Glossary
This glossary serves as a reference for terms and concepts used throughout this book on fundamental analysis. Return here whenever a term feels unfamiliar or you need a quick refresher on a concept's definition and practical application.
Accruals
Income or expenses recorded before cash is received or paid, inflating reported earnings without actual cash flow.
A company records $100,000 in revenue when an invoice is sent, but payment arrives two months later. If accruals grow faster than cash from operations, earnings quality may be questionable. Analysts compare accrual earnings to operating cash flow to assess whether reported profits are genuine.
See also: Cash conversion cycle, Quality of earnings.
Alpha
The excess return generated by an investment relative to what a risk-adjusted benchmark would predict.
An investor beats the S&P 500 by 5% in a year when market conditions only justified a 2% outperformance given the portfolio's volatility. That 3% is alpha—value created by skill rather than risk exposure.
See also: Beta, Return on equity.
Asset Turnover
A measure of how efficiently a company converts assets into sales revenue.
A retailer with $50 million in assets generates $200 million in annual revenue, yielding an asset turnover ratio of 4.0. A technology startup with the same revenue but $200 million in assets would have turnover of 1.0, indicating less efficient use of capital.
See also: Efficiency ratio, DuPont.
Beta
A measure of a stock's volatility relative to the overall market.
A stock with a beta of 1.2 is 20% more volatile than the market index; a beta of 0.8 means 20% less volatile. During a market crash, a high-beta stock typically falls harder; in rallies, it tends to rise faster.
See also: Cost of equity, Equity risk premium.
Book Value
The net assets of a company as shown on the balance sheet—total assets minus total liabilities.
A bank with $100 million in assets and $70 million in liabilities has a book value of $30 million. Book value per share is used to calculate the price-to-book ratio and is especially meaningful for asset-heavy industries like insurance and banking.
See also: Price-to-book, Return on assets.
Capex
Capital expenditures—cash spent to purchase, upgrade, and maintain physical assets like plants, equipment, and technology.
A manufacturer spends $5 million annually on new factory equipment and facility upgrades; this is capex. Unlike operating expenses, capex creates assets that appear on the balance sheet and are depreciated over time.
See also: Free cash flow, Working capital.
Cash Conversion Cycle
The time between when a company pays suppliers and when it collects cash from customers.
A grocery chain pays suppliers in 30 days, holds inventory for 20 days, and collects from customers in 10 days; its cycle is roughly 0 days. A software company paying suppliers in 30 days but collecting in 60 days has a 30-day cycle, requiring more working capital.
See also: Days inventory, Days payables, Days receivables.
Comparable
Another company or group of companies used as a benchmark to assess valuation or performance.
An analyst values a mid-cap software firm by comparing its price-to-earnings ratio to peers like Salesforce and Microsoft. Comparables anchor valuation to the market's actual pricing of similar businesses.
See also: Peer set, Valuation multiple.
Cost of Equity
The required return investors demand in compensation for the risk of investing in a company's stock.
If a company's WACC calculation assumes a 10% cost of equity, that reflects investor expectations given the business's risk profile. A high-growth technology firm might have a 15% cost of equity; a stable utility might be 8%.
See also: Beta, WACC, Equity risk premium.
Current Ratio
A liquidity measure comparing current assets to current liabilities.
A company with $50 million in current assets and $25 million in current liabilities has a current ratio of 2.0. A ratio above 1.5 is generally considered healthy; below 1.0 signals potential difficulty meeting short-term obligations.
See also: Liquidity, Working capital.
Days Inventory
The average number of days a company holds inventory before selling it.
A clothing retailer with $10 million in inventory and $100 million in annual cost of goods sold has a days inventory of roughly 36 days. Lower is typically better, as it means cash isn't trapped in unsold stock.
See also: Cash conversion cycle, Days payables.
Days Payables
The average number of days a company takes to pay its suppliers.
A manufacturing firm with $5 million in accounts payable and $50 million in annual cost of goods sold takes roughly 36 days to pay suppliers. Extending payables can free up cash, but excessively long periods may strain supplier relationships.
See also: Cash conversion cycle, Days inventory, Working capital.
Days Receivables
The average number of days a company takes to collect cash from customers after a sale.
A B2B software company with $8 million in accounts receivable and $100 million in annual revenue has a days receivables of roughly 29 days. Faster collection improves cash flow and reduces the risk of customer defaults.
See also: Cash conversion cycle, Liquidity.
Debt-to-Equity
A leverage ratio comparing total debt to shareholders' equity, measuring financial risk.
A company with $200 million in debt and $100 million in equity has a debt-to-equity ratio of 2.0. Higher ratios indicate more financial leverage; very high leverage increases bankruptcy risk during downturns.
See also: Leverage, Net debt, WACC.
Discounted Cash Flow
A valuation method that projects future cash flows and discounts them to present value using a discount rate.
If a company will generate $10 million in free cash flow next year and the discount rate is 10%, today's value of that cash is roughly $9.1 million. DCF sums all discounted future cash flows to estimate intrinsic value.
See also: Discount rate, Intrinsic value, Terminal value.
Discount Rate
The interest rate used to convert future cash flows into present value, reflecting risk and the time value of money.
A discount rate of 8% assumes investors require an 8% annual return; higher rates (e.g., 12%) are applied to riskier businesses, reducing the present value of future cash flows.
See also: WACC, Cost of equity, Discounted cash flow.
DuPont
A framework decomposing return on equity into profitability, efficiency, and leverage components.
ROE of 15% might break down as a 5% net profit margin, 2.0 asset turnover, and 1.5 leverage multiplier. This breakdown reveals whether strong returns come from pricing power, operational efficiency, or financial leverage.
See also: Return on equity, Asset turnover, Leverage.
Earnings Yield
Annual earnings per share divided by stock price, representing the earnings return per dollar invested.
A stock trading at $100 with earnings per share of $5 has an earnings yield of 5%. This is the inverse of price-to-earnings; a lower P/E ratio means a higher earnings yield.
See also: Price-to-earnings, Return on equity.
EBITDA
Earnings before interest, taxes, depreciation, and amortization—a measure of operating cash generation before capital structure and tax effects.
A company with net income of $50 million, interest expense of $10 million, taxes of $20 million, depreciation of $30 million, and amortization of $5 million has EBITDA of $115 million. EBITDA is useful for comparing companies with different capital structures or tax situations.
See also: Free cash flow, Operating cash flow.
Economic Value Added
The profit earned above the cost of capital employed in the business.
If a company generates $100 million in profit and its WACC is 8% on $1 billion of invested capital (costing $80 million), EVA is $20 million. Positive EVA signals value creation; negative EVA means value destruction.
See also: WACC, Return on invested capital.
Efficiency Ratio
A broad measure of how productively a company uses its assets to generate revenue.
A bank's efficiency ratio of 60% means it spends $0.60 to generate $1 of revenue; lower is better. Asset turnover and margin metrics together paint a picture of operational efficiency.
See also: Asset turnover, DuPont.
Enterprise Value
The total value of a company to all investors, calculated as market cap plus net debt.
A firm with a $1 billion market cap and $200 million in net debt has an enterprise value of $1.2 billion. EV is used in valuation multiples like EV/EBITDA to normalize for differences in capital structure.
See also: Net debt, Valuation multiple.
Equity Risk Premium
The additional return investors require for stock investment versus risk-free bonds.
If Treasury bonds yield 4% and stocks are expected to yield 10%, the equity risk premium is 6%. This premium compensates for higher volatility and uncertainty in equity returns.
See also: Beta, Cost of equity, Risk-free rate.
FCFE
Free cash flow to equity holders—the cash available to shareholders after all expenses, taxes, and reinvestment.
A company with operating cash flow of $100 million, capex of $20 million, debt repayment of $10 million, and new debt issuance of $5 million has FCFE of roughly $75 million. This metric is especially useful for valuing equity directly.
See also: Free cash flow, FCFF.
FCFF
Free cash flow to the firm—the cash available to all investors (debt and equity holders) after operating expenses and reinvestment.
A company with EBIT of $100 million, taxes of $20 million, and capex and working capital investment totaling $30 million generates FCFF of roughly $50 million. FCFF is used to value the entire enterprise.
See also: Free cash flow, FCFE, Discounted cash flow.
Free Cash Flow
Cash generated from operations after capital expenditures and reinvestment needs.
A manufacturer with operating cash flow of $200 million and capex of $50 million has free cash flow of $150 million available for dividends, debt repayment, or acquisitions. Strong, growing FCF is a hallmark of a healthy business.
See also: Capex, Cash conversion cycle.
Fundamental Analysis
The practice of evaluating a company's intrinsic value by analyzing its financial statements, competitive position, and industry dynamics.
An analyst studies a retailer's balance sheet, income statement, cash flows, competitive advantages, and market conditions to estimate whether its stock is overpriced or underpriced. Fundamental analysis contrasts with technical analysis, which focuses on price patterns.
See also: Intrinsic value, Margin of safety.
Growth Rate
The expected rate at which earnings, revenue, or cash flows will expand over time.
A software company with historical revenue growth of 25% annually might be assumed to grow at 15% over the next five years and 3% thereafter in a DCF model. Conservative estimates are preferred to avoid overvaluation.
See also: Discounted cash flow, Terminal value, PEG ratio.
Intrinsic Value
The true, fundamental value of a company based on its ability to generate cash flows, independent of market price.
An analyst calculates a company's intrinsic value at $80 per share using a DCF model, but the stock trades at $60, suggesting a buying opportunity. Intrinsic value is the target that drives investment decisions.
See also: Discounted cash flow, Margin of safety, Mr. Market.
Leverage
The use of borrowed money to amplify returns, magnifying both profits and losses.
A real estate developer borrows $4 for every $1 of equity capital deployed; this 4:1 leverage can magnify returns if the asset appreciates but can destroy equity if values fall. Financial leverage is measured by debt-to-equity ratios.
See also: Debt-to-equity, WACC.
Liquidity
The ease and speed with which an asset or business can be converted into cash without significant loss of value.
A blue-chip stock is highly liquid—millions of shares trade daily at transparent prices. A private company stake is illiquid; months may pass before a buyer is found, and discounts apply.
See also: Current ratio, Days receivables.
Margin of Safety
The difference between intrinsic value and the price paid, providing a cushion against error.
If intrinsic value is $100 and an investor buys at $70, the 30% margin of safety protects against mistakes in valuation or adverse developments. A wide margin reduces risk.
See also: Intrinsic value, Mr. Market.
Mr. Market
A metaphor for the emotional, irrational stock market that fluctuates based on sentiment rather than fundamental value.
On some days, Mr. Market offers irrationally low prices driven by panic; on others, he demands irrationally high prices driven by euphoria. A disciplined analyst ignores Mr. Market's emotional swings and buys when prices disconnect from intrinsic value.
See also: Margin of safety, Intrinsic value.
Multiple
A valuation ratio comparing price to a financial metric like earnings, revenue, or book value.
A stock trading at $100 with earnings per share of $5 trades at a P/E multiple of 20. If peers trade at a P/E of 15, this stock appears relatively expensive on a multiple basis.
See also: Price-to-earnings, Comparable, Valuation multiple.
Net Debt
Total debt minus cash and equivalents, representing the net borrowing of a company.
A firm with $500 million in debt and $100 million in cash has net debt of $400 million. Net debt is a cleaner measure of leverage than gross debt because it accounts for cash available to repay debt.
See also: Debt-to-equity, Enterprise value.
Owner Earnings
The cash a business generates that belongs to shareholders, calculated as net income plus depreciation minus capex and working capital increases.
A company reports $100 million in net income, adds back $30 million in depreciation, subtracts $40 million in capex and $5 million in working capital growth, yielding owner earnings of $85 million. This metric emphasizes true economic profit available to owners.
See also: Free cash flow, Quality of earnings.
Payout Ratio
The percentage of earnings paid out as dividends to shareholders.
A company with earnings per share of $4 and a dividend per share of $1 has a payout ratio of 25%. A low payout ratio leaves room for reinvestment; a very high ratio raises sustainability concerns.
See also: Return on equity, Growth rate.
PEG Ratio
The price-to-earnings ratio divided by expected earnings growth rate, adjusting valuation for growth.
A stock with a P/E of 40 and expected earnings growth of 25% annually has a PEG of 1.6. A PEG near 1.0 suggests fair valuation relative to growth; above 2.0 often signals overvaluation.
See also: Price-to-earnings, Growth rate.
Peer Set
A group of comparable companies used as a benchmark for valuation and performance analysis.
A mid-cap software company's peer set might include similar-sized players like Datadog, Twilio, and Shopify. Analyzing the peer set reveals industry norms for margins, growth, and multiples.
See also: Comparable, Valuation multiple.
Porter Five Forces
A framework analyzing the competitive intensity of an industry through five dimensions: supplier power, buyer power, threat of substitutes, threat of new entrants, and rivalry among competitors.
A fast-food company faces intense rivalry, modest supplier power, high buyer power (customers can choose competitors), and limited threat of new entrants due to established brands. The combination suggests modest profitability for most players.
See also: Fundamental analysis.
Price-to-Book
The stock price divided by book value per share, indicating how much investors pay for each dollar of net assets.
A bank with book value of $20 per share trading at $40 has a P/B ratio of 2.0. Banks typically trade at lower P/B ratios (1.0–2.0) than software companies (5.0–15.0) due to asset composition differences.
See also: Book value, Valuation multiple.
Price-to-Earnings
The stock price divided by earnings per share, indicating how many dollars investors pay for each dollar of annual earnings.
A company trading at $100 with earnings per share of $5 has a P/E ratio of 20. A low P/E suggests the stock is cheap relative to current earnings; a high P/E implies growth expectations or overvaluation.
See also: Earnings yield, Multiple, PEG ratio.
Profitability Ratio
A metric measuring how much profit a company generates from revenue, assets, or equity.
Net profit margin (net income ÷ revenue) shows earnings as a percentage of sales. ROA and ROE show profitability relative to assets and equity. A software company might have a 20% net margin; a retailer might have 3%.
See also: Return on assets, Return on equity, DuPont.
Quality of Earnings
A measure of how closely reported earnings match actual cash flows and underlying economic performance.
A company reporting $100 million in earnings but only $50 million in operating cash flow has low quality earnings; the difference suggests aggressive accounting or unsustainable accruals. High-quality earnings are backed by real cash.
See also: Accruals, Owner earnings.
Return on Assets
A profitability measure comparing net income to total assets, showing how efficiently a company uses assets to generate profit.
A company with $50 million in net income and $500 million in assets has an ROA of 10%. A technology company might achieve 15% ROA; a utility might achieve 5% due to different asset intensities.
See also: DuPont, Return on invested capital.
Return on Equity
Net income divided by shareholders' equity, measuring how effectively a company generates profit from shareholder capital.
A bank with $50 million in net income and $500 million in equity has an ROE of 10%. Strong companies consistently achieve ROEs of 15% or higher; weak companies fall below 10%.
See also: DuPont, Return on assets.
Return on Invested Capital
A measure of how efficiently a company uses all capital (debt and equity) to generate profit.
A company generating $100 million in operating profit on $1 billion in invested capital has a ROIC of 10%. ROIC above the WACC indicates value creation; ROIC below WACC signals value destruction.
See also: WACC, Economic value added.
Risk-Free Rate
The interest rate on a risk-free investment, typically government bonds, used as the baseline for cost of capital calculations.
A 10-year U.S. Treasury bond yielding 4% sets the risk-free rate at 4%. The cost of equity for any stock is at least this rate plus a risk premium reflecting the stock's additional risk.
See also: Cost of equity, Equity risk premium.
Sensitivity Analysis
A technique testing how valuation outcomes change when assumptions (growth rate, discount rate, margins) are varied.
In a DCF model, an analyst tests valuation at discount rates of 8%, 10%, and 12% to see how sensitive intrinsic value is to this assumption. Wide sensitivity suggests the valuation is fragile and dependent on a specific scenario.
See also: Discounted cash flow.
Terminal Value
The projected value of a business at the end of an explicit forecast period, typically assuming stable, perpetual growth.
In a DCF model forecasting five years of detailed cash flows, terminal value assumes the company grows at 2% annually forever after year five. Terminal value often represents 60–80% of total intrinsic value, making it a critical and sensitive assumption.
See also: Discounted cash flow, Growth rate.
Valuation Multiple
A ratio comparing price to a financial metric, used to assess whether an asset is expensive or cheap relative to peers or history.
EV/EBITDA, P/E, and Price-to-Sales are common valuation multiples. Comparing a company's EV/EBITDA of 12x to an industry median of 10x suggests it trades at a premium.
See also: Multiple, Comparable, Enterprise value.
WACC
Weighted average cost of capital—the blended cost of debt and equity financing, used as the discount rate in valuation models.
A company financed 60% with equity (cost 10%) and 40% with debt (cost 5%, after tax) has a WACC of 8%. This 8% hurdle rate is used to discount future cash flows in DCF valuation.
See also: Cost of equity, Discount rate, Economic value added.
Working Capital
Current assets minus current liabilities, representing the cash required to fund day-to-day operations.
A manufacturing company with $100 million in current assets and $60 million in current liabilities has $40 million in working capital. Rapid growth often strains working capital as the company must finance growing receivables and inventory.
See also: Cash conversion cycle, Current ratio, Days inventory.