings per share or eps. Heres
an example.
Ayala Land Inc. (ALI) is trading at P40.60 per share.

The recent eps is P1.20. To get the P/E ratio, we
divide P40.60 to P1.20.
P/E Ratio = P40.60/P1.20

P/E Ratio = 33.83
This number represents the amount of money you

need to spend to make P1 of profit one year later. In
ALIs case, its P33.83.
Lets take another example. This time, its

Megaworld Corp. (MEG).
MEG is trading at P5.06 per share and the recent eps

is P0.32. The P/E ratio is computed at 15.81.
If you compare the two, youll see that MEG sounds

like a more attractive investment than ALI. You only
need to pay P15.81 per P1 of profit in MEG
compared to ALI which will cost you more than
double the amount.
It is clear in these examples that the lower the P/E

ratio, the cheaper the company sound.
Since MEG is a more attractive investment between

the two, lets find out its intrinsic value.
Finding the Intrinsic Value

The first thing we need to do is to get the average
historical P/E ratio of MEG for the last 5 years.
From my research, I found out that MEG averaged at
around 11.42.
We also need to find out the latest EpS in the four

most recent quarters. This is also called EpS
(Trailing Twelve Months) or EpS (TTM). The
EpS (TTM) of MEG is 0.33.
The last thing we need is the growth rate at which

MEG is expected to grow its profits in the next five
years. I found this to be 15.24% by taking the 5-yr.
average net income growth. You can also use the 5-

yr. annual compounding growth rate. Its all up to
you what you want to use.
Now that we have all the data, the formula to find the
future value (FV) of the stock is;
Future Value = EpS x (1+% Growth)^5 x P/E
We put in the values;
FV = 0.33 x (1+0.1524)^5 x 11.42

FV = P7.66
The future value of MEG is computed at P7.66 per

share five years from now. What we want is to find
out what the stock is worth today, not five years from
now. To do that, we need to use a Discount Rate.
What is a Discount Rate

Always remember this; the value of your money today
is higher than the value of that same amount of money
in the future because if youll invest it today, it will
earn an interest. This interest is what we call the
discount rate. We use this rate to calculate how much
the future value is worth in todays money.
This is the trickiest part because the discount rate that

youre going to use in this scenario will determine
your estimated intrinsic value.
To demonstrate, lets try to use the 5-yr. return on

government bond rates. Right now, the return is at
2.818%.
The formula to calculate the intrinsic value is shown

below;
Intrinsic Value = Future Value / (1+ % Disc.

rate)^5
Computing for MEGs the intrinsic value, we get;
Intrinsic value = P7.66 / (1+0.02818)^5

Intrinsic value = P6.67
According to this calculation, if we choose a minimum

rate of return equal to that of a 5- yr. government
bond, then the stock is worth P6.67 today.
Now what if we use a higher discount rate? Lets

assume a 10% discount rate which is almost equal to
the historical long-term return of the stock market.
Calculating, we get;
Intrinsic value = P7.66 / (1+0.1)^5

Intrinsic value = P4.76
At a 10% discount rate, we get an intrinsic value of

P4.76.
I want to point out that when computing for the

intrinsic value, the value will depend on how much
money you want to earn every year. So if you want to
make 15% rate of return every year, then use a 15%
discount rate.
Using a Margin of Safety

Finding the intrinsic value is not an exact science.
Sometimes, we can commit errors along the way. To
make room for this, well introduce the concept of
Margin of Safety as popularized by Benjamin
Graham, the Father of Value Investing.
In the previous example the growth rate used is

15.24%. Now lets assume a safety margin of 25%.
Note that it doesnt have to be always 25%. Its up to
you how much risk you are willing to reduce.
In the example above, we can arrive at a conservative

growth rate of 11.43% as shown below;
Growth rate = 0.1524 x (1 0.25)

Growth rate = 11.43%
Using the new growth rate, we arrive at a future value

of P6.47. And when we calculate the intrinsic value
using a 10% discount rate, we get a value of P4.02.
Right now, MEGs market price is P5.06 per share.

Based on our intrinsic value calculations, MEG is no
longer undervalued so we leave it for now and look
for other stocks in the market.
The P/E valuation method is the most straightforward

and easiest way of calculating a stocks intrinsic value.
This method is perfect for beginners so right now, I
want you to take out a piece of paper and try to
compute the intrinsic values of your investments to
find out if you have bought them cheap or at an
expensive price.
How to Value a Stock Using Return

on Equity Valuation Method
What is Return on Equity
To understand Return on Equity (RoE) a little
better, let me demonstrate why RoE is one of the
most important metrics to understand to determine a
companys profitability.
Lets go back to my previous example, Minas Halo-

Halo Stand business. Her business has earnings of P1
per share and a book value of P0.70 per share.
Assuming her business continued to operate for
another year, she again will earn P1 per share
assuming theres no increase of sales. If she decides to
not pay herself a dividend and instead reinvest all that
money back into the business (buy new equipment,
buy a larger stand, buy her own land), her book value
will increase to P1.70 per share or a substantial 147%
growth!
Now, Im going to introduce another business for the

purpose of comparison. Lets call this business
Trinas Ice Cream Shop. Trinas business also
earns P1 per share but the book value of her business
is P50 per share. So after a year, she decided to

reinvest all of her earnings back into the business.
Trinas book value has now increased to P51 per share
or a 2% growth.
Heres what I want you to understand. Both of these

businesses made the same amount of money but their
RoEs differ within a mile. Mina made a 147% return
while Trina only made 2%.
So what does this mean as a value investor? Assuming

both companies trade at premium to their book value,
if we bought 100,000 shares of Minas business at a
market price of P0.70 per share for a total of
P70,000, our investment is now worth P172,900 or a
147% growth!
Compare that to Trinas business. If we bought 1,400

shares at P50 per share for a total of P70,000, our
investment would just gain 2% or worth P71,400.
So heres what you need to remember. A business

that consistently shows high returns on equity is a
business that knows exactly how to reinvest their
earnings to make more money. A business that shows
poor returns means that the business is doing a bad job

of reinvesting their capital.
Now that we defined what return on equity is and

how important it is in identifying good businesses, its
time to learn how we can use this metric to value a
stock.
Using Return on Equity to Value a

Stock
In order to use this method of valuation, we need to
gather all the data needed. For this demonstration,
well again try to valuate Megaworld Corporation
(MEG).
We need the following data below;
1. 5-yr. Average RoE

2. 5-yr. Average Dividend Payout Ratio
3. Recent book value per share
4. 5-yr. Average P/E ratio
5. Discount rate
I calculated the average RoE of MEG for the last five

years. As of this writing, I found it out to be 12.22%.
The Dividend Payout Ratio for the last 5 years is
11.12%. The recent book value is 3.67. The 5-yr.

average P/E ratio is calculated to be at 9.19. And
lastly, well use a 10% discount rate in this example.
Constructing the Return on Equity

Valuation Model
Now that we have all the data needed, well now
construct the RoE model. Ive shown below the
calculated 10-yr. projections.
To demonstrate how this is done, we first get the

recent book value of MEG which is 3.67. From that
value, we derive the EpS by multiplying 3.67 to the

average RoE. The Dividend per Share (DpS) is
calculated by multiplying the EpS and the dividend
payout ratio.
In the first row, we calculated the values of EpS and

DpS to be P0.45 and P0.05 respectively. On the
second row, the BVpS, EpS and DpS from the first
row (3.67 + 0.45 + 0.05) is added and entered in the
second row in the BVpS column (4.07). We continue
to do this calculation up to the 10th year.
On the 10th year, the earnings are now at P1.26 per

share. We then also take the sum of all the dividends
paid which is P2.88 per share. To calculate the
projected price, we multiply the 10th year EpS to the
average P/E ratio.
Projected Price = 1.26 x 9.19

Projected Price = 11.56
Add P11.56 to the sum of all dividends and we get a

total gain of P12.53.
Now, what we need to do is to get the Intrinsic Value

by using the 10% discount rate. Well use the
calculated projected price.
Intrinsic Value = 11.56 / (1 + 0.10)^10

Intrinsic value = 4.46
MEG trades at P5.06 per share as of this writing. So

based on our calculations, MEG is now overvalued.
Based on this, we can just wait for a bad news or a
global economic event that will push the stock price
down. If it reaches our calculated intrinsic value, then
well buy the stock.
Warren Buffetts Durable

Competitive Advantage
Im a fan of this investment philosophy by Warren
Buffett. This is one of the things I follow because its
really just common sense but not everyone is aware of
this.
According to Buffett, a business with a Durable

Competitive Advantage (DCA) has these
following characteristics;
Sell a product or a service that is a basic

necessity.
Is in an industry with very little competition.
Sell a unique product that doesn't change
much.
Provides a unique service that's difficult to
replicate.
Is a low-cost buyer and seller of products the
public constantly needs.
Spends very little or none at all on Research
and Development.
If you find a business with these characteristics, the

next thing to do is to validate that by digging into the
companys financial statements.
Here are 10 things you need to check in the financial

statements to qualify a business DCA;
High return on equity

High return on invested capital
Increasing historical earnings
Little to no debt (except for financial
companies)
Competitive product or service
No organized labor groups
Product or service increase along with
inflation
Low operational costs
Business buys back its shares
Retained earnings are used efficiently thus
adding value to the business and therefore
increases the market value.
Buffett said that a business with a DCA is a cash cow.

Thats why in my blog, www.investingengineer.com,
I do valuations and stock reviews using financial

statements to find these hidden gems in the Philippine
Stock Market.
You can read more about how Buffett identifies these

types of businesses by reading books and articles about
this topic on the Internet.
Now, if you find an interesting company that you

think has a DCA, then use the P/E and RoE valuation
methods I taught in this book to identify the best price
to buy the stock.
My Final Message
Ive explained in this book the definition of what
Value Investing is all about and how you can value
stocks using two basic methods; the P/E Ratio model
and the Return on Equity model. Ive also discussed
briefly how Warren Buffett finds companies worthy
to invest by looking at a companys Durable
Competitive Advantage.
These methods require a lot of different assumptions

and therefore, are not perfect. But knowing these
kinds of calculations will give you trust and
confidence in making investment decisions. Just dont
forget that investing is more common sense than
elegant mathematics. Dont heavily rely on the figures
that youll get but instead, use them to justify whats
really happening in the real world.
Thank you for the time reading this book. If you like
it, please share it to people who you think will benefit
from it.
Happy investing!
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Glossary of Terms
Note: All definitions are taken from www.investopedia.com. I give
the site credit where credit is due.
Value Investing is an investment strategy where

stocks are selected that trade for less than their
intrinsic values. Value investors actively seek stocks
they believe the market has undervalued. Investors
who use this strategy believe the market overreacts to
good and bad news, resulting in stock price
movements that do not correspond with a company's
long-term fundamentals, giving an opportunity to
profit when the price is deflated.
Revenue is the amount of money that a company

actually receives during a specific period, including
discounts and deductions for returned merchandise. It
is the "top line" or "gross income" figure from which
costs are subtracted to determine net income.
The Cost of Revenue is the total cost of

manufacturing and delivering a product or service.
Cost of revenue information is found in a company's
income statement, and is designed to represent the
direct costs associated with the goods and services the
company provides. Cost of revenue is different from

cost of goods sold (COGS) because it includes costs
outside of production, such as distribution and
marketing.
Cost of Goods Sold (COGS) are the direct costs

attributable to the production of the goods sold by a
company. This amount includes the cost of the
materials used in creating the good along with the
direct labor costs used to produce the good. It
excludes indirect expenses such as distribution costs
and sales force costs. COGS appear on the income
statement and can be deducted from revenue to
calculate a company's gross margin. Also referred to
as "Cost of Sales.
An Operating Expense is an expense a business

incurs through its normal business operations. Often
abbreviated as OPEX, operating expenses include
rent, equipment, inventory costs, marketing, payroll,
insurance and funds allocated toward research and
development. One of the typical responsibilities that
management must contend with is determining how
low operating expenses can be reduced without
significantly affecting a firm's ability to compete with

its competitors.
Gross Profit is a company's total revenue (equivalent

to total sales) minus the cost of goods sold. Gross
profit is the profit a company makes after deducting
the costs associated with making and selling its
products, or the costs associated with providing its
services.
Operating Income is an accounting figure that

measures the amount of profit realized from a
business's operations, after deducting operating
expenses such as cost of goods sold (COGS), wages
and depreciation. Operating income takes a
company's gross income, which is equivalent to
revenue minus COGS, and subtracts all operating
expenses and depreciation. A business's operating
expenses are costs incurred from operating activities
and include items such as office supplies, heat and
electricity.
Net Income (NI) is a company's total earnings (or

profit); net income is calculated by taking revenues
and subtracting the costs of doing business such as
depreciation, interest, taxes and other expenses. This

number appears on a company's income statement and
is an important measure of how profitable the
company is over a period of time. Net income also
refers to an individual's income after taking taxes and
deductions into account.
An Income Statement is a financial statement that

reports a company's financial performance over a
specific accounting period. Financial performance is
assessed by giving a summary of how the business
incurs its revenues and expenses through both
operating and non-operating activities. It also shows
the net profit or loss incurred over a specific
accounting period.
A Dividend is a distribution of a portion of a

company's earnings, decided by the board of
directors, to a class of its shareholders. Dividends can
be issued as cash payments, as shares of stock, or
other property.
Retained Earnings refer to the percentage of net

earnings not paid out as dividends, but retained by the
company to be reinvested in its core business, or to
pay debt. It is recorded under shareholders' equity on

the balance sheet. The formula calculates retained
earnings by adding net income to, or subtracting any
net losses from, beginning retained earnings, and
subtracting any dividends paid to shareholders.
A Balance Sheet is a financial statement that

summarizes a company's assets, liabilities and
shareholders' equity at a specific point in time. These
three balance sheet segments give investors an idea as
to what the company owns and owes, as well as the
amount invested by shareholders.
An Asset is a resource with economic value that an

individual, corporation or country owns or controls
with the expectation that it will provide future
benefit. Assets are reported on a company's balance
sheet, and they are bought or created to increase the
value of a firm or benefit the firm's operations. An
asset can be thought of as something that in the future
can generate cash flow, reduce expenses, improve
sales, regardless of whether it's a company's
manufacturing equipment or a patent on a particular
technology.
A Liability is a company's financial debt or

obligations that arise during the course of its business
operations. Liabilities are settled over time through
the transfer of economic benefits including money,
goods or services. Recorded on the right side of the
balance sheet, liabilities include loans, accounts
payable, mortgages, deferred revenues and accrued
expenses.
Equity is the value of an asset less the value of all

liabilities on that asset.
A Stock is a share in the ownership of a company.

Stock represents a claim on the company's assets and
earnings. As you acquire more stock, your ownership
stake in the company becomes greater. Whether you
say shares, equity, or stock, it all means the same
thing.
Outstanding Shares refer to a company's stock

currently held by all its shareholders, including share
blocks held by institutional investors and restricted
shares owned by the companys officers and insiders.
Outstanding shares are shown on a companys balance
sheet under the heading Capital Stock. The number
of outstanding shares is used in calculating key metrics

such as a companys market capitalization, as well as
its earnings per share (EPS) and cash flow per share
(CFPS).
The Market Price is the current price at which an

asset or service can be bought or sold. Economic
theory contends that the market price converges at a
point where the forces of supply and demand meet.
Shocks to either the supply side and/or demand side
can cause the market price for a good or service to be
re-evaluated.
Earnings per Share (EPS) is the portion of a

company's profit allocated to each outstanding share
of common stock. Earnings per share serves as an
indicator of a company's profitability.
Book Value of Equity per Share (BVPS) is a ratio

that divides common equity value by the number of
common stock shares outstanding. The book value of
equity per share is one factor that investors can use to
determine whether a stock price is undervalued. If a
business can increase its BVPS, investors may view the
stock as more valuable, and the stock price increases.
The Price-Earnings Ratio (P/E Ratio) is the ratio

for valuing a company that measures its current share
price relative to its per-share earnings.
The Future Value (FV) is the value of a current asset

at a specified date in the future based on an assumed
rate of growth over time.
The Intrinsic Value is the actual value of a company

or an asset based on an underlying perception of its
true value including all aspects of the business, in
terms of both tangible and intangible factors. This
value may or may not be the same as the current
market value. Additionally, intrinsic value is primarily
used in options pricing to indicate the amount an
option is in the money.
Margin of Safety is a principle of investing in which

an investor only purchases securities when the market
price is significantly below its intrinsic value. In other
words, when market price is significantly below your
estimation of the intrinsic value, the difference is the
margin of safety. This difference allows an investment
to be made with minimal downside risk.
Return on Equity (ROE) is the amount of net

income returned as a percentage of shareholders
equity. Return on equity measures a corporation's
profitability by revealing how much profit a company
generates with the money shareholders have invested.
The Dividend Payout Ratio is the percentage of

earnings paid to shareholders in dividends.
Dividend per Share (DPS) is the sum of declared

dividends issued by a company for every ordinary
share outstanding. Dividend per share (DPS) is the
total dividends paid out by a business, including
interim dividends, divided by the number of
outstanding ordinary shares issued. A company's DPS
is usually derived using the dividend paid in the most
recent quarter, which is also used to calculate the
dividend yield.
Competitive Advantages are conditions that allow

a company or country to produce a good or service at
a lower price or in a more desirable fashion for
customers. These conditions allow the productive
entity to generate more sales or superior margins than
its competition. Competitive advantages are
attributed to a variety of factors, including cost

structure, brand, quality of product offerings,
distribution network, intellectual property and
customer support.
Return on Invested Capital is a calculation used

to assess a company's efficiency at allocating the
capital under its control to profitable investments.
Return on invested capital gives a sense of how well a
company is using its money to generate returns.
Comparing a company's return on capital (ROIC)
with its weighted average cost of capital (WACC)
reveals whether invested capital is being used
effectively.
Thank you for reading!
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You must not rely on the information in the e-book as

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The Tiny Book

The Investing Engineer PH

Constructing the Return on Equity Valuation

When I first started investing, it took me a while to

Most investors fail to realize the importance of a

When I started, I dont have any idea how to make

After I started learning the basics, I applied these

Today, the personal challenge I want to achieve is to

I hope that the basic techniques that I will teach in this

Why Should You Read This Book

This book aims to teach you how to invest using a

Now, if you dont have any clue how to invest in the

LINK: GET STARTED!

Thank you and good luck!

What is Value Investing

To quickly understand this definition, Ill introduce

and decided to sell his position making him P150,000

Pablo on the other hand, has also P50,000 that hes

This is what Value Investing is all about. You buy

Value Investing is pretty simple right? You really

How to Value a Business

Mina wants to start a Halo-Halo business. Lets call

On the first day, a customer bought a glass of Halo-

To make a glass of Halo-Halo, Mina needs crushed

around P10. This expense is what we call Cost of

Besides the cost of revenue, Mina needs to pay Jasons

So lets recap. Mina made P50 revenue. Subtract the

Let us also not forget that Mina needs to pay her

From here, Mina has two choices. She can choose to

reinvested back into the business as Retained

Now, lets assume that for one year, her business

The balance sheet consists of all the Total Assets and

Minas Halo-Halo business has total assets of

Minas business has a bank account and that account

Her business has total liabilities of P80,000 which

Halo-Halo Stand - P55,000

Mina took out a loan to buy the Halo-Halo stand.

Subtracting both of these figures, we get the total

So what do all these figures mean? You can see that

Now think about this, if she decides to sell her

Before you answer that question, lets go back to

Halo-Halo Stand - P25,000

Total Liabilities - P40,000

Total Equity - P70,000

So what we have here is that she paid her loans

Now she again decides to sell her business but this

Determining the Right Price

Are you willing to buy it for P250,000? What about

This is where everything starts to become confusing.

Based on the income, if you buy the company at

Based on equity, if you buy the company at P250,

If youll notice, the higher you buy the company, the

time to gain back your initial investment. In

The Stock Price and Its Relation to the

Mina values her business at P500,000. If you divide it

The best way to understand this is to look at that one

If you divide the net income to the number of shares

As you can see from here, the market price is directly

This is the fundamental concept of why buying a stock

much a company is worth, youll know how much a

In the next chapter, Ill discus some simple techniques

How to Value Stocks Using the Price

Ayala Land Inc. (ALI) is trading at P40.60 per share.