Tuesday, January 14, 2020

MBA in a Nutshell #20 - Accounting and Finance : The Balance Sheet

Image result for balance sheet

Interesting the section on balance sheet is only two pages long.

In a nutshell, a balance sheet is a snap-shot that summarizes everything the company owns (assets) and owes (liabilities). The difference between what the company owns and owe belongs to shareholders and this is called equity. The following equation must hold for all balance sheet

Assets = Liabilities + Equity

Beyond this very simple discussion on the balance are some items investors need to be aware of.

Assets minus Liabilities is also known as a company's Book Value. Dividing the market capitalization of the stock by the total book value will generate the P/B ratio. Value investors buy low P/B ratio companies because they are in essence buying up assets at a price lower than its value. Interesting, if you have gone for a lower P/B ratio in the Singapore stock market, you would get a return of 10.11% over the return of the entire universe of Singapore stocks which was 8.2%. This return would have been obtained at a lower risk.

The other interesting ratio is the debt to equity ratio which is total liabilities divided by total equity. I never do back-testing on this metric for equities because in all the tests done in the US that stretch back 50+ years, having a high D/E ratio and a low D/E ratio both lead to under performance. The sweet spot is to be around the 30% percentile. While I do D/E ratio back-testing for REITs, strategies targeting low gearing are no longer profitable in our stock-market. 

No one ever said investing is easy.


1 comment:

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