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When doing your investment research, don't make these 3 common mistakes
  1. Relying on the P/E Ratio for big companies w/ other income

The price-to-earnings (P/E) ratio relates a company's share price to its earnings per share. A high P/E ratio could mean a company's stock is overvalued, or that investors are expecting high growth in the future.

However, GAAP accounting forces companies to mark up “other income” when their holdings increase in value, and down when their stocks fall.

Other income may include interest, rent, and gains resulting from the sale of fixed assets.

The delta can get especially large when there’s a ton of cash on the balance sheet accruing interest or they sell off something valuable. As a result, you can get false signals as to the health of the underlying core operations of a company.

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  1. Using EBITDA as a proxy for how much money is available to service debt.

Most businesses have maintenance capex. If they don’t spend that capex, the business' earning power will go down each year.

There’s Growth CapEx and Maintenance CapEx. Think of it in this way - when a company such as Walmart refurbishes an existing store – laying new flooring, painting the walls, replacing cash registers, etc. – it is engaging in maintenance CapEx. Likewise, if Walmart opens a new store, this would be considered growth CapEx.

If you want the business to stay alive, what’s actually available to service debt is either:
  • `EBITDA - Maintenance Capex`
  • `Cash Flow From Operations + Interest + Taxes - Maintenance Capex`


Your businesses needs oxygen. Don't suffocate it.

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  1. Excluding Working Capital from ROIC (return on invested capital)

Many ignore working capital when calculating of ROIC. Working capital includes all the capital wrapped up in current assets and current liabilities (like accounts payable, and accounts receivables).

Depending on the business model there can be a lot of money somewhere in the cash conversion cycle.

To avoid overstating returns you should calculate ROIC as:
`ROIC = (Net Operating Profit After Tax) / (Working Capital + Property Plant and Equipment)`

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