Investment Study Guide

📖 Core Concepts Investment – committing resources (usually money) to an asset expecting future value growth. Cash flow – net monetary receipt in a single period; a series over time is a cash flow stream. Return – gain from an investment; can be capital gains/losses (realised or unrealised) or periodic income (dividends, interest, rent). Risk‑Return relationship – higher expected returns compensate for higher risk; low‑risk assets deliver lower returns. Time value of money – money today is worth more than the same amount later because it can be invested to earn a return. --- 📌 Must Remember Cash flow = net receipt in one period; cash flow stream = receipts over multiple periods. Price‑to‑earnings (P/E) = Share price ÷ Earnings per share. Lower P/E ⇒ cheaper earnings. Price‑to‑book (P/B) = Share price ÷ Net assets per share (excludes intangibles). Earnings per share (EPS) = Net income ÷ Outstanding shares. Debt‑to‑Equity (D/E) = Total debt ÷ Equity; high D/E = higher financial risk. Free cash flow (FCF) = cash generated after working‑capital & cap‑ex reinvestments; signals dividend/interest‑paying ability. Risk types: capital loss, savings default, foreign‑exchange risk, arbitrage (no risk, no capital). --- 🔄 Key Processes Value‑Investing Screening Scan financial statements → compute P/E and P/B → identify low ratios → verify undervaluation → buy; sell when ratios rise. Growth‑Investing Evaluation Estimate future earnings → compare current P/E to industry peers → higher P/E acceptable if strong growth forecasts. Dollar‑Cost Averaging (DCA) Choose fixed monetary amount → invest at regular intervals → automatically buy more shares when price low, fewer when high → reduces average purchase price. Free Cash Flow Calculation (simplified) FCF = Operating cash flow – Capital expenditures – Change in working capital. --- 🔍 Key Comparisons Value vs. Growth Investing Value: seeks cheap, under‑priced stocks (low P/E, low P/B). Growth: seeks expensive, fast‑growing stocks (high P/E, high earnings growth). Equity vs. Debt Investments Equity (stocks) – ownership, potential unlimited upside, higher risk. Debt (bonds, loans) – creditor relationship, fixed interest, lower risk. Realised vs. Unrealised Returns Realised: profit/loss after selling the asset. Unrealised: paper gain/loss while still holding the asset. --- ⚠️ Common Misunderstandings “All investments earn returns.” → Returns are not guaranteed; capital loss risk exists. “Higher P/E always means a bad stock.” → Growth stocks often have high P/E justified by future earnings. “Arbitrage is a type of investment.” → Arbitrage yields profit without capital risk; it is distinct from investing. “Cash holdings have no risk.” → Currency cash can lose value via foreign‑exchange movements or provider default. --- 🧠 Mental Models / Intuition Risk‑Reward Trade‑off – imagine a see‑saw: the farther you lean toward higher returns, the more you must balance with higher risk. DCA as “buy low, sell high” on autopilot – regular purchases smooth out market volatility, like averaging grades over many tests. Free cash flow as “spending money after paying the bills” – the cash left over for investors after necessary reinvestments. --- 🚩 Exceptions & Edge Cases Low‑risk assets can still lose capital (e.g., bond default, currency devaluation). High P/E may be justified for companies with breakthrough technology or monopolistic positions. Dollar‑cost averaging may incur higher brokerage fees if transaction costs are per trade. --- 📍 When to Use Which Choose Value Investing when you have time for deep fundamental analysis and seek lower‑priced stocks. Choose Growth Investing if you tolerate higher volatility, have a longer horizon, and prioritize capital appreciation over dividends. Use DCA when you lack confidence in timing the market or want to invest a steady income stream. Prefer Debt (bonds) over Equity when you need predictable income and lower risk. --- 👀 Patterns to Recognize Consistently low P/E & P/B across sectors → possible undervaluation → flag for value analysis. Rising free cash flow paired with stable or decreasing D/E → financially healthy company. High dividend yield + falling stock price → potential dividend trap (yield may be high because price is collapsing). --- 🗂️ Exam Traps Confusing realised vs. unrealised returns – exam may ask for tax implications; only realised gains are taxed. Selecting “arbitrage” as an investment – remember arbitrage carries no capital risk, unlike true investments. Choosing high P/E as “expensive” without context – may be a growth stock with justified premium. Assuming cash holdings are risk‑free – foreign‑exchange risk and provider default are common distractors. ---