Officer on Horseback

WEBVTT
Kind: captions
Language: en

00:00:00.710 --> 00:00:04.170
I was sent some problems by
one of the viewers out there.

00:00:04.170 --> 00:00:09.760
I believe his name is Cortagio
or Cortajio, I apologize.

00:00:09.760 --> 00:00:11.260
I'm sure I'm mispronouncing it.

00:00:11.260 --> 00:00:13.570
But they are really
interesting problems.

00:00:13.570 --> 00:00:16.390
What's interesting about them
is that they don't involve

00:00:16.390 --> 00:00:18.300
super-fancy mathematics.

00:00:18.300 --> 00:00:22.000
They just involve an elegant
way to apply fairly

00:00:22.000 --> 00:00:22.970
simple mathematics.

00:00:22.970 --> 00:00:24.950
So, without me talking too much
about the problems, let's

00:00:24.950 --> 00:00:27.140
try to solve one of them.

00:00:27.140 --> 00:00:28.740
Actually, I don't know where
I'm going to categorize this.

00:00:28.740 --> 00:00:31.770
Either in algebra or in the
brain-teaser playlist,

00:00:31.770 --> 00:00:32.770
or maybe both.

00:00:32.770 --> 00:00:35.950
So, an officer on horseback
starts at the back of a column

00:00:35.950 --> 00:00:40.140
of marching soldiers and rides
to the front of the column.

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Then turns around and rides
to the rear of the column.

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If the rider travels three
times as fast as the column

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moves, and the column is 100
meters long -- OK, I think we

00:00:49.310 --> 00:00:52.160
have enough information
to start drawing this.

00:00:52.160 --> 00:00:54.090
Let me draw the
column of soldiers.

00:00:54.090 --> 00:00:56.450
I'll just draw this
as a big fat line.

00:00:56.450 --> 00:01:00.630
So, that's the
column of soldiers.

00:01:00.630 --> 00:01:02.310
I'm about to cough.

00:01:02.310 --> 00:01:03.480
Excuse me.

00:01:03.480 --> 00:01:06.000
I've learned not to cough
directly in the microphone.

00:01:06.000 --> 00:01:08.120
Don't want blow
your speakers out.

00:01:08.120 --> 00:01:10.630
So that's the column of
soldiers right there.

00:01:10.630 --> 00:01:15.920
And the problem tells us
that it's 100 meters long.

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So this distance right
here is 100 meters.

00:01:21.020 --> 00:01:23.420
And it's moving with
some velocity.

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Let's say, to the right.

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So I'm going to just call
it, it's moving with

00:01:26.990 --> 00:01:29.570
some velocity, v.

00:01:29.570 --> 00:01:31.090
We'll have to stay abstract
there because it doesn't

00:01:31.090 --> 00:01:32.280
tell us the velocity.

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And then we have the officer.

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I wanted to make sure I was
giving the correct title.

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So, an officer on horseback
stars at the back of a column.

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So he starts here.

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He's on his horse.

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He's on his horse.

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That's my rendition of the
horse for these purposes, it

00:01:51.875 --> 00:01:54.800
has an officer on on the back.

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And he is going to, while the
whole column is going forward

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with the velocity, v, he's
going to go to the front of it.

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Obviously he can go faster
because he's on a horse.

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And then he's going to go to
the back and they want to

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know how far did this
whole column move.

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And how fast is he going?

00:02:07.950 --> 00:02:12.990
Let's see, if the rider travels
3 times as fast as the column,

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if the column is this traveling
with the velocity v, he's going

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to be traveling with
the velocity of 3v.

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So let's think
about two things.

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Let's think about the time it
takes him to go to the front

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of the column, and the
time it takes to go back.

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So let's say t1 is equal
to time to front.

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And then t2 would
be time to back.

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There might be other ways to
solve this, but this is the

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way that's jumping
out into my brain.

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So let's figure out what
the time to the front

00:02:49.560 --> 00:02:51.040
of the column is.

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So, over some period of time
-- so, how far is the column

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going to move over to t1?

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The column is going to move,
well, actually, let me write

00:02:59.380 --> 00:03:00.510
a little formula here.

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Although I'm sure you
know this formula.

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Distance is equal to
rate times time.

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Right?

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So, over time 1, how far
does the column move?

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It's going to move v.

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v times time 1.

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And how far is this
guy going to move?

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Well, we're saying over
time, when he moves to

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the front of the column.

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So, this whole column is
moving to the right.

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And at the same time,
this guy's moving to

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the right faster.

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So at the end of time 1, which
I've defined as the time

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it takes him to get to the
front, what's true about the

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officer on the horseback?

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He will have had to travel
100 meters further than

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the column, right?

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In order to catch up to the
front of the column, he would

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have had to go 100 meters
further than the column.

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So, the distance that the
column travels, plus 100 meters

00:03:53.520 --> 00:03:57.040
is going to be the distance
that the officer travels in

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the same amount of time.

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And what's the distance
that he travels in that

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same amount of time?

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Well, distance is equal to
rate, 3v, times time, t1.

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Time to the front.

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So this is a relationship
between velocity and

00:04:10.970 --> 00:04:12.300
the time to the front.

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And let's see if we can
simplify this a little bit.

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So, if we track v t1 from both
sides, we get 100 is equal to

00:04:22.070 --> 00:04:28.030
3v t1 minus v t1, that's 2v t1,
and divide both sides

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by 2, you get 50.

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v t1 is equal to 50.

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The velocity of this column of
soldiers times the time it

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takes this officer to get to
the front is equal to 50.

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Well, that doesn't
solve our problem yet.

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We want to know how far
does the column move?

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We have two variables
with one equation.

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Not helpful yet.

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Let's see if t2 can
help us a little bit?

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All right.

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I'll switch colors to
ease the monotony.

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Time to back.

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So, now we're in the opposite
situation, where the

00:05:02.420 --> 00:05:04.030
guy's gotten here.

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He turns around.

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I'd argue, immediately.

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He turns around immediately.

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And he goes back.

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With the velocity of 3v.

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So, my question to you as he
starts out here, and relative

00:05:15.800 --> 00:05:19.550
to him, he's going this
direction at a velocity of 3v.

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And the back of the column
is moving towards him with

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the velocity of v, right?

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So if you think about it, the
back of the column is going to

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be approaching the rider
with the velocity of 4v.

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When you have two velocities
that are moving in opposite

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directions -- if I move in this
direction, at 60 miles per

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hour, and you're moving in that
direction at 60 miles per hour.

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Relative to me, if I assume
that I'm stationary, you would

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look like you're coming at
me at 120 miles per hour.

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So that same idea -- this
officer is going to be

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approaching the end of the
column, the back of the column,

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with the velocity of 4v.

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So how long does it take
them to get to the back?

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Well, let's see.

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His velocity is 4v.

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I'll do that in green.

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So his velocity is 4v.

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That's how fast he's
approaching the back

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of the column.

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And it's going to take him
time 2, times time 2.

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And his distance, he's going to
travel 100 meters, because

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that's the length
of the column.

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Is equal to 100.

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And let's see, if we divide
both sides of this by 4,

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we got velocity times
time 2 is equal to 25.

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And, once again, we have 1
equation with two unknowns.

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It doesn't help a lot.

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Let's review the problem again
to see if somehow we can use

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this information and this
information to solve what

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they're asking for.

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So, they want to know how far
does the column move by the

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time the officer arrives back
at the rear of the column.

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So, they want to know how far
did this whole thing move over

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the entire time of this
problem happening?

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What was the entire time?

00:07:01.080 --> 00:07:02.910
It was t1 plus t2.

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That's the entire time. t1 to
go to the front, and then

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t2 to go back to the back.

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So how far did the column move?

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Well, the column, distance is
equal to rate times time.

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So the column will move its
distance -- is equal to the

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column's rate, velocity.

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And then what's the time
that this whole little

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problem occurs on?

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Well t1 is how long it
takes the officer to

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get to the front.

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Plus t2.

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So this is what
we're solving for.

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This is what we need to know.

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We need to know the distance
traveled by the column.

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And, once again, we have
all these variables.

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But maybe we can do
something interesting.

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Let's look at this.

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So what is -- so if we just
distribute this, we have

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distance is equal to v
times t1 plus v times t2.

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And do we know what
these things are?

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Well, sure.

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We were able to kind of stumble
our way into into what

00:07:55.760 --> 00:07:56.510
these values are.

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And that's what's interesting
about this problem.

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We never figured out v.

00:07:59.150 --> 00:08:00.680
We never figured out t1 or t2.

00:08:00.680 --> 00:08:01.980
But we can figure out
this whole thing.

00:08:01.980 --> 00:08:06.590
Because v times t1 --
they tell us, is 50.

00:08:06.590 --> 00:08:08.920
So we can substitute
it back here.

00:08:08.920 --> 00:08:11.660
So the distance is equal to 50.

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Plus, what's v times t2?

00:08:13.280 --> 00:08:15.460
Well, we solved it here when we
figured out how long it would

00:08:15.460 --> 00:08:18.050
take to go back to the
front of the column.

00:08:18.050 --> 00:08:19.960
So that's 25.

00:08:19.960 --> 00:08:22.440
So that, we'll put over here.

00:08:22.440 --> 00:08:26.370
So the total distance that the
column traveled is 50 plus

00:08:26.370 --> 00:08:29.380
25 meters, or 75 meters.

00:08:29.380 --> 00:08:32.040
And this is a neat problem,
because they didn't tell us

00:08:32.040 --> 00:08:33.610
how fast the column
is actually going.

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They're just saying it's v.

00:08:34.720 --> 00:08:36.880
They just said that the
officer is going 3 times

00:08:36.880 --> 00:08:39.320
as fast, but we don't
know absolute velocities.

00:08:39.320 --> 00:08:42.330
But we were still able to
figure out, even without even

00:08:42.330 --> 00:08:45.440
knowing the absolute times, we
were still able to figure out

00:08:45.440 --> 00:08:47.590
the total distance that
the column travelled.

00:08:47.590 --> 00:08:49.080
Anyway, I hope you
enjoyed that.

00:08:49.080 --> 00:08:52.840
And if you did, you can thank
Cortagio for the problem.


EBITDA

WEBVTT
Kind: captions
Language: en

00:00:00.440 --> 00:00:03.370
In the last couple of videos
we saw that looking just

00:00:03.370 --> 00:00:06.800
purely at market capitalization
can be a little

00:00:06.800 --> 00:00:09.190
bit misleading, when you look at
companies that have a good

00:00:09.190 --> 00:00:11.380
bit of leverage or companies
that have a good bit of debt.

00:00:11.380 --> 00:00:14.530
For example, if that's the
assets of the company, and

00:00:14.530 --> 00:00:18.181
let's say that they have
this much debt.

00:00:18.181 --> 00:00:19.810
And this is their equity.

00:00:24.430 --> 00:00:26.180
And then let's say they
have some excess cash.

00:00:26.180 --> 00:00:28.420
Cash that's not necessary to
actually operate the business.

00:00:28.420 --> 00:00:30.150
I'll draw that up here.

00:00:30.150 --> 00:00:31.520
So this is excess cash.

00:00:31.520 --> 00:00:34.850
Some cash is necessary, and
oftentimes people don't make

00:00:34.850 --> 00:00:35.220
the distinction.

00:00:35.220 --> 00:00:37.800
And they'll just view this
as all the cash.

00:00:37.800 --> 00:00:41.420
But we really want to separate
the value of the enterprise

00:00:41.420 --> 00:00:45.620
out of the market value
of the equity or the

00:00:45.620 --> 00:00:46.720
value of the debt.

00:00:46.720 --> 00:00:47.900
So let me just write
all this down.

00:00:47.900 --> 00:00:50.230
So this right here, this is
the value of the business.

00:00:50.230 --> 00:00:51.480
The enterprise value.

00:00:54.500 --> 00:00:58.160
Here is the debt.

00:00:58.160 --> 00:00:59.490
There's the debt.

00:00:59.490 --> 00:01:01.175
And this is the equity.

00:01:03.920 --> 00:01:06.870
And this is a little bit of
a slight, I would say,

00:01:06.870 --> 00:01:07.190
technicality.

00:01:07.190 --> 00:01:08.950
And you don't have to worry
about this if it

00:01:08.950 --> 00:01:10.100
confuses you at all.

00:01:10.100 --> 00:01:12.780
When I write the enterprise
here, this is the value of the

00:01:12.780 --> 00:01:13.730
business itself.

00:01:13.730 --> 00:01:18.060
So it's kind of the operational
assets net of the

00:01:18.060 --> 00:01:19.230
operational liabilities.

00:01:19.230 --> 00:01:21.560
It's literally-- if you had
to go out in the past two

00:01:21.560 --> 00:01:24.500
examples and buy the pizzeria--
how much net would

00:01:24.500 --> 00:01:26.150
you have to pay for
that pizzeria?

00:01:26.150 --> 00:01:29.150
And that's what we're trying to
figure out right here when

00:01:29.150 --> 00:01:31.440
we're talking about the
enterprise value.

00:01:31.440 --> 00:01:33.585
And we saw in the last couple
of videos how you calculate

00:01:33.585 --> 00:01:35.370
it, but it never hurts
to review it.

00:01:35.370 --> 00:01:38.070
This is actually one of those
less intuitive calculations

00:01:38.070 --> 00:01:40.380
the first few times you
see it, so it doesn't

00:01:40.380 --> 00:01:41.970
hurt to do it again.

00:01:41.970 --> 00:01:43.950
So the first thing to figure out
is, how do you figure out

00:01:43.950 --> 00:01:45.680
the market value
of the equity?

00:01:45.680 --> 00:01:47.400
The book value of the
equity is very easy.

00:01:47.400 --> 00:01:49.570
You could go into a company's
balance sheet and they'll

00:01:49.570 --> 00:01:50.070
write down a number.

00:01:50.070 --> 00:01:54.120
They'll say, this is what our
accountants say that the book

00:01:54.120 --> 00:01:55.730
value of our equity is worth.

00:01:55.730 --> 00:01:58.260
But the market value, figure it
out from what the market's

00:01:58.260 --> 00:01:59.580
willing to pay for a share.

00:01:59.580 --> 00:02:07.670
So the market value of equity or
the market cap is equal to

00:02:07.670 --> 00:02:11.520
price per share times the
number of shares.

00:02:14.040 --> 00:02:16.240
And that's the market value
of this equity.

00:02:16.240 --> 00:02:18.800
And you can see, just even from
this diagram, that the

00:02:18.800 --> 00:02:25.230
enterprise value plus the
non-operating cash or

00:02:25.230 --> 00:02:28.590
investments or liquid
investments, whatever you want

00:02:28.590 --> 00:02:29.280
to call them.

00:02:29.280 --> 00:02:37.580
Enterprise value plus the cash
is equal to the debt plus,

00:02:37.580 --> 00:02:39.420
let's just say the market cap.

00:02:39.420 --> 00:02:42.970
Because we want to know, when we
look at a price, we want to

00:02:42.970 --> 00:02:45.230
be able to figure out what
is the market saying the

00:02:45.230 --> 00:02:46.970
enterprise value of
the company is?

00:02:46.970 --> 00:02:49.500
What is the market value
of the enterprise?

00:02:49.500 --> 00:02:51.820
So debt plus-- instead of
equity-- I'll write market

00:02:51.820 --> 00:02:54.020
capitalization, because
it's the same thing.

00:02:54.020 --> 00:02:58.150
Market capitalization is the
market's value of the equity

00:02:58.150 --> 00:02:59.840
plus market cap.

00:02:59.840 --> 00:03:01.690
So we know market cap.

00:03:01.690 --> 00:03:04.240
We can look up the debt on a
company's balance sheet.

00:03:04.240 --> 00:03:05.820
We can look up the cash.

00:03:05.820 --> 00:03:09.470
So we just subtract cash from
both sides, and we get

00:03:09.470 --> 00:03:20.480
enterprise value is equal
to market cap

00:03:20.480 --> 00:03:25.120
plus debt minus cash.

00:03:25.120 --> 00:03:27.500
We're just taking cash
onto the right-hand

00:03:27.500 --> 00:03:30.730
side of this equation.

00:03:30.730 --> 00:03:35.070
So for example, if I have a
stock that is trading at-

00:03:35.070 --> 00:03:38.650
let's say the price is $10.

00:03:38.650 --> 00:03:45.290
And let's say that there
are 1 million shares.

00:03:45.290 --> 00:03:52.450
And let's say that the company
has $50 million of debt.

00:03:52.450 --> 00:03:59.400
And let's say it has $5 million
of excess cash, what's

00:03:59.400 --> 00:04:00.880
its enterprise value?

00:04:00.880 --> 00:04:02.510
Well, you first figure
out its market cap.

00:04:02.510 --> 00:04:06.750
Its market cap is $10 per share
times a million shares.

00:04:06.750 --> 00:04:08.670
So that's 10 million shares.

00:04:08.670 --> 00:04:10.510
That's the market cap.

00:04:10.510 --> 00:04:11.410
You add the debt.

00:04:11.410 --> 00:04:13.560
So, plus $50 million.

00:04:13.560 --> 00:04:15.760
And once again, I said this in
the last video, it's very

00:04:15.760 --> 00:04:17.390
unintuitive when you figure
out the value of the

00:04:17.390 --> 00:04:19.459
enterprise to add the debt.

00:04:19.459 --> 00:04:23.480
And the intuition is that if
someone were to want to buy

00:04:23.480 --> 00:04:27.040
this company from the
stakeholders and be debt free,

00:04:27.040 --> 00:04:29.750
they would have to pay these
people the total amount of

00:04:29.750 --> 00:04:32.270
debt, and they'd have to pay
these people the total amount

00:04:32.270 --> 00:04:33.060
of the market value.

00:04:33.060 --> 00:04:35.610
So they'd have to pay the
debt plus the equity.

00:04:35.610 --> 00:04:37.830
And they get a refund
of the cash.

00:04:37.830 --> 00:04:40.100
This would be extra stuff that
they would be buying that they

00:04:40.100 --> 00:04:41.970
could get money back for.

00:04:41.970 --> 00:04:44.260
So you have to pay the equity
holders, you have to pay the

00:04:44.260 --> 00:04:46.720
debt holders, and then you
get a refund of the cash.

00:04:46.720 --> 00:04:51.630
And so the enterprise value's
what? $60 million minus 5.

00:04:51.630 --> 00:04:54.200
That's $55 million.

00:04:54.200 --> 00:04:54.780
Fair enough.

00:04:54.780 --> 00:04:58.170
This is all just review of the
enterprise value video.

00:04:58.170 --> 00:05:00.980
But the question is, now that
you've figured out enterprise

00:05:00.980 --> 00:05:02.490
value, how do you figure
out if that's a

00:05:02.490 --> 00:05:04.130
fair enterprise value?

00:05:04.130 --> 00:05:06.290
When you looked at market
capitalization you compared

00:05:06.290 --> 00:05:09.440
that to earnings.

00:05:09.440 --> 00:05:11.560
The price to earnings ratio.

00:05:11.560 --> 00:05:12.880
You were doing this
on a per share.

00:05:12.880 --> 00:05:16.320
This is price per share divided
by earnings per share.

00:05:16.320 --> 00:05:22.350
This ratio's equivalent to
market cap divided by the

00:05:22.350 --> 00:05:23.810
actual net income
of the company.

00:05:27.570 --> 00:05:29.520
Where if you just multiply the
numerator and the denominator

00:05:29.520 --> 00:05:32.370
by the number of shares, you get
market cap and net income.

00:05:32.370 --> 00:05:33.490
This is EPS.

00:05:33.490 --> 00:05:36.210
P/E is actually price
per share divided by

00:05:36.210 --> 00:05:37.240
earnings per share.

00:05:37.240 --> 00:05:38.880
And that was one way
to look at it.

00:05:38.880 --> 00:05:40.210
You could compare
two companies.

00:05:40.210 --> 00:05:42.570
And we saw it breaks down if
they have different types of

00:05:42.570 --> 00:05:43.310
capital structure.

00:05:43.310 --> 00:05:45.880
So what do you compare
enterprise value to?

00:05:45.880 --> 00:05:48.670
Here we did market cap
to net income.

00:05:48.670 --> 00:05:52.450
Enterprise value should
be compared to what?

00:05:52.450 --> 00:05:55.460
Now I made an argument in the
last video that, well if we're

00:05:55.460 --> 00:05:58.340
looking at the enterprise, we
should look at essentially the

00:05:58.340 --> 00:06:00.850
earnings that are popping
out of the enterprise.

00:06:00.850 --> 00:06:03.640
We should look at the earnings
that are coming out of this

00:06:03.640 --> 00:06:05.100
asset right here.

00:06:05.100 --> 00:06:08.280
And on the very first video
on the income statement, I

00:06:08.280 --> 00:06:10.180
implied that-- let's do
a balance sheet--

00:06:10.180 --> 00:06:12.370
you have your revenue.

00:06:12.370 --> 00:06:14.740
Your revenue could be 100.

00:06:14.740 --> 00:06:18.730
You have your cost
of goods sold.

00:06:18.730 --> 00:06:23.130
Cost of goods sold could be,
let's say it's minus 50.

00:06:23.130 --> 00:06:24.520
And I'll show you another
convention.

00:06:24.520 --> 00:06:27.720
One of the commenters suggested
that I do this

00:06:27.720 --> 00:06:28.100
convention.

00:06:28.100 --> 00:06:30.380
Which is actually the most
typical convention for a lot

00:06:30.380 --> 00:06:32.260
of accountants and financial
analysts.

00:06:32.260 --> 00:06:34.050
Instead of writing a negative,
they'll write it in

00:06:34.050 --> 00:06:34.720
parentheses.

00:06:34.720 --> 00:06:36.000
That means negative.

00:06:36.000 --> 00:06:38.270
Minus 50.

00:06:38.270 --> 00:06:45.060
And then the gross profit
would be 50.

00:06:45.060 --> 00:06:47.350
And then, actually I want to
do something a little bit

00:06:47.350 --> 00:06:47.750
interesting.

00:06:47.750 --> 00:06:50.830
Let's say that this cost of
goods sold, it involves no

00:06:50.830 --> 00:06:52.170
depreciation or amortization.

00:06:52.170 --> 00:06:55.360
And watch those videos if
those words confuse you.

00:06:55.360 --> 00:06:57.720
And all of the appreciation and
amortization is actually

00:06:57.720 --> 00:06:58.850
occurring at the corporate
level.

00:06:58.850 --> 00:07:04.760
So let's say that there
is some SG&A.

00:07:04.760 --> 00:07:07.240
But this is without the
depreciation and amortization.

00:07:07.240 --> 00:07:14.630
So let's say that this
is an expense of 10.

00:07:14.630 --> 00:07:16.110
Let's say there's some
depreciation and

00:07:16.110 --> 00:07:18.505
amortization as well.

00:07:18.505 --> 00:07:20.990
D&A.

00:07:20.990 --> 00:07:23.250
In the last couple of videos
I kind of grouped.

00:07:23.250 --> 00:07:24.490
And that tends to be the case.

00:07:24.490 --> 00:07:26.540
On a lot of income statements
they won't separate out the

00:07:26.540 --> 00:07:28.060
depreciation and amortization.

00:07:28.060 --> 00:07:29.470
And you'll actually have to
look at the cash flow

00:07:29.470 --> 00:07:30.890
statement to figure
out what this is.

00:07:30.890 --> 00:07:32.920
And I'm going to do that
in a future video.

00:07:32.920 --> 00:07:34.560
But let's say that we actually
do break it out.

00:07:34.560 --> 00:07:35.700
Sometimes that does happen.

00:07:35.700 --> 00:07:39.200
And let's say that
that's another 5.

00:07:39.200 --> 00:07:41.620
Maybe these are in thousands.

00:07:41.620 --> 00:07:45.160
And then you're left with
the operating profit.

00:07:49.410 --> 00:07:53.740
In this case, which is 50
minus 15, so it's 35.

00:07:53.740 --> 00:07:55.010
And then you have things
below that.

00:07:55.010 --> 00:07:58.360
You have interest. And I'll do
those just for-- you have the

00:07:58.360 --> 00:08:00.420
non-operating income and
interest and all that.

00:08:00.420 --> 00:08:01.150
Let me just do that.

00:08:01.150 --> 00:08:08.160
Interest. Let's say that that is
also 5,000, if that's what

00:08:08.160 --> 00:08:09.430
we care about.

00:08:09.430 --> 00:08:11.750
And then you have pre-tax.

00:08:11.750 --> 00:08:13.500
I didn't put the non-operating
income.

00:08:13.500 --> 00:08:15.820
Let's say this cash isn't
generating anything.

00:08:15.820 --> 00:08:19.570
So pre-tax income is 30,000,
if that's what

00:08:19.570 --> 00:08:20.710
we're dealing with.

00:08:20.710 --> 00:08:21.920
It's getting a little messy.

00:08:21.920 --> 00:08:23.480
So then you have taxes.

00:08:23.480 --> 00:08:25.390
Let's say it's 1/3.

00:08:25.390 --> 00:08:27.380
It's 10,000 of taxes.

00:08:27.380 --> 00:08:28.630
And then you have earnings.

00:08:31.090 --> 00:08:33.409
30 minus 10 is 20,000.

00:08:33.409 --> 00:08:37.250
So I suggested, what part of
this income statement is

00:08:37.250 --> 00:08:40.059
dependent purely on this
piece right here?

00:08:45.450 --> 00:08:47.180
Well all this stuff with
interest, that's

00:08:47.180 --> 00:08:48.570
dependent on the debt.

00:08:48.570 --> 00:08:50.810
And essentially taxes is also
dependent on the debt.

00:08:50.810 --> 00:08:52.630
Because the more interest
you have, the more

00:08:52.630 --> 00:08:53.500
you can deduct it.

00:08:53.500 --> 00:08:58.980
And so all of this down
here is dependent on

00:08:58.980 --> 00:09:01.300
your capital structure.

00:09:01.300 --> 00:09:03.620
So if you wanted to look just
what the enterprise value is

00:09:03.620 --> 00:09:05.810
generating, it's generating
the operating profit.

00:09:10.220 --> 00:09:13.220
So I suggested that a pretty
good ratio, although this is

00:09:13.220 --> 00:09:14.200
very non traditional.

00:09:14.200 --> 00:09:16.050
It's not very not traditional,
but you don't

00:09:16.050 --> 00:09:17.970
hear it said a lot.

00:09:17.970 --> 00:09:21.730
I'd argue that you could look at
EV to operating profit as a

00:09:21.730 --> 00:09:22.980
good metric.

00:09:29.300 --> 00:09:36.550
Which in a lot of cases is the
inverse of the return on

00:09:36.550 --> 00:09:39.200
assets, as I defined it
in the first video.

00:09:39.200 --> 00:09:41.770
There's a lot of different
return on asset definitions.

00:09:41.770 --> 00:09:44.350
But it's essentially saying, for
every dollar of operating

00:09:44.350 --> 00:09:46.940
profit, how much are you paying
for the enterprise.

00:09:46.940 --> 00:09:49.010
Which I think is a pretty
good metric.

00:09:49.010 --> 00:09:52.340
Now, the more conventional
metric that you'll see when

00:09:52.340 --> 00:09:55.100
you see people talk about
enterprise values, enterprise

00:09:55.100 --> 00:09:56.370
value to EBITDA.

00:09:56.370 --> 00:09:59.340
And if you go and get a job as
a research analyst at some

00:09:59.340 --> 00:10:01.550
firm, this is going to be
something that you're going to

00:10:01.550 --> 00:10:03.620
be expected to calculate
for a company.

00:10:03.620 --> 00:10:06.410
And hopefully talk reasonably
intelligently about it.

00:10:06.410 --> 00:10:10.080
So the first question, to talk
reasonably intelligently about

00:10:10.080 --> 00:10:11.720
anything is, what is EBITDA?

00:10:11.720 --> 00:10:18.460
So EBITDA is Earnings Before
Interest, Taxes, Depreciation

00:10:18.460 --> 00:10:20.300
and Amortization.

00:10:20.300 --> 00:10:22.560
So let's see what that
would be here.

00:10:22.560 --> 00:10:28.890
So it's earnings before
interest, taxes, depreciation

00:10:28.890 --> 00:10:29.900
and amortization.

00:10:29.900 --> 00:10:32.280
So it's before all
of this stuff.

00:10:32.280 --> 00:10:33.920
Actually, let's compare that to

00:10:33.920 --> 00:10:35.120
something we covered before.

00:10:35.120 --> 00:10:36.370
So you have EBITDA.

00:10:39.280 --> 00:10:41.660
And you have EBIT.

00:10:41.660 --> 00:10:45.660
EBIT is Earnings Before
Interest and Taxes.

00:10:45.660 --> 00:10:47.520
So EBIT is earnings.

00:10:47.520 --> 00:10:49.240
You add back taxes and
interest. You're

00:10:49.240 --> 00:10:51.350
at operating profit.

00:10:51.350 --> 00:10:53.530
And I've gone over this in the
past, but the distinction

00:10:53.530 --> 00:10:57.220
between operating profit and
EBIT is that EBIT might

00:10:57.220 --> 00:10:59.080
include some non-operating
income, which

00:10:59.080 --> 00:10:59.890
I haven't put here.

00:10:59.890 --> 00:11:03.790
But if this cash was generating
some profit

00:11:03.790 --> 00:11:05.740
unrelated to the operations
of the business, it'd

00:11:05.740 --> 00:11:06.620
be included in EBIT.

00:11:06.620 --> 00:11:07.810
It wouldn't be an operating
profit.

00:11:07.810 --> 00:11:10.900
But they're usually pretty close
if we're talking about,

00:11:10.900 --> 00:11:13.310
let's say, a non-financial
type of business.

00:11:13.310 --> 00:11:14.370
So this is EBIT.

00:11:14.370 --> 00:11:16.440
And if you want to get EBITDA,
you just add back the

00:11:16.440 --> 00:11:18.670
depreciation and amortization.

00:11:18.670 --> 00:11:20.310
So EBITDA would be here.

00:11:23.510 --> 00:11:27.440
So the EBIT is 35,000.

00:11:27.440 --> 00:11:30.380
If you add that back,
it would be 40,000.

00:11:30.380 --> 00:11:32.510
So the EBITDA in this
case is 40.

00:11:32.510 --> 00:11:36.360
And if my units are in
thousands, it's 40,000.

00:11:36.360 --> 00:11:39.450
Now the question is, why do
people care about EBITDA?

00:11:39.450 --> 00:11:42.710
Why is EBITDA used instead
of operating profit?

00:11:42.710 --> 00:11:45.610
And the logic is that
depreciation and amortization,

00:11:45.610 --> 00:11:48.040
and we did this in the
depreciation and amortization

00:11:48.040 --> 00:11:50.860
videos, these are just
spread-out costs that

00:11:50.860 --> 00:11:54.240
necessarily aren't cash going
out the door in this period.

00:11:54.240 --> 00:11:56.390
We saw that this depreciation
and amortization.

00:11:56.390 --> 00:12:01.120
Maybe this is, I bought
a $100 or $100,000

00:12:01.120 --> 00:12:03.020
object 10 years ago.

00:12:03.020 --> 00:12:09.250
And every year I depreciate
1/20 of it.

00:12:09.250 --> 00:12:11.180
But the cash went out the
door 20 years ago.

00:12:11.180 --> 00:12:14.220
And so this depreciation and
amortization in this period,

00:12:14.220 --> 00:12:16.040
it isn't necessarily cash
out of the door.

00:12:16.040 --> 00:12:17.350
In fact, it isn't cash
out the door.

00:12:17.350 --> 00:12:20.190
We'll talk in future videos
about how do you find out what

00:12:20.190 --> 00:12:22.390
the cash out the door
is in a period.

00:12:22.390 --> 00:12:24.175
So it's considered a
non-cash expense.

00:12:27.210 --> 00:12:30.580
So when you figure out EBITDA,
when you add back taxes, you

00:12:30.580 --> 00:12:33.290
add back interest, and you
add back depreciation and

00:12:33.290 --> 00:12:34.360
amortization.

00:12:34.360 --> 00:12:37.820
What you're left with is
essentially, how much raw cash

00:12:37.820 --> 00:12:39.925
is the enterprise
spitting out?

00:12:43.720 --> 00:12:45.950
And a lot of people care about
this because this is an

00:12:45.950 --> 00:12:47.510
indication of, one,
the company's

00:12:47.510 --> 00:12:50.150
ability to do things.

00:12:50.150 --> 00:12:54.010
To do things like pay its
interest, pay its taxes, or

00:12:54.010 --> 00:12:55.630
invest in the business itself.

00:12:55.630 --> 00:13:03.010
Or another way to view it is,
if you look at EV to EBITDA,

00:13:03.010 --> 00:13:06.030
you're saying for every dollar
of raw cash that this

00:13:06.030 --> 00:13:07.360
business spits out.

00:13:07.360 --> 00:13:10.490
And let's say I were not to
reinvest in the business or

00:13:10.490 --> 00:13:11.590
buy new equipment.

00:13:11.590 --> 00:13:13.850
If it's just raw dollars, how
much am I paying for the

00:13:13.850 --> 00:13:14.760
enterprise?

00:13:14.760 --> 00:13:16.860
And a general rule of thumb, and
we'll do more on this in

00:13:16.860 --> 00:13:17.290
the future.

00:13:17.290 --> 00:13:21.210
I think I'm already well over my
regular time limit, is that

00:13:21.210 --> 00:13:26.090
for a very, stable, simple,
non-declining non-growing

00:13:26.090 --> 00:13:30.330
business, five times EBITDA is
considered a good valuation.

00:13:30.330 --> 00:13:34.340
But what matters more is what
other companies in that

00:13:34.340 --> 00:13:35.490
industry are trading at.

00:13:35.490 --> 00:13:38.270
So all of these ratios
are better as

00:13:38.270 --> 00:13:40.160
relative valuation metrics.

00:13:40.160 --> 00:13:42.240
In the future I'll show you how
to do maybe a discounted

00:13:42.240 --> 00:13:46.160
cash flow or a discounted free
cash flow type of analysis.

00:13:46.160 --> 00:13:48.410
Or a dividend discount model or
something, so you can kind

00:13:48.410 --> 00:13:49.890
of figure out an
absolute value.

00:13:49.890 --> 00:13:52.830
But when you're looking in
public markets, when you're

00:13:52.830 --> 00:13:55.330
picking to decide something,
you're also implicitly picking

00:13:55.330 --> 00:13:56.650
not to buy other things.

00:13:56.650 --> 00:13:58.690
When you're choosing to sell
something, you're also

00:13:58.690 --> 00:14:00.800
implicitly choosing not
to sell other things.

00:14:00.800 --> 00:14:04.110
So relative value starts to
matter a little bit more.

00:14:04.110 --> 00:14:06.910
Anyway, hopefully you
found that helpful.


Enterprise value

WEBVTT
Kind: captions
Language: en

00:00:00.670 --> 00:00:03.580
In the price to earnings
conundrum video we encountered

00:00:03.580 --> 00:00:07.340
a situation where two different
entrepreneurs bought

00:00:07.340 --> 00:00:11.130
an identical asset, in this case
it was a pizza parlor or

00:00:11.130 --> 00:00:14.050
a pizzeria, but they
each financed it

00:00:14.050 --> 00:00:14.950
in a different way.

00:00:14.950 --> 00:00:16.830
This guy was a little bit
more conservative.

00:00:16.830 --> 00:00:18.650
He paid for it outright.

00:00:18.650 --> 00:00:21.230
The entire asset
was his equity.

00:00:21.230 --> 00:00:22.210
He had no debt.

00:00:22.210 --> 00:00:24.630
While this guy, he borrowed
some money and he even had

00:00:24.630 --> 00:00:26.240
some non-operating assets.

00:00:26.240 --> 00:00:27.590
So he levered up.

00:00:27.590 --> 00:00:31.170
For every $1 he put in he
borrowed $10 from the bank in

00:00:31.170 --> 00:00:33.610
order to buy more assets
that he actually

00:00:33.610 --> 00:00:34.680
brought to the table.

00:00:34.680 --> 00:00:37.620
And we saw when you did their
financial statements-- their

00:00:37.620 --> 00:00:40.280
revenue, cost of goods--
everything up to the operating

00:00:40.280 --> 00:00:41.940
profit line was the same.

00:00:41.940 --> 00:00:44.810
And that makes sense because,
if you remember the first

00:00:44.810 --> 00:00:48.080
introduction to income statement
video, operating

00:00:48.080 --> 00:00:52.100
profit is really indicative of
what the operating assets are

00:00:52.100 --> 00:00:53.100
generating.

00:00:53.100 --> 00:00:58.880
So in this case it's what this
purple area right here is

00:00:58.880 --> 00:00:59.940
generating.

00:00:59.940 --> 00:01:03.740
You could also consider
that the enterprise.

00:01:03.740 --> 00:01:06.110
What the enterprise
is generating.

00:01:06.110 --> 00:01:08.840
And everything below the
operating line, everything

00:01:08.840 --> 00:01:11.880
below the operating profit line,
is either coming from

00:01:11.880 --> 00:01:14.540
non-operating assets, that
would the case of

00:01:14.540 --> 00:01:16.210
non-operating income.

00:01:16.210 --> 00:01:18.370
And the entrepreneur on the
right had some of that.

00:01:18.370 --> 00:01:22.330
He had some of this
non-operating income, $2,000

00:01:22.330 --> 00:01:23.230
per year in that case.

00:01:23.230 --> 00:01:24.510
While this guy didn't
have any.

00:01:24.510 --> 00:01:26.490
And then you have expenses
associated

00:01:26.490 --> 00:01:27.930
with interest. Right?

00:01:27.930 --> 00:01:31.250
In this case this entrepreneur
had 5% of

00:01:31.250 --> 00:01:33.910
$100,000, so $5,000 a year.

00:01:33.910 --> 00:01:36.250
And then when you have these
differences in capital

00:01:36.250 --> 00:01:39.090
structure it changes what
your net income is.

00:01:39.090 --> 00:01:41.030
And they have slightly different
net income numbers.

00:01:41.030 --> 00:01:43.600
But what we saw is when we
applied the same price to

00:01:43.600 --> 00:01:46.310
earnings ratio, and they had
the same share counts-- I

00:01:46.310 --> 00:01:48.490
didn't change too many variables
here I just really

00:01:48.490 --> 00:01:51.860
changed how they paid
for the asset.

00:01:51.860 --> 00:01:55.680
But when you apply the same
price to earnings ratio to

00:01:55.680 --> 00:02:00.700
both earning streams, to both
companies, you got something

00:02:00.700 --> 00:02:02.280
that was reasonably
unintuitive.

00:02:02.280 --> 00:02:04.940
And there's no trick
here really.

00:02:04.940 --> 00:02:07.530
Because it's not crazy to
assign the same price to

00:02:07.530 --> 00:02:08.320
earnings ratio.

00:02:08.320 --> 00:02:11.760
And if you try it out, if you
grow this guy's revenue a

00:02:11.760 --> 00:02:14.260
little bit, if you actually grow
both of their revenues by

00:02:14.260 --> 00:02:16.770
the same amount or both of their
gross profits by the

00:02:16.770 --> 00:02:19.360
same amount or if you grow
both of their operating

00:02:19.360 --> 00:02:21.610
profits by the same amount,
you're actually going to see

00:02:21.610 --> 00:02:25.170
that this guy's earnings per
share is growing faster.

00:02:25.170 --> 00:02:27.040
So given that someone might
say, oh, because of the

00:02:27.040 --> 00:02:29.300
leverage maybe I'm willing to
pay even a higher multiple.

00:02:29.300 --> 00:02:32.230
So it's not crazy to pay the
same multiple for both of

00:02:32.230 --> 00:02:33.070
these guys.

00:02:33.070 --> 00:02:35.630
But we saw at the end of the
last video, when you apply,

00:02:35.630 --> 00:02:39.270
let's say, a 10 multiple, or
really any multiple to both of

00:02:39.270 --> 00:02:43.000
these earning streams, you get
a situation that at first

00:02:43.000 --> 00:02:43.780
doesn't look crazy.

00:02:43.780 --> 00:02:47.210
OK, the market cap of this guy
is $210,000 if you apply a 10

00:02:47.210 --> 00:02:50.140
multiple to their earnings
stream, while the market cap

00:02:50.140 --> 00:02:54.310
of this guy is $189,000 if you
apply a 10 multiple to their

00:02:54.310 --> 00:02:54.730
earning stream.

00:02:54.730 --> 00:02:54.980
Right?

00:02:54.980 --> 00:02:58.400
10 times 18.9 thousand
is 189,000.

00:02:58.400 --> 00:03:01.480
10 times 21 thousand
is 210,000.

00:03:01.480 --> 00:03:04.390
But what was the conundrum, what
really got us thinking,

00:03:04.390 --> 00:03:09.150
was how can this whole equity
stream right here, or this

00:03:09.150 --> 00:03:11.940
equity, or this earnings stream
be, worth 210 and this

00:03:11.940 --> 00:03:15.770
one be worth 189 when this guy
only put $10,000 in initially

00:03:15.770 --> 00:03:17.790
and this guy put $100,000?

00:03:17.790 --> 00:03:19.440
He put in 10 times as much.

00:03:19.440 --> 00:03:23.940
And so when you're paying
$210,000 for this asset, for

00:03:23.940 --> 00:03:25.600
this equity, you are essentially
saying that this

00:03:25.600 --> 00:03:27.680
asset is worth $210,000.

00:03:27.680 --> 00:03:31.230
But if you're saying that this
equity is worth $189,000,

00:03:31.230 --> 00:03:32.620
right, that's what the
market cap is.

00:03:32.620 --> 00:03:34.030
It's the value of the equity.

00:03:34.030 --> 00:03:36.690
Then you're implicitly saying
that this asset, that all of

00:03:36.690 --> 00:03:40.500
these assets are worth the
value of this market

00:03:40.500 --> 00:03:43.330
capitalization plus
this debt, right?

00:03:43.330 --> 00:03:45.230
So that's $289,000.

00:03:45.230 --> 00:03:47.670
And then if you wanted the value
of this operating asset

00:03:47.670 --> 00:03:50.080
you would subtract out this
much right here, the cash.

00:03:50.080 --> 00:03:52.205
So you got something
like $279,000.

00:03:52.205 --> 00:03:56.190
So when you apply the same price
to earnings to to these

00:03:56.190 --> 00:03:59.160
similar businesses you've
actually got a situation where

00:03:59.160 --> 00:04:03.110
you're overpaying for this asset
relative to this one,

00:04:03.110 --> 00:04:04.370
even though they're identical.

00:04:04.370 --> 00:04:07.530
So that left us with a question:
what do we do?

00:04:07.530 --> 00:04:11.030
What can we use other than a
price to earnings ratio?

00:04:11.030 --> 00:04:12.670
And that's what this
video is for.

00:04:12.670 --> 00:04:14.730
So the short answer is,
one, you do have to

00:04:14.730 --> 00:04:15.630
use something different.

00:04:15.630 --> 00:04:19.950
Price to earnings ratio is a
good a quick way of comparing

00:04:19.950 --> 00:04:22.180
two companies relative
to their growth or

00:04:22.180 --> 00:04:23.490
relative to an industry.

00:04:23.490 --> 00:04:27.040
But it does lose a lot of
information relative to how

00:04:27.040 --> 00:04:28.420
the companies are capitalized.

00:04:28.420 --> 00:04:31.140
You saw in the last video that
how you're capitalized, and

00:04:31.140 --> 00:04:32.770
when I say capitalized
I mean how do you

00:04:32.770 --> 00:04:34.230
pay for your assets.

00:04:34.230 --> 00:04:38.090
If you have a lot of debt versus
a lot of equity, what

00:04:38.090 --> 00:04:39.750
actually happens on
the earnings line

00:04:39.750 --> 00:04:41.160
is very, very different.

00:04:41.160 --> 00:04:43.130
And so you lose all of
that information.

00:04:43.130 --> 00:04:45.830
And so if you want to capture
that information, when you

00:04:45.830 --> 00:04:48.720
look at the price of a stock
you have to figure out what

00:04:48.720 --> 00:04:51.730
you're actually paying for the
enterprise of the company, the

00:04:51.730 --> 00:04:54.340
enterprise value
of the company.

00:04:54.340 --> 00:04:57.000
So when I talk about the
enterprise, or the enterprise

00:04:57.000 --> 00:04:59.025
value, I'm talking about
the operating assets.

00:05:01.750 --> 00:05:03.450
It gets a little bit more
complicated if you're talking

00:05:03.450 --> 00:05:05.180
about a financial company
like a bank or

00:05:05.180 --> 00:05:05.990
an insurance company.

00:05:05.990 --> 00:05:08.790
But if we're talking about a
widget factory, the enterprise

00:05:08.790 --> 00:05:11.620
is essentially the assets.

00:05:11.620 --> 00:05:15.050
The enterprise value is the
asset value of the assets that

00:05:15.050 --> 00:05:16.410
allow the company
to do business.

00:05:16.410 --> 00:05:19.840
So whatever factories-- well, in
this case it's a pizzeria,

00:05:19.840 --> 00:05:26.030
so the ovens, the building,
the places, where people

00:05:26.030 --> 00:05:28.940
actually eat their food, and
even the cash that's necessary

00:05:28.940 --> 00:05:31.000
to operate the business.

00:05:31.000 --> 00:05:34.500
The enterprise value shouldn't
incorporate the cash that's

00:05:34.500 --> 00:05:37.650
surplus, that's not necessary
to operate the business.

00:05:37.650 --> 00:05:41.080
So that begs the question,
how do you calculate the

00:05:41.080 --> 00:05:43.100
enterprise value?

00:05:43.100 --> 00:05:46.110
So you could go backwards and
you say, OK, for a given price

00:05:46.110 --> 00:05:47.980
how much am I paying for
an enterprise value?

00:05:47.980 --> 00:05:54.190
So let's say that this stock--
let's say that Company A or

00:05:54.190 --> 00:06:03.510
this one, let's say the stock
right now is trading at $20.

00:06:03.510 --> 00:06:06.180
So this is the current price
that you could buy it at.

00:06:06.180 --> 00:06:09.530
So it's the asking price in
the market is at $20.

00:06:09.530 --> 00:06:14.610
While this one is at, let's
say it's at $10.

00:06:14.610 --> 00:06:15.700
It's at $10.

00:06:15.700 --> 00:06:18.040
So at first glance you might
just do a quick price to

00:06:18.040 --> 00:06:18.930
earnings ratio.

00:06:18.930 --> 00:06:25.840
And you'll say, OK, for $20 I'm
getting $2.10 earnings per

00:06:25.840 --> 00:06:27.660
year, assuming it's not
growing or something.

00:06:27.660 --> 00:06:31.170
So my price to earnings is
approximately, I don't know

00:06:31.170 --> 00:06:34.070
have my calculator in front of
me, but $20 divided by $2.10

00:06:34.070 --> 00:06:35.870
is going to be 9 point
something, something.

00:06:35.870 --> 00:06:36.940
Right?

00:06:36.940 --> 00:06:42.700
While this guy, for $10,
I am getting $1.89 of

00:06:42.700 --> 00:06:44.010
earnings per year.

00:06:44.010 --> 00:06:45.440
So what's 100 divided by 18?

00:06:45.440 --> 00:06:48.230
It's 5 or 6 times.

00:06:48.230 --> 00:06:51.270
It's going to be 5
point something.

00:06:51.270 --> 00:06:56.360
6 times 18 is 60 plus -- Yeah
it's going to be 5 point

00:06:56.360 --> 00:06:56.980
something, something.

00:06:56.980 --> 00:06:58.900
So when you superficially just
look at this you're going to

00:06:58.900 --> 00:07:01.930
say, wow, this is a cheaper
price to earnings ratio, maybe

00:07:01.930 --> 00:07:03.250
I should buy that.

00:07:03.250 --> 00:07:05.290
But what we saw in the last
video is that price to

00:07:05.290 --> 00:07:08.780
earnings isn't a good relative
valuation metric when two

00:07:08.780 --> 00:07:11.120
different companies are
capitalized very differently.

00:07:11.120 --> 00:07:14.640
So what you want to do is
instead back out what these

00:07:14.640 --> 00:07:17.660
prices imply about the
enterprise value.

00:07:17.660 --> 00:07:20.280
So what does $20 imply about the
enterprise value and what

00:07:20.280 --> 00:07:21.760
does $10 imply.

00:07:21.760 --> 00:07:22.670
And how do you do that?

00:07:22.670 --> 00:07:26.270
Well first you say what
is the market cap?

00:07:26.270 --> 00:07:28.300
Market cap.

00:07:28.300 --> 00:07:30.450
So you take the price times
the number of shares.

00:07:30.450 --> 00:07:32.980
If you remember, we
had 10,000 shares.

00:07:32.980 --> 00:07:35.710
So in this case $20 times
10,000 shares implies a

00:07:35.710 --> 00:07:38.090
$200,000 market cap.

00:07:38.090 --> 00:07:42.310
In this case we have $10 times
10,000 shares so it implies a

00:07:42.310 --> 00:07:45.900
$100,000 market cap.

00:07:45.900 --> 00:07:48.790
Now remember, the market cap
is just what's left over.

00:07:48.790 --> 00:07:53.410
So let me redraw those two
diagrams because I feel like

00:07:53.410 --> 00:07:54.420
I'm--

00:07:54.420 --> 00:07:58.490
So for this entrepreneur
you have the assets

00:07:58.490 --> 00:08:01.530
and there's no debt.

00:08:01.530 --> 00:08:03.140
So the assets are kind
of completely

00:08:03.140 --> 00:08:06.280
represented by the equity.

00:08:06.280 --> 00:08:10.170
So if the market cap is $200,000
you're essentially

00:08:10.170 --> 00:08:13.210
saying that these assets, these
operating assets, are

00:08:13.210 --> 00:08:15.150
worth $200,000.

00:08:15.150 --> 00:08:20.860
So in this case, at a price
of $20, we know that the

00:08:20.860 --> 00:08:24.910
enterprise value, the market
enterprise value, so what the

00:08:24.910 --> 00:08:27.290
market is saying the enterprise
is worth, the

00:08:27.290 --> 00:08:31.670
operating assets are
worth, is $200,000.

00:08:31.670 --> 00:08:34.080
Now, in this case, remember the
market is saying that the

00:08:34.080 --> 00:08:36.010
equity is worth $100,000.

00:08:36.010 --> 00:08:37.230
Let me draw that.

00:08:37.230 --> 00:08:42.260
The market is saying that the
equity is worth $100,000.

00:08:42.260 --> 00:08:44.620
But of course this company
has a lot of debt.

00:08:44.620 --> 00:08:47.200
It has another $100,000
of debt.

00:08:47.200 --> 00:08:49.230
Actually let me draw this
a little bit different.

00:08:56.290 --> 00:08:58.380
All right.

00:08:58.380 --> 00:09:02.160
So in this situation the market
is saying that its

00:09:02.160 --> 00:09:05.070
market cap is $100,000.

00:09:05.070 --> 00:09:08.440
So just to be proportional
let me draw it like that.

00:09:11.240 --> 00:09:14.430
Not really use that one.

00:09:14.430 --> 00:09:18.480
So $100,000, this is the
equity or the market

00:09:18.480 --> 00:09:21.320
capitalization or the market
value of the equity.

00:09:21.320 --> 00:09:22.520
That's what the market cap is.

00:09:22.520 --> 00:09:25.230
So that's just the price times
the number of shares.

00:09:25.230 --> 00:09:27.700
And then it has debt.

00:09:27.700 --> 00:09:34.280
If I remember correctly it
has $100,000 in debt.

00:09:34.280 --> 00:09:49.983
We take $100,000 in debt.

00:09:49.983 --> 00:09:52.410
$100,000.

00:09:52.410 --> 00:09:54.520
And so what is it saying
about the assets?

00:09:54.520 --> 00:09:57.150
So the equity plus
the debt, or the

00:09:57.150 --> 00:09:58.860
liabilities, is $200,000.

00:09:58.860 --> 00:10:07.850
So it's saying all of the assets
are worth $200,000.

00:10:07.850 --> 00:10:10.760
This is all of the
assets, $200,000.

00:10:10.760 --> 00:10:12.420
But what we need to do, we want
to figure out the value

00:10:12.420 --> 00:10:13.840
of the enterprise.

00:10:13.840 --> 00:10:15.900
Not just all of the assets.

00:10:15.900 --> 00:10:18.170
So if we remember there was some
of the assets that were

00:10:18.170 --> 00:10:21.260
actually operational and some
were non-operational.

00:10:21.260 --> 00:10:25.460
So we had $10,000 of
cash right there.

00:10:25.460 --> 00:10:31.110
So we have $10,000 of cash.

00:10:31.110 --> 00:10:34.990
So when this stock is trading
at $10 it implies a market

00:10:34.990 --> 00:10:37.250
capitalization of $100,000.

00:10:37.250 --> 00:10:39.250
It implies that the liabilities

00:10:39.250 --> 00:10:41.550
plus equity is $200,000.

00:10:41.550 --> 00:10:44.100
So all of the assets
are $200,000.

00:10:44.100 --> 00:10:47.110
But if we were to subtract out
the cash or the non-operating

00:10:47.110 --> 00:10:49.810
assets, what's not necessary
to operate the business, we

00:10:49.810 --> 00:10:55.160
get $190,000 of enterprise
value.

00:10:55.160 --> 00:10:56.520
So in this case we're
saying that the

00:10:56.520 --> 00:11:00.790
enterprise value is $190,000.

00:11:00.790 --> 00:11:03.570
So in this case, when you look
at the price to earnings

00:11:03.570 --> 00:11:05.660
you're like, wow, this is half
as expensive as that.

00:11:05.660 --> 00:11:07.270
This is great deal,
let me buy it.

00:11:07.270 --> 00:11:09.590
And I just happened to make up
the numbers so even when I did

00:11:09.590 --> 00:11:12.560
the enterprise value it's
only 5% cheaper.

00:11:12.560 --> 00:11:14.430
Here it looks 50% cheaper.

00:11:14.430 --> 00:11:16.540
Here it looks 5% cheaper.

00:11:16.540 --> 00:11:18.960
And so it might be a
little unintuitive.

00:11:18.960 --> 00:11:22.730
To figure out the enterprise
value you take, and this will

00:11:22.730 --> 00:11:24.830
be the formula you see
in a lot of books.

00:11:24.830 --> 00:11:29.880
Enterprise value is equal
to market cap

00:11:29.880 --> 00:11:33.660
plus debt minus cash.

00:11:33.660 --> 00:11:35.930
And you might be like, when I'm
trying to value something

00:11:35.930 --> 00:11:37.620
why should I add debt back?

00:11:37.620 --> 00:11:39.450
Debt is a negative thing.

00:11:39.450 --> 00:11:41.590
Shouldn't debt make my
enterprise worth less?

00:11:41.590 --> 00:11:43.480
And why am I subtracting cash?

00:11:43.480 --> 00:11:45.390
Because cash is a positive
thing, shouldn't that make my

00:11:45.390 --> 00:11:47.170
enterprise value more?

00:11:47.170 --> 00:11:50.230
And the reason why, first, you
subtract cash is, and it

00:11:50.230 --> 00:11:53.540
really should be just cash that
is not associated with

00:11:53.540 --> 00:11:54.220
the enterprise.

00:11:54.220 --> 00:11:56.280
And you'll see a lot of people
do it in different ways.

00:11:56.280 --> 00:11:58.850
Some people subtract out all
cash with the argument that

00:11:58.850 --> 00:12:01.030
the company doesn't need
to use any of it.

00:12:01.030 --> 00:12:06.110
But the real idea behind it is
to kind of capture the assets

00:12:06.110 --> 00:12:10.120
that are actually generating the
profits of the enterprise.

00:12:10.120 --> 00:12:12.930
And the profits of the
enterprise are

00:12:12.930 --> 00:12:14.860
the operating profits.

00:12:14.860 --> 00:12:16.430
And the reason why you
add debt is, think

00:12:16.430 --> 00:12:17.350
about it this way.

00:12:17.350 --> 00:12:21.100
If you wanted to buy
out this company.

00:12:21.100 --> 00:12:24.360
Let's say from this company you
wanted to buy his assets

00:12:24.360 --> 00:12:26.210
at the market price.

00:12:26.210 --> 00:12:27.880
How would you do it?

00:12:27.880 --> 00:12:29.800
You would have to pay, what?

00:12:29.800 --> 00:12:33.040
You would have to maybe
get $200,000.

00:12:33.040 --> 00:12:36.210
If you got $200,000 you could
buy these guys off.

00:12:36.210 --> 00:12:38.740
You could pay them $100,000
and own that.

00:12:38.740 --> 00:12:40.830
And then you could
buy the bank out

00:12:40.830 --> 00:12:43.030
and pay them $100,000.

00:12:43.030 --> 00:12:46.740
So if you paid $200,000, you
would own all of this.

00:12:46.740 --> 00:12:46.970
Right?

00:12:46.970 --> 00:12:48.670
This would all be your equity.

00:12:48.670 --> 00:12:51.780
And then you would get $10,000
back if you know if you wanted

00:12:51.780 --> 00:12:54.060
to take this cash, right?

00:12:54.060 --> 00:12:57.310
So you would have essentially
paid $200,000 which is the

00:12:57.310 --> 00:12:59.040
market cap plus the debt.

00:12:59.040 --> 00:13:02.840
That's what you would have to
do to buy out both of those

00:13:02.840 --> 00:13:04.330
stakeholders in the company.

00:13:04.330 --> 00:13:06.050
And then you would get
back the cash.

00:13:06.050 --> 00:13:11.120
So you would have to pay net
$190,000 to own this

00:13:11.120 --> 00:13:12.060
enterprise.

00:13:12.060 --> 00:13:14.030
And hopefully that makes a
little bit more sense as why

00:13:14.030 --> 00:13:19.020
the enterprise value is actually
described this way.

00:13:19.020 --> 00:13:21.390
Now the one thing you might say,
OK, Sal, you figured out

00:13:21.390 --> 00:13:23.620
how to calculate enterprise
value from a share price.

00:13:23.620 --> 00:13:25.140
But what if I want to go
the other way around.

00:13:25.140 --> 00:13:28.270
How do I figure out what a
company's enterprise value

00:13:28.270 --> 00:13:31.750
should be and then figure
out what its share

00:13:31.750 --> 00:13:33.440
price should be?

00:13:33.440 --> 00:13:35.350
Well one metric, and there's
two metrics.

00:13:35.350 --> 00:13:38.630
The most common metric that's
used is EBITDA.

00:13:38.630 --> 00:13:39.950
EBITDA.

00:13:39.950 --> 00:13:42.620
I won't cover that now because
it's a new term for you, but

00:13:42.620 --> 00:13:46.230
it means earnings before
interest, taxes, depreciation,

00:13:46.230 --> 00:13:47.340
and amortization.

00:13:47.340 --> 00:13:49.840
And people look at something
called an enterprise value to

00:13:49.840 --> 00:13:51.060
EBITDA ratio.

00:13:51.060 --> 00:13:52.710
And I'll do that in
the next video.

00:13:52.710 --> 00:13:54.820
But what I like to do is just
think about, OK, what are the

00:13:54.820 --> 00:13:58.130
real earnings from
the enterprise?

00:13:58.130 --> 00:14:00.500
Well, that's the operating
profit.

00:14:00.500 --> 00:14:02.700
That's the operating
profit, right?

00:14:02.700 --> 00:14:05.700
And then you could apply a
multiple to that based on what

00:14:05.700 --> 00:14:08.120
other companies are trading at
or how fast it's growing.

00:14:08.120 --> 00:14:10.850
Let's say in this case we're
saying they're both generating

00:14:10.850 --> 00:14:13.760
$30,000 in operating
profit per year.

00:14:13.760 --> 00:14:19.660
Let's say that I want to
apply a 5 multiple to

00:14:19.660 --> 00:14:21.520
its operating profits.

00:14:21.520 --> 00:14:29.530
So let's say I want to say that
EV to operating profit,

00:14:29.530 --> 00:14:31.730
which I frankly think is a
better metric than EV to

00:14:31.730 --> 00:14:34.970
EBITDA-- and I'll cover EBITDA
in a future video-- let's say

00:14:34.970 --> 00:14:39.130
that I think for this industry
it should be 5.

00:14:39.130 --> 00:14:40.660
Let me say it should be 6.

00:14:40.660 --> 00:14:42.530
6 times is a good multiple.

00:14:42.530 --> 00:14:49.840
So in both those cases the
operating profit was $30,000.

00:14:49.840 --> 00:14:55.990
So that means that EV should be
$30,000 times 6, which is

00:14:55.990 --> 00:14:59.410
equal to $180,000.

00:14:59.410 --> 00:15:04.250
Now for the first guy if the EV
is $180,000, if I'm saying

00:15:04.250 --> 00:15:06.440
that this thing right here, the
market value, should be

00:15:06.440 --> 00:15:09.380
$180,000, then I'm implying
that the equity should be

00:15:09.380 --> 00:15:10.970
worth $180,000.

00:15:10.970 --> 00:15:17.490
And there are 10,000 shares.

00:15:17.490 --> 00:15:21.300
So essentially I would take that
EV and I would say, well,

00:15:21.300 --> 00:15:24.540
all of that's equity, there's
no cash there, there's no

00:15:24.540 --> 00:15:26.350
debt, so all of this
is equity.

00:15:26.350 --> 00:15:28.200
So I would divide that
by the shares.

00:15:28.200 --> 00:15:30.870
I would say that the market cap
for the first guy should

00:15:30.870 --> 00:15:32.830
be $180,000.

00:15:32.830 --> 00:15:36.520
So the per-share price,
the price I'd be

00:15:36.520 --> 00:15:39.000
willing to pay, is $18.

00:15:39.000 --> 00:15:40.580
Because it had 10,000 shares.

00:15:40.580 --> 00:15:41.920
$18.

00:15:41.920 --> 00:15:44.690
Now let's take the second
guy's situation.

00:15:44.690 --> 00:15:47.340
We both agree in both situations
their enterprise

00:15:47.340 --> 00:15:54.150
value should be $180,000.

00:15:54.150 --> 00:15:59.190
But in this guy's case,
what are the assets?

00:15:59.190 --> 00:16:04.270
The assets are the enterprise,
$180,000 plus $10,000.

00:16:04.270 --> 00:16:05.880
Plus $10,000, right?

00:16:05.880 --> 00:16:10.290
This whole left-hand
side is $190,000.

00:16:10.290 --> 00:16:12.570
And then if you wanted to
subtract out, figure out the

00:16:12.570 --> 00:16:15.570
market cap, you would take
this whole thing and then

00:16:15.570 --> 00:16:17.630
subtract out the debt to
get the market cap.

00:16:17.630 --> 00:16:17.870
Right?

00:16:17.870 --> 00:16:21.850
And then you would be left with
this piece right here.

00:16:21.850 --> 00:16:22.890
That right there, right?

00:16:22.890 --> 00:16:24.990
You were just figuring out
this whole distance,

00:16:24.990 --> 00:16:27.540
subtracting out this distance.

00:16:27.540 --> 00:16:31.760
So essentially you would say
that the market cap is equal

00:16:31.760 --> 00:16:36.260
to the enterprise value plus
the cash minus the debt.

00:16:36.260 --> 00:16:37.870
And it's good to draw those
balance sheets if

00:16:37.870 --> 00:16:38.930
you ever get confused.

00:16:38.930 --> 00:16:39.800
Minus the debt.

00:16:39.800 --> 00:16:43.920
So the market cap is equal to
$190,000 minus $100,000 is

00:16:43.920 --> 00:16:46.050
equal to $90,000.

00:16:46.050 --> 00:16:49.920
And so if you divide that by
10,000 shares you'd say that

00:16:49.920 --> 00:16:53.960
I'm willing to pay
$9 per share.

00:16:53.960 --> 00:16:56.710
So if you believe that the
enterprise value of these

00:16:56.710 --> 00:16:59.100
pizzerias are identical and
that they're both worth

00:16:59.100 --> 00:17:02.520
$180,000, you should
be willing to pay

00:17:02.520 --> 00:17:04.700
$18 for Company A.

00:17:04.700 --> 00:17:07.450
And if you're completely
equivalent to it, you should

00:17:07.450 --> 00:17:09.369
pay $9 for Company B.

00:17:09.369 --> 00:17:11.420
And now if you're a little bit
more aggressive you might like

00:17:11.420 --> 00:17:13.550
the leverage, you might
like how Company B

00:17:13.550 --> 00:17:14.440
is growing, et cetera.

00:17:14.440 --> 00:17:17.170
Maybe you would like to pay a
premium for that leverage or

00:17:17.170 --> 00:17:19.250
maybe you wouldn't, because it
also increases your risk.

00:17:19.250 --> 00:17:22.599
Because you get leverage on the
upside or on the downside.

00:17:22.599 --> 00:17:24.369
But anyways I wanted to
introduce you to value.

00:17:24.369 --> 00:17:26.690
On the next video I'll introduce
you to EBITDA.


P/E conundrum

WEBVTT
Kind: captions
Language: en

00:00:00.600 --> 00:00:02.620
Let's say we have two
entrepreneurs.

00:00:02.620 --> 00:00:06.700
And they are both interested
in buying a pizzeria and

00:00:06.700 --> 00:00:08.480
eventually turning it into
a public company.

00:00:08.480 --> 00:00:09.640
So let's compare the two.

00:00:09.640 --> 00:00:13.630
So let me draw a dividing line
here between the first and the

00:00:13.630 --> 00:00:16.260
second entrepreneurs.

00:00:16.260 --> 00:00:18.460
And they're actually going
to buy identical assets.

00:00:18.460 --> 00:00:20.140
So they're going to buy
a pizzeria with the

00:00:20.140 --> 00:00:21.460
ovens inside of them.

00:00:21.460 --> 00:00:24.250
And the same amount of cash
in the cash register.

00:00:24.250 --> 00:00:26.980
Everything they need to operate
the pizzeria and they

00:00:26.980 --> 00:00:28.550
may be in identical locations.

00:00:28.550 --> 00:00:30.790
Maybe right next to each other
at the same intersection.

00:00:30.790 --> 00:00:33.220
Or across the street
from each other.

00:00:33.220 --> 00:00:34.400
It's the same asset.

00:00:34.400 --> 00:00:36.270
Let me draw that out.

00:00:36.270 --> 00:00:39.830
I don't want to draw this box.

00:00:39.830 --> 00:00:41.620
So that's the asset.

00:00:41.620 --> 00:00:43.410
And it costs $100,000.

00:00:43.410 --> 00:00:44.910
That includes the building.

00:00:44.910 --> 00:00:47.160
It includes the oven.

00:00:47.160 --> 00:00:50.420
It includes the places where
the customers come sit.

00:00:50.420 --> 00:00:51.870
It even includes
the cash needed

00:00:51.870 --> 00:00:53.190
to operate the business.

00:00:53.190 --> 00:00:55.800
So you need some cash to pay
vendors just to get started

00:00:55.800 --> 00:00:57.540
and to pay for things
like dough.

00:00:57.540 --> 00:00:59.270
And have some money in
the cash register.

00:00:59.270 --> 00:01:01.250
And to have a little bit
of a bank account.

00:01:01.250 --> 00:01:01.890
Things like that.

00:01:01.890 --> 00:01:03.130
So that's all inclusive.

00:01:03.130 --> 00:01:09.100
All of the assets needed to
start the firm, the pizzeria.

00:01:09.100 --> 00:01:10.820
So this is the assets.

00:01:10.820 --> 00:01:13.100
And they both buy identical
assets.

00:01:13.100 --> 00:01:14.350
So let me copy and paste that.

00:01:19.050 --> 00:01:20.870
They buy identical assets.

00:01:20.870 --> 00:01:23.720
Now, the first entrepreneur,
he's very conservative and

00:01:23.720 --> 00:01:25.930
he's been saving all his
whole life to do this.

00:01:25.930 --> 00:01:30.840
So he actually has $100,000 of
cash to buy his pizzeria, so

00:01:30.840 --> 00:01:32.010
he buys it outright.

00:01:32.010 --> 00:01:36.115
So he owns it outright so all of
the $100,000 of asset value

00:01:36.115 --> 00:01:38.060
is actually his equity.

00:01:38.060 --> 00:01:41.875
Let me do equity in
a different color.

00:01:41.875 --> 00:01:45.690
It's all his equity.

00:01:45.690 --> 00:01:49.040
So that's all his equity.

00:01:49.040 --> 00:01:51.060
This guy here, maybe he's a
little bit earlier in his

00:01:51.060 --> 00:01:54.170
career, or he's just not as
good at saving money.

00:01:54.170 --> 00:01:57.040
So he doesn't quite
have $100,000.

00:01:57.040 --> 00:02:00.190
He actually only has $10,000
in his pocket.

00:02:00.190 --> 00:02:03.450
But he's a smooth talker.

00:02:03.450 --> 00:02:05.480
So he goes to the local bank
and says, hey I have this

00:02:05.480 --> 00:02:09.350
great idea for-- let me write
this down, $10,000 of equity,

00:02:09.350 --> 00:02:12.590
that's what he has-- but he
tells the guy at the bank, and

00:02:12.590 --> 00:02:14.676
he buys him lunch, and he says,
I have this great idea

00:02:14.676 --> 00:02:15.080
for a pizzeria.

00:02:15.080 --> 00:02:17.630
And they agree to give
him not just $90,000.

00:02:17.630 --> 00:02:19.160
This guy, he's a little
ambitious too.

00:02:19.160 --> 00:02:21.160
He thinks not just beside
a pizzeria.

00:02:21.160 --> 00:02:22.970
In the name of the pizzeria
he's going to borrow some

00:02:22.970 --> 00:02:26.110
money and then maybe invest that
in stocks or something.

00:02:26.110 --> 00:02:28.780
So he gets a sweetheart
deal on the loan.

00:02:28.780 --> 00:02:30.970
And he's able to actually borrow
a little bit more than

00:02:30.970 --> 00:02:31.760
what he even needs.

00:02:31.760 --> 00:02:35.530
He only needs $90,000, but let's
say he borrows $100,000.

00:02:35.530 --> 00:02:38.140
So he borrows $100,000
of debt.

00:02:49.710 --> 00:02:53.490
And so, he has $110,000
to play with.

00:02:53.490 --> 00:02:56.280
He buys a $100,000 pizzeria.

00:02:56.280 --> 00:03:00.150
And then he has another $10,000
left over to do with

00:03:00.150 --> 00:03:00.800
what he wants.

00:03:00.800 --> 00:03:03.460
And he puts it in the pizzeria's
name, in the

00:03:03.460 --> 00:03:05.100
pizzeria's bank account.

00:03:05.100 --> 00:03:06.800
Because he has to show the bank
that it's going towards

00:03:06.800 --> 00:03:07.090
the pizzeria.

00:03:07.090 --> 00:03:09.570
But his real intent is to maybe
gamble with it on the

00:03:09.570 --> 00:03:13.110
side in the pizzeria's name, and
maybe invest in stocks or

00:03:13.110 --> 00:03:15.600
speculate on pork
belly futures or

00:03:15.600 --> 00:03:16.340
something like that.

00:03:16.340 --> 00:03:23.600
But for all intents and
purposes it's cash.

00:03:23.600 --> 00:03:26.460
And so they go off and they
start their pizzeria.

00:03:26.460 --> 00:03:28.140
Let's see what happens.

00:03:28.140 --> 00:03:34.570
So let's look at them over
the course of one year.

00:03:34.570 --> 00:03:35.820
So let's say, revenue.

00:03:41.290 --> 00:03:43.490
So let's say the first year
they're identical.

00:03:43.490 --> 00:03:45.150
They both make $100,000
in revenue.

00:03:49.760 --> 00:03:52.890
Let's say their cost of goods
sold is roughly 50% of that.

00:03:52.890 --> 00:03:55.340
So it's $50,000.

00:03:55.340 --> 00:03:57.020
I'll put a minus there because
it's an expense.

00:03:57.020 --> 00:03:58.910
Minus $50,000.

00:03:58.910 --> 00:04:06.770
So both of their gross
profit is $50,000.

00:04:06.770 --> 00:04:08.510
And then their SG&A
is the same.

00:04:08.510 --> 00:04:14.140
If you've watched the video on
depreciation and amortization,

00:04:14.140 --> 00:04:16.510
this might even include the
depreciation on some of the

00:04:16.510 --> 00:04:18.279
physical assets they've
bought, or maybe the

00:04:18.279 --> 00:04:22.850
amortization on the rights to
the name Super Pizzeria.

00:04:22.850 --> 00:04:23.540
In either case.

00:04:23.540 --> 00:04:25.730
Maybe the brands
are identical.

00:04:25.730 --> 00:04:29.010
So that's another $20,000.

00:04:29.010 --> 00:04:31.350
Minus $20,000.

00:04:31.350 --> 00:04:33.790
So far they look very,
very identical.

00:04:33.790 --> 00:04:39.000
And that's because they have
the same exact asset.

00:04:39.000 --> 00:04:40.250
So their operating profit.

00:04:44.280 --> 00:04:48.780
50 minus 20 is $30,000.

00:04:48.780 --> 00:04:51.020
And now we'll start to see
a little difference.

00:04:51.020 --> 00:04:53.210
And this goes back to the
very first video we saw.

00:04:53.210 --> 00:04:55.480
It says if you have an identical
asset and it's being

00:04:55.480 --> 00:04:58.060
managed identically, which it
is in this case, they will

00:04:58.060 --> 00:05:00.700
generate an identical amount
of operating profit.

00:05:00.700 --> 00:05:02.660
But when I talk about the asset,
I'm talking about only

00:05:02.660 --> 00:05:04.570
the operating assets.

00:05:04.570 --> 00:05:06.600
This guy has some non-operating
assets, although

00:05:06.600 --> 00:05:07.690
it's officially part
of the company.

00:05:07.690 --> 00:05:09.100
He doesn't need it to operate.

00:05:09.100 --> 00:05:11.330
This is cash above
and beyond what's

00:05:11.330 --> 00:05:12.740
needed in the cash register.

00:05:12.740 --> 00:05:16.530
And we might have a little bit
of cash here in this asset

00:05:16.530 --> 00:05:18.410
that's needed for the
cash register.

00:05:18.410 --> 00:05:20.980
And I'll teach you more
about working capital.

00:05:20.980 --> 00:05:22.370
But in order to pay vendors
and things like this.

00:05:22.370 --> 00:05:24.480
This is cash above and beyond
what's necessary.

00:05:24.480 --> 00:05:25.525
This guy has a little
bit of cash just

00:05:25.525 --> 00:05:26.650
to operate the business.

00:05:26.650 --> 00:05:29.310
He just doesn't have this
gambling cash out here.

00:05:29.310 --> 00:05:31.830
So now we add an interesting
line.

00:05:31.830 --> 00:05:33.120
Non-operating income.

00:05:37.730 --> 00:05:38.850
This guy doesn't
make anything.

00:05:38.850 --> 00:05:40.150
He's not gambling.

00:05:40.150 --> 00:05:42.090
This guy's pretty good
with this $10,000

00:05:42.090 --> 00:05:43.320
of speculation cash.

00:05:43.320 --> 00:05:46.300
He makes, say, 20% on it
in this first year.

00:05:46.300 --> 00:05:49.060
So he makes $2,000.

00:05:49.060 --> 00:05:53.120
And then we have interest
expense.

00:05:53.120 --> 00:05:54.720
This guy has no debt.

00:05:54.720 --> 00:05:55.610
Very prudent.

00:05:55.610 --> 00:06:04.240
He has no interest. So his
pre-tax income is $30,000.

00:06:04.240 --> 00:06:08.210
This guy, he does have interest.
And let's say on

00:06:08.210 --> 00:06:11.580
that $100,000 of debt, he
got a really good deal.

00:06:11.580 --> 00:06:13.930
Let's say that the Fed thought
that he was systemically

00:06:13.930 --> 00:06:16.390
important to the future of
our financial system.

00:06:16.390 --> 00:06:20.290
So he gave him a sweetheart 2%
debt deal, because he was

00:06:20.290 --> 00:06:24.570
afraid that if this pizzeria
were to fail, it would bring

00:06:24.570 --> 00:06:26.930
down the entire financial
system.

00:06:26.930 --> 00:06:29.810
So given that 2% on
$100,000 debt.

00:06:29.810 --> 00:06:31.190
That's $2,000 of debt a year.

00:06:31.190 --> 00:06:32.840
So minus $2,000.

00:06:32.840 --> 00:06:34.240
I'll make it a little
bit more realistic.

00:06:37.740 --> 00:06:38.990
Let's say it's 5%.

00:06:45.360 --> 00:06:50.330
So 5% on $100,000 is $5,000
per year in interest. So

00:06:50.330 --> 00:06:51.440
that's his interest expense.

00:06:51.440 --> 00:06:51.910
Let me write that.

00:06:51.910 --> 00:06:55.490
This was interest. This
was non-op income.

00:06:55.490 --> 00:06:57.690
This was operating profit.

00:06:57.690 --> 00:07:00.320
You just have to carry
the lines over.

00:07:00.320 --> 00:07:05.330
And so his pre-tax income
is now 30 plus

00:07:05.330 --> 00:07:08.620
2 minus 5 is $27,000.

00:07:08.620 --> 00:07:14.010
They both pay 30% in taxes.

00:07:14.010 --> 00:07:18.090
And so this guy's
paying $10,000.

00:07:18.090 --> 00:07:20.460
Well, actually, $9,000
would be 30%.

00:07:20.460 --> 00:07:24.330
And this guy, 30% of 27.

00:07:24.330 --> 00:07:24.720
So let's see.

00:07:24.720 --> 00:07:26.570
Taxes.

00:07:26.570 --> 00:07:30.710
3, 6,000 plus-- 8,100.

00:07:30.710 --> 00:07:31.970
Minus $8,100.

00:07:31.970 --> 00:07:33.250
Is that right?

00:07:33.250 --> 00:07:33.540
Yeah.

00:07:33.540 --> 00:07:34.820
That's $9,000.

00:07:34.820 --> 00:07:37.490
And then if you have $3,000
less, you should be $900 less.

00:07:37.490 --> 00:07:38.610
Yep, that's right.

00:07:38.610 --> 00:07:40.780
And so, we're finally at
the net income line.

00:07:44.710 --> 00:07:46.880
This guy makes $21,000.

00:07:46.880 --> 00:07:49.390
This guy makes-- what is this?

00:07:49.390 --> 00:07:58.140
This is $18,900 net income.

00:07:58.140 --> 00:08:01.150
And of course the difference
is the money that he had to

00:08:01.150 --> 00:08:03.900
spend on tax.

00:08:03.900 --> 00:08:05.420
On interest expense.

00:08:05.420 --> 00:08:08.120
If you net out all of his little
financial engineering,

00:08:08.120 --> 00:08:12.290
he had to pay $3,000 more in
interest, if you net out his

00:08:12.290 --> 00:08:15.080
profit he made on his little
cash bets, his side bets.

00:08:15.080 --> 00:08:18.000
And that was able to
be a tax deduction.

00:08:18.000 --> 00:08:21.420
So the actual effect ends
up being $2,100.

00:08:21.420 --> 00:08:25.020
Which is essentially $3,000
of a 30% tax rate.

00:08:25.020 --> 00:08:26.280
So, fair enough.

00:08:26.280 --> 00:08:27.350
That's not what I
want to do here.

00:08:27.350 --> 00:08:30.790
I don't want to focus too much
on the tax savings on

00:08:30.790 --> 00:08:33.559
interest. What I want to do here
is focus on valuation and

00:08:33.559 --> 00:08:36.520
see whether the price to
earnings ratio holds up to

00:08:36.520 --> 00:08:38.669
scrutiny in this situation,
where you have an identical

00:08:38.669 --> 00:08:41.950
asset but very different
capital structures.

00:08:41.950 --> 00:08:46.640
So let's say they both
have 10,000 shares.

00:08:46.640 --> 00:08:48.070
I'll arbitrarily switch colors.

00:08:48.070 --> 00:08:52.380
10,000.

00:08:52.380 --> 00:08:54.150
So EPS.

00:08:54.150 --> 00:08:56.960
This guy made $21,000
this year.

00:08:56.960 --> 00:09:01.480
Divided by 10,000 shares
is $2.10 per share.

00:09:01.480 --> 00:09:08.080
This guy, $18,900 divided by
$10,000 is $1.89 per share.

00:09:08.080 --> 00:09:11.450
And we could have modeled
out their

00:09:11.450 --> 00:09:12.460
income statements further.

00:09:12.460 --> 00:09:15.360
And actually, this guy, even if
the top line, even if the

00:09:15.360 --> 00:09:17.900
revenue grew the same and the
operating profit grew the

00:09:17.900 --> 00:09:20.260
same, because of his leverage
he would actually grow a

00:09:20.260 --> 00:09:20.980
little bit faster.

00:09:20.980 --> 00:09:24.380
I'll do another video on how
that works with leverage.

00:09:24.380 --> 00:09:26.090
But let's say that someone looks
at this and says, OK,

00:09:26.090 --> 00:09:27.780
it's the same business
and everything.

00:09:27.780 --> 00:09:30.250
And if anything, this guy's
growing a little bit faster

00:09:30.250 --> 00:09:32.350
because he's got that leverage,
that extra juice

00:09:32.350 --> 00:09:35.630
from the financials, from the
capital structure he's got.

00:09:35.630 --> 00:09:40.060
So they both deserve at least
a price to earnings of 10.

00:09:40.060 --> 00:09:43.330
So you say, they both deserve
a price to earnings of 10.

00:09:43.330 --> 00:09:45.090
So 10 price to earnings.

00:09:45.090 --> 00:09:48.340
You'd say, I'm willing to
pay $21 for this guy.

00:09:48.340 --> 00:09:53.410
And I'm willing to pay
$18.90 for this guy.

00:09:53.410 --> 00:09:56.860
Now what does that result in
their valuation, or in terms

00:09:56.860 --> 00:09:57.670
of their market cap?

00:09:57.670 --> 00:10:02.050
So in this guy's case,
market cap.

00:10:02.050 --> 00:10:06.850
$21 times 21,000 times 10,000
shares, means that you are

00:10:06.850 --> 00:10:11.630
ascribing a-- 21 times 10--
you're saying that the equity

00:10:11.630 --> 00:10:17.330
in this company is
worth $210,000.

00:10:17.330 --> 00:10:19.320
In this case, you're saying
that the equity in this

00:10:19.320 --> 00:10:24.850
company is worth $189,000.

00:10:24.850 --> 00:10:26.600
So this one's worth a little bit
more, because it's earning

00:10:26.600 --> 00:10:28.170
a little bit more money.

00:10:28.170 --> 00:10:30.290
Although I don't want to
complicate it, but you might

00:10:30.290 --> 00:10:32.310
be willing to pay a higher
multiple here.

00:10:32.310 --> 00:10:34.400
So something very interesting
is happening.

00:10:34.400 --> 00:10:38.980
By applying the same price to
earnings, we're saying that

00:10:38.980 --> 00:10:43.990
the market value of this equity
is $210,000, while the

00:10:43.990 --> 00:10:56.590
market value of this equity is--
what was it?-- $189,000.

00:10:56.590 --> 00:10:58.710
Something doesn't seem
to make sense.

00:10:58.710 --> 00:11:01.740
This guy put up $100,000,
and sure, they invested

00:11:01.740 --> 00:11:02.620
it and did all that.

00:11:02.620 --> 00:11:04.650
So now the market's willing to
say, hey, you know what?

00:11:04.650 --> 00:11:07.160
This is a pretty profitable
business, more profitable than

00:11:07.160 --> 00:11:09.900
most. You're making
good margins.

00:11:09.900 --> 00:11:12.580
And I'll do a bunch of videos
on margins in the future.

00:11:12.580 --> 00:11:14.720
We're willing to say that
the market value of

00:11:14.720 --> 00:11:17.020
your equity is $210,000.

00:11:17.020 --> 00:11:21.030
Which implicitly means that the
market value of this asset

00:11:21.030 --> 00:11:24.230
is $210,000.

00:11:24.230 --> 00:11:26.340
They're saying, this
is worth $210,000.

00:11:26.340 --> 00:11:28.810
That's because this must
be worth $210,000.

00:11:28.810 --> 00:11:32.140
But if you look here, by giving
the same price to

00:11:32.140 --> 00:11:33.990
earnings, because they're
the same business.

00:11:33.990 --> 00:11:35.750
And maybe this guy's even
growing faster, so maybe

00:11:35.750 --> 00:11:38.060
they're being conservative by
only giving this guy a 10

00:11:38.060 --> 00:11:40.190
price to earnings.

00:11:40.190 --> 00:11:43.590
You get a $189,000 market
cap for this equity.

00:11:43.590 --> 00:11:45.880
Which, all of a sudden, this guy
only put in $10,000, and

00:11:45.880 --> 00:11:47.490
people are saying it's
worth $189,000?

00:11:47.490 --> 00:11:54.740
And if this little fraction
right here is $189,000, then

00:11:54.740 --> 00:11:57.890
it implies what about
this asset?

00:11:57.890 --> 00:11:59.600
What does it imply about the
value of that asset?

00:11:59.600 --> 00:12:02.990
You have $189,000 as the
value of this equity.

00:12:02.990 --> 00:12:05.320
The value of this debt
is $100,000.

00:12:05.320 --> 00:12:08.070
So the market is saying, the
right-hand side of the balance

00:12:08.070 --> 00:12:09.870
sheet is what?

00:12:09.870 --> 00:12:12.780
It's $189,000 plus $100,000.

00:12:12.780 --> 00:12:16.125
It's $289,000.

00:12:16.125 --> 00:12:18.845
And let's say this cash
is still cash.

00:12:18.845 --> 00:12:20.270
It's worth $10,000.

00:12:20.270 --> 00:12:23.340
So if you subtract it out, the
market is saying, this is

00:12:23.340 --> 00:12:28.380
$289,000 minus this
$10,000, $279,000.

00:12:28.380 --> 00:12:30.960
So something is very
bizarre right here.

00:12:30.960 --> 00:12:34.490
That the market-- just because
of how this guy has

00:12:34.490 --> 00:12:36.780
capitalized his company--
if they just apprised a

00:12:36.780 --> 00:12:40.540
superficial price to earnings of
10 to both companies, it's

00:12:40.540 --> 00:12:44.080
willing to say that this asset
is worth $279,000, and this

00:12:44.080 --> 00:12:46.970
asset's only worth $210,000,
even though

00:12:46.970 --> 00:12:49.190
they're identical assets!

00:12:49.190 --> 00:12:52.983
So I've already used more than
enough time on this video, so

00:12:52.983 --> 00:12:54.290
I'll let you ponder
that a little bit.

00:12:54.290 --> 00:12:57.220
In the next video, I'll show you
that the reason why this

00:12:57.220 --> 00:12:59.590
is kind of breaking down is
because a price to earnings

00:12:59.590 --> 00:13:02.790
ratio does break down to a
certain degree when you start

00:13:02.790 --> 00:13:05.580
comparing things with different
capital structures.

00:13:05.580 --> 00:13:09.590
And in the next video, I'll
introduce you to other ways of

00:13:09.590 --> 00:13:11.900
comparing things with a
different capital structures,

00:13:11.900 --> 00:13:13.730
or essentially deleveraging
them.

00:13:13.730 --> 00:13:16.620
That when you just talk about
price to earnings or market

00:13:16.620 --> 00:13:18.820
capitalization-- when you
just looked at market

00:13:18.820 --> 00:13:20.030
capitalization, it looked OK.

00:13:20.030 --> 00:13:21.150
Oh, they're similar
businesses.

00:13:21.150 --> 00:13:22.490
This one's worth a little
bit more because

00:13:22.490 --> 00:13:23.880
this one has debt.

00:13:23.880 --> 00:13:27.270
But when you actually back out
the implicit value of the

00:13:27.270 --> 00:13:29.150
asset, all of a sudden you
realize that you're really

00:13:29.150 --> 00:13:30.960
overpaying for this asset.

00:13:30.960 --> 00:13:32.340
So think about that
a little bit.

00:13:32.340 --> 00:13:33.810
What's the conundrum here?

00:13:33.810 --> 00:13:35.830
What went wrong?

00:13:35.830 --> 00:13:38.300
And in the next video I'll
give you some tools to

00:13:38.300 --> 00:13:40.470
actually do this right.


Amortization

WEBVTT
Kind: captions
Language: en

00:00:00.720 --> 00:00:04.170
In the depreciation video, we
saw that if a company had to

00:00:04.170 --> 00:00:06.730
buy some equipment for its
factory, let's say at the

00:00:06.730 --> 00:00:11.060
beginning of 2007, just based
on the cash that went out of

00:00:11.060 --> 00:00:13.970
the door, there might have been
this temptation to say,

00:00:13.970 --> 00:00:18.950
OK, in 2007, we had an
equipment expense.

00:00:18.950 --> 00:00:20.200
EQ expense.

00:00:22.290 --> 00:00:23.540
And they could have just
wrote, let's say that

00:00:23.540 --> 00:00:26.060
equipment cost $50,000.

00:00:26.060 --> 00:00:29.940
So they would have just put a
$50,000 expense right in 2007.

00:00:29.940 --> 00:00:31.770
I write it as a negative number
just because I like to

00:00:31.770 --> 00:00:36.450
remember it's an expense,
although normally people just

00:00:36.450 --> 00:00:38.406
write it as a positive expense,
but I always like to

00:00:38.406 --> 00:00:40.340
put a negative for an expense
to know that it's going to

00:00:40.340 --> 00:00:41.980
subtract from your revenue.

00:00:41.980 --> 00:00:46.080
So they would put that cash
expense there in 2007.

00:00:46.080 --> 00:00:53.760
And then in future years, maybe
2008, 2009, 2010, they

00:00:53.760 --> 00:00:56.070
would have no expense until
maybe they had to replace that

00:00:56.070 --> 00:00:57.550
machine or buy a new one.

00:00:57.550 --> 00:01:00.795
And we saw that that is one way
to account for things, but

00:01:00.795 --> 00:01:03.180
it really doesn't reflect the
reality of the business.

00:01:03.180 --> 00:01:07.810
The fact that this machine right
here that cost $50,000

00:01:07.810 --> 00:01:12.030
is used for-- in this example,
in the depreciation video, it

00:01:12.030 --> 00:01:13.120
was usable for two years.

00:01:13.120 --> 00:01:15.390
Let's say in this example, it's
usable for four years.

00:01:15.390 --> 00:01:18.970
So what they do is, instead of
just expensing the cost of the

00:01:18.970 --> 00:01:22.220
machine, when the machine is
bought on the balance sheet at

00:01:22.220 --> 00:01:28.390
the beginning of 2007, they
say, we now have an asset

00:01:28.390 --> 00:01:29.745
called a machine.

00:01:29.745 --> 00:01:31.900
I'll just call it
M for machine.

00:01:31.900 --> 00:01:37.450
That's $50,000 at this point
right here, right when we

00:01:37.450 --> 00:01:38.150
bought the machine.

00:01:38.150 --> 00:01:40.760
Remember, balance sheets
are snapshots in time.

00:01:40.760 --> 00:01:43.720
And then instead of having an
equipment expense, instead of

00:01:43.720 --> 00:01:47.800
having that expense, they'll
have an equipment

00:01:47.800 --> 00:01:49.050
depreciation expense.

00:01:52.970 --> 00:01:56.300
And the difference here is
instead of saying that the

00:01:56.300 --> 00:01:59.240
entire expense was that machine
in just the first

00:01:59.240 --> 00:02:01.470
period, they're saying no,
we're using some of the

00:02:01.470 --> 00:02:02.700
machine in that period.

00:02:02.700 --> 00:02:05.110
And let's say we do a
straight-line depreciation,

00:02:05.110 --> 00:02:09.460
which means we essentially
depreciate the asset evenly

00:02:09.460 --> 00:02:10.949
over its lifespan.

00:02:10.949 --> 00:02:12.130
So in this case, we're assuming

00:02:12.130 --> 00:02:13.600
it's a four-year lifespan.

00:02:13.600 --> 00:02:15.860
So let me draw that out.

00:02:15.860 --> 00:02:19.420
So the asset should linearly
go to zero

00:02:19.420 --> 00:02:21.350
over these four years.

00:02:21.350 --> 00:02:23.720
So essentially, in the
first year, our

00:02:23.720 --> 00:02:24.830
expense would be what?

00:02:24.830 --> 00:02:26.000
It's $12,000.

00:02:26.000 --> 00:02:30.130
If you divide $50,000
by 4, it's $12,500.

00:02:30.130 --> 00:02:37.040
It would be minus $12,500 in
each year, depreciation

00:02:37.040 --> 00:02:45.340
expense, and we would account
for it on the balance sheet.

00:02:45.340 --> 00:02:47.500
Because remember, income
statements are just telling

00:02:47.500 --> 00:02:50.320
you how do you get from one
balance sheet to another.

00:02:50.320 --> 00:02:54.830
So expenses reduce the
value of your assets.

00:02:54.830 --> 00:02:56.960
So, for example, in this one,
at the beginning of the

00:02:56.960 --> 00:03:00.950
period, before the 2007
income statement, the

00:03:00.950 --> 00:03:02.600
asset was worth $50,000.

00:03:02.600 --> 00:03:06.710
We depreciated $12,500 from it,
so at this point in time,

00:03:06.710 --> 00:03:10.020
the balance sheet as of the end
of 2007 or the beginning

00:03:10.020 --> 00:03:13.780
of 2008, we're going to say
that our machine is now

00:03:13.780 --> 00:03:18.370
$12,500 less, so $47,500.

00:03:18.370 --> 00:03:22.160
And then at the end of 2008,
beginning of 2009, our balance

00:03:22.160 --> 00:03:25.230
sheet under the assets, the
machine, if they gave us that

00:03:25.230 --> 00:03:28.550
level of granularity, would
be $12,500 less than that.

00:03:28.550 --> 00:03:37.350
So that's what? $37,500.

00:03:37.350 --> 00:03:40.240
So then the machine
is $25,000.

00:03:40.240 --> 00:03:42.900
And then another $12,500
on the books.

00:03:42.900 --> 00:03:45.960
It'll say the machine
is worth $12,500.

00:03:45.960 --> 00:03:47.960
And then at the end of
2010, it'll say the

00:03:47.960 --> 00:03:49.550
machine is worth nothing.

00:03:49.550 --> 00:03:52.390
And if we did our depreciation
schedule right, or if the

00:03:52.390 --> 00:03:55.630
lifespan of this machine really
is four years, then

00:03:55.630 --> 00:03:57.990
it's time to go buy another
machine and start doing this

00:03:57.990 --> 00:03:58.730
all over again.

00:03:58.730 --> 00:04:01.430
This is all a review of the
depreciation video.

00:04:01.430 --> 00:04:05.500
Amortization is the exact same
thing, but it deals with

00:04:05.500 --> 00:04:06.790
intangible assets.

00:04:06.790 --> 00:04:07.870
What's an intangible?

00:04:07.870 --> 00:04:13.560
It's something you can't see,
touch, feel, smell, eat.

00:04:13.560 --> 00:04:15.670
Obviously , a machine you can't
do all of those things

00:04:15.670 --> 00:04:19.279
to it, but you can at least
touch it and possibly smell

00:04:19.279 --> 00:04:20.399
and taste it.

00:04:20.399 --> 00:04:23.740
So an intangible asset, we can't
do any of that stuff to,

00:04:23.740 --> 00:04:25.790
but it's the exact same idea.

00:04:25.790 --> 00:04:31.720
For example, let's say we are
some type of widget company.

00:04:31.720 --> 00:04:35.460
And let me write down
the years: 2007,

00:04:35.460 --> 00:04:42.090
2008, 2009 and 2010.

00:04:42.090 --> 00:04:45.400
And let's say that if we just
did it from a cash point of

00:04:45.400 --> 00:04:47.090
view, let's say we had
to buy a patent in

00:04:47.090 --> 00:04:48.810
order to make our widgets.

00:04:48.810 --> 00:04:53.200
So we could have said, oh, we
have to buy a patent expense.

00:04:53.200 --> 00:04:54.940
We had to buy a patent
from some

00:04:54.940 --> 00:04:58.680
brilliant inventor someplace.

00:04:58.680 --> 00:05:00.000
We could just say, oh,
you know what?

00:05:00.000 --> 00:05:03.240
The patent cost $4,000.

00:05:03.240 --> 00:05:05.800
So we could just put that there
even though the useful

00:05:05.800 --> 00:05:09.130
life of the patent might
be four years.

00:05:09.130 --> 00:05:11.640
And so it doesn't reflect the
fact that we still are using

00:05:11.640 --> 00:05:14.260
that patent in these years, and
we just take the hit here.

00:05:14.260 --> 00:05:17.160
So this income will look
unusually low, while these

00:05:17.160 --> 00:05:19.860
will look unusually high.

00:05:19.860 --> 00:05:21.830
It's not reflective of the fact
that you're using this

00:05:21.830 --> 00:05:24.540
patent that has four
years left on it.

00:05:24.540 --> 00:05:27.660
So instead of doing that, what
you do is, at the beginning of

00:05:27.660 --> 00:05:33.360
the period you say, we have
acquired a patent, an asset,

00:05:33.360 --> 00:05:38.000
that is worth $4,000, And then
every year over the life of

00:05:38.000 --> 00:05:40.950
the patent, we'd amortize a
fourth of it since it has a

00:05:40.950 --> 00:05:41.900
four-year life.

00:05:41.900 --> 00:05:45.760
So it would be patent
amortization.

00:05:45.760 --> 00:05:48.620
And there's all sorts of
intangible assets that you

00:05:48.620 --> 00:05:50.740
might amortize.

00:05:50.740 --> 00:05:53.820
And amortizing really just means
spreading out the cost

00:05:53.820 --> 00:05:56.400
of this asset, just like
depreciation was spreading out

00:05:56.400 --> 00:05:58.880
the cost of a physical asset.

00:05:58.880 --> 00:06:03.070
So patent amortization would be
$1,000 in this year, $1,000

00:06:03.070 --> 00:06:07.450
in this year, $1,000 in this
year, and $1,000 in this year.

00:06:07.450 --> 00:06:12.180
And then our snapshot, or our
balance sheet at the end of

00:06:12.180 --> 00:06:15.030
2007, will have on its
assets a patent

00:06:15.030 --> 00:06:17.280
that's now worth $3,000.

00:06:17.280 --> 00:06:19.930
And at the end of 2008,
it'll have a patent

00:06:19.930 --> 00:06:21.395
that's now worth $2,000.

00:06:21.395 --> 00:06:24.040
The end of 2009-- I think you
get the point-- you'll have a

00:06:24.040 --> 00:06:26.760
patent worth $1,000.

00:06:26.760 --> 00:06:29.530
And at the end of 2010, probably
because the patent is

00:06:29.530 --> 00:06:34.430
now expired and anyone can go
out and produce whatever that

00:06:34.430 --> 00:06:37.170
invention that was patented
without having the patent, we

00:06:37.170 --> 00:06:40.400
then say that the patent
is worthless.

00:06:40.400 --> 00:06:43.570
And a very relevant thing is if
you were a drug company and

00:06:43.570 --> 00:06:46.550
you were buying the patent to
some pharmaceutical that had

00:06:46.550 --> 00:06:50.320
four years left so that you
could have exclusive rights to

00:06:50.320 --> 00:06:53.430
develop that drug. and at this
point, all of a sudden, now

00:06:53.430 --> 00:06:56.030
anyone can develop the drug, so
that patent is worthless.

00:06:56.030 --> 00:06:59.410
So the balance sheet is really
trying to capture what your

00:06:59.410 --> 00:07:01.170
asset is worth at that
point in time.

00:07:01.170 --> 00:07:04.290
At this point in time, your
patent is arguably only worth

00:07:04.290 --> 00:07:06.870
$1,000, because you paid $4,000
for four years, and now

00:07:06.870 --> 00:07:08.150
you only have a year left.

00:07:08.150 --> 00:07:09.520
But that's all amortization
is.

00:07:09.520 --> 00:07:10.770
Nothing fancy.

00:07:15.540 --> 00:07:18.050
Really, in my mind, it's very
similar to depreciation.

00:07:18.050 --> 00:07:19.340
Depreciation is tangible.

00:07:19.340 --> 00:07:20.760
Amortization is intangible.

00:07:20.760 --> 00:07:22.940
It could be patents, it
could be licenses.

00:07:22.940 --> 00:07:26.290
It could be fees associated
with the financing.

00:07:26.290 --> 00:07:28.530
Let's say you have some debt
that you took from a company,

00:07:28.530 --> 00:07:32.690
and the debt is going to last
for 10 years, and you had to

00:07:32.690 --> 00:07:35.010
pay a one-time lump-sum
to the bank.

00:07:35.010 --> 00:07:38.020
Well, that one-time lump-sum fee
should probably be spread

00:07:38.020 --> 00:07:40.760
over the life of the debt, so
you would amortize that

00:07:40.760 --> 00:07:42.470
expense over its life.

00:07:42.470 --> 00:07:43.750
Anyway, see you in
the next video.