Reading a company.

The P/E ratio

Price divided by earnings per share. What you pay for $1 of annual profit.

A P/E alone tells you almost nothing, cheap is often cheap for a reason. The useful move is to flip it. One divided by the P/E gives the earnings yield, which puts a stock on the same footing as a bond and makes the comparison concrete.

At 35×, you're accepting a 2.86% earnings yield today because you believe those earnings grow fast. That's the actual bet. The multiple just hides it.

Why the denominator is the problem: a low multiple is not a cheap stock.

Free cash flow vs net income

Net income is an opinion. Free cash flow is closer to a fact.

Net income is the output of accounting choices, depreciation schedules, write-offs, revenue recognition. Free cash flow is operating cash minus capital spending: money that actually arrived and stayed. It's what pays dividends, buybacks and debt.

When the two diverge for years, ask why. Cash flow far above net income can be healthy (heavy depreciation on assets bought long ago). Net income far above cash flow, persistently, is the classic warning sign.

What is left after growth is paid for: growth is not a virtue.

Buybacks and EPS

Fewer shares, same profit, higher earnings per share. Growth without growing.

This is the mechanic behind a huge share of reported EPS growth, and most people never see it.

Buybacks are an investment decision, and like any investment the return depends on the price paid. Retiring shares at 10× earnings is excellent. Doing it at 40× destroys value while still making the EPS line look good, which is exactly why some management teams do it.

Whether one creates value depends entirely on price: the price makes the buyback.

Shareholder yield

Dividends plus net buybacks, over market cap. The full picture of cash returned.

Dividend yield alone badly understates modern capital return, because buybacks have largely replaced dividends as the way US companies hand cash back. A company with a 1% dividend can be returning 9%.

Applied in the BKNG report.

Payout ratio

The share of earnings paid as dividends. A safety gauge, not a yield gauge.

The question a payout ratio answers isn't "how much am I paid"; it's "how likely is this to survive a bad year, and is there room to grow it?"

• Under ~40%: comfortable. Room to raise, room to absorb a downturn.
• 60–80%: mature. The dividend is roughly the whole story.
• Over 100%: paying out more than it earns. Funded by debt or asset sales. Ask how long that can continue.

A 7% yield with a 110% payout ratio is not a 7% yield. It's a countdown to a cut, and the market usually knows, which is why the yield is 7% in the first place.

Put to work in how to build a dividend calendar.

Tangible book value

Shareholders' equity with the intangibles stripped out. What is actually there.

Book value includes goodwill and other intangible assets, which are accounting entries created mostly by past acquisitions. Tangible book removes them, along with preferred stock, leaving the equity that would survive a hard look.

For most companies this is a footnote. For banks it is the central valuation measure, because a bank's assets are financial instruments rather than brands or factories, and because the difference between a healthy bank and a failed one is whether tangible equity absorbs the losses.

JPMorgan reported book value of $133.01 per share and tangible book of $113.35 at the same date, so roughly 15% of stated book was intangible.

Used as the anchor of the whole framework in the JPMorgan initiation.

Return on tangible common equity

What a bank earns on the equity that actually exists. The number that justifies any premium to tangible book.

Return on tangible common equity, usually shortened to ROTCE, divides earnings available to common shareholders by average tangible common equity. It answers the only question that matters for a bank's valuation: is this business earning more than shareholders require for the risk?

The identity that follows is exact and worth memorizing. Justified price to tangible book equals return on tangible equity minus growth, divided by cost of equity minus growth. A bank earning exactly its cost of equity is worth exactly one times tangible book. Every point above that is what a premium pays for.

Beware the reported figure. JPMorgan printed 29% in one recent quarter, but 19.8% of that net income came from one-time gains. Excluding them the figure was 23%.

The framework applied, including why a price to earnings ratio is the wrong tool for a bank: JPMorgan Chase.

Goodwill

The premium paid over the fair value of what was bought, parked on the balance sheet as an asset.

When a company acquires another for more than its identifiable assets are worth, the difference becomes goodwill. It is not a productive asset. It is a record of what was paid, and it sits at cost until somebody decides it is no longer supportable.

This is why tangible book value strips it out. Goodwill cannot be sold, lent against, or used to absorb a loss. For a bank in particular, the equity that matters in a crisis is the equity that actually exists.

What the premium had to earn: a premium is a promise, paid in advance.

Impairment

Writing an asset down when it is no longer worth its carrying value. Usually an admission, arriving late.

Impairments are non-cash, which is why they are routinely excluded from adjusted earnings, and why excluding them is sometimes reasonable and sometimes evasive. The cash left years earlier, when the acquisition was paid for.

Treat a goodwill impairment as what it is: the company conceding that a past deal did not work. The useful question is not whether to adjust for it but why the premium was paid, who approved it, and whether the same people are still allocating capital.

How to judge an adjustment: the one-time item that happens every year.

Working capital

The cash tied up running the business day to day. Inventory and receivables, less what you owe suppliers.

Growth consumes working capital. Sell more and you carry more inventory and wait on more receivables, and that money leaves before the profit arrives. A company can be profitable on the income statement and short of cash at the same time, entirely through growth.

It is also a quiet lever. Stretching payables or squeezing inventory releases cash and flatters a quarter's cash flow without anything improving. Worth checking whether a strong cash flow quarter came from operations or from the timing of payments.

What growth actually costs: growth is not a virtue.

Economic moat

A durable reason competitors cannot simply copy what a company does and compete the returns away.

High returns on capital attract competition. A moat is whatever stops that competition from arriving quickly enough to matter: switching costs, network effects, scale in a market that only supports one efficient operator, a regulatory position, or a brand people will pay more for out of habit.

The test is not whether returns are high today. It is how long they can stay high. A business earning 8% margins with no moat is a business whose margins are on loan from its competitors' inattention.

What cannot be bought quickly: what money cannot buy quickly.