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Current time:0:00Total duration:10:32

Video transcript

so let's see where we left off we were studying the balance sheet of this Bank eh I think that's what I called it and we said okay on the asset side had some government bonds had some triple-a corporate bonds some commercial mortgages and then this is the thing that I really wanted to highlight is that you all it also had four billion dollars of residential collateralized debt obligations and I explained a little bit about what those are and I have several videos where I explain that in more detail and how they probably led or most definitely led to the housing bubble and then we have a little bit of cash on top of that on the liability side the bank just owns a lot of money to people if this was were a commercial bank kind of you know your bank of Americas or your Chase's of the world then one of the liabilities here would have also been the deposits of the people who kept keep their money at the bank but we're not going to assume that this could be just kind of any bank actually this could this could be any type of financial institution frankly it doesn't have to be a bank this could be the balance sheet of a of a hedge fund or a private equity firm or pretty much any type of financial institution but anyway back to where we were in the example we said then we learned it in the first video and we learned it in the balance sheet video that if you take your assets and you subtract out your liability so you take what you have you subtract out what you owe you're left with what you're really worth and that's called your equity and if you're a publicly traded company actual you don't even have to be publicly traded but if you're a corporation that's called your shareholders equity and what does that mean well that means the people who own a stake in the company or the shareholders they share this piece and just to make hit the point home I think this is an important one because I feel like people kind of talk past this there's two notions there's your book value of equity and that's the value of the equity that comes out of your balance sheet so if you assume that everything all of these numbers are accurate and we're going to think a lot about what it means to have an accurate number here and you assume that all of these numbers are accurate then the number that pops out on the equity side that is the book value of your equity and just in this example I said well let's say that Bank a is a public company it has five hundred million shares and so that means that if you take us three billion dollars of equity divided by five hundred million shares that means that there is six hours of book equity per share so that means if these if all of these numbers are correct then the stock of that company is worth $6 per share exactly exactly $6 per share I know you're saying wait wait Sal doesn't make sense we all know that the stock market is a wild ride especially banking stocks they swing left and right and and yeah up and down and you know how can you tell me that you know just by looking at a balance sheet you can give an exact amount for what its its equity value is and that is an important distinction so let me let me scroll down a little bit maybe I'll erase this actually let me let me clear this X I think it's a distraction you might just want to watch the video on mortgage-backed securities and collateralized debt obligations if you need a refresher there so what what does it mean when a when you know I'm telling you right now that a you know you can look at a company's balance sheet and if you believe what they say you can actually calculate a book value per share so so why do stock wide of stocks fluctuate wildly left and right well it's interesting it actually tells you a lot about what the market thinks about a company's balance sheet so I mean let me let me fill this in this was 26 billion of assets and then I had what 23 billion of liabilities 23 billion and then we get that is how we got equity of 3 billion and book equity per share or the or the book value per share of $6 now let's say we you know we go on to Yahoo Finance and we type in the ticker symbol for this Bank you know Bank a whatever we want to call it and let's say that its market price is I don't know it is $12 per share $12 per share so what is happening here the the book value is $6 but the market is saying no no we are willing to pay $12 per share for one of those shares and just make a point here when you look up a share price in the stock market or even better when you buy a stock on the stock market that money is not going to the company the company initially raises money by selling shares and that's often done with an initial public offering they will sell some shares directly to the market and that money goes directly to the company or they might do it in an offering and we'll talk more about that later but 99% of the time when you buy a share it is not going to the company it is going to the previous person who held that share that's why it's called a secondary market it's not going to the company so it's just a bunch of people trading the share price and the only reason why that share price really fundamentally matters to the company is with the company were to raise money at a future date so if let's say the share price today is $12 let's say I bought a share for $12 a share today that means I bought it from maybe I bought it from you I didn't buy it from the company but that at least tells the company that if it were to go to if it needed money if it needed to raise money it could sell sell shares probably it's something close to $12 a share it also tells someone who wanted to buy out the whole company so if they wanted to take over the company that maybe if they offered some type of a premium to $12 a share they could buy out all of the stock well that's that's not the topic for this and actually the more I think about it I really should do videos on all of these concepts but anyway so the market is is is giving a $12 per share value what does that mean who the person who's paying $12 a share is assuming that this is understated the book value is understated and so if the book value is understated that means that either the assets are understated or the liabilities are overstated most times the liabilities are are pretty easy to get a handle on sometimes pension liabilities and or some type of litigation liabilities that's hard to get a grasp on but most time you can look at a balance sheet oh you say okay this is the money they owe that's not too hard to value what is often very interesting to value are the assets on a balance sheet so if if you know with this balance sheet you would say $6 per share but the markets willing to say 12 they say you know what the company either these assets are somehow being undervalued or the company might have some assets that somehow are not captured on the balance sheet right so maybe they're intangible assets or there's some type of earning power that in some way is not capture captured here I think when I originally did the videos on balance sheet I actually talked about you know you can't you can't you can't quantify charisma and good looks and so that's maybe why you know I have more assets than then you know use my balance sheet might predict well this notion is the same thing but on the company level maybe if this was if this were Goldman Sachs's balance sheet maybe it's a book value per share is six dollars but the markets willing to pay $12 for it because it's Goldman Sachs that's the corporate equivalent of charisma and good looks they say you know just by their brand they are able to make more money than everyone else they're able to do more with whatever assets we give them so I'm willing to pay a premium to their book value and you know whether or not that's true that's that's a tough case I think that argument can very easily be made with a company like coca-cola where it does have a very powerful brand where that brand and that formula that secret formula really are the value of the firm and they probably aren't captured on their balance sheet with a bank I'd be a little more skeptical of paying a significant multiple of this right here what multiple are we paying if this is the market value so let's say this is the mark the stock price or the market stock price market stock price I'd be skeptical of of paying two times the book value but it's actually not hard to find a lot of companies that are trading at far more than two times the book value so that's what it means that's what the market is essentially saying if they're paying $12 a share for something that essentially has a book value of $6 per share they're saying well or maybe one of these assets are worth more maybe they had you know on the books there's like a a property here and and I don't know Manhattan that they bought 50 years ago that they have it on the books for 50 cents but maybe the shareholders say oh no that's really worth a million dollars or something I don't know and another way to think about it is if the market is paying twelve million dollars per share what's the market cap of the company and the market cap of the company is really the what's the markets guess of what the shareholders equity is so the market cap you take $12 per share multiply it by 500 million shares so 12 times 500 million or let's say 0.5 billion and you get a six billion dollar market cap so if the if the equity is trading or if the stock is trading that day at $12 per share that says that the market or at least the people on the margin trading that stock that day and I'll do another whole nother set of videos on what that means and how prices are set but that means that they think that this equity isn't 3 billion that it's actually worth six billion dollars and I told you for all the reasons maybe the brand is worth a lot or they have some secret formula or one of these assets somehow is understated so that's fine that's the situation where the market price is above the book value but what's the situation where let's say that on that day of trading the share price is at three dollars per share three dollars per share well if we say three times point five billion that means that the market says that this company's market cap is 1.5 billion or another way of viewing it is that this is the markets guess or you could about the market value of the equity this is the markets guess of the value of this company's equity so the market says okay I don't care that you know Bank a says that they have three billion dollars that their assets minus liabilities are three billion we don't buy it we actually think that this is only worth 1.5 billion dollars and it's probably because they think that one of these things on the left hand side of the balance sheet one of these assets are worth less than what the bank says they're worth I mean it could be that you know one of these liabilities are worth more maybe there's some type of environmental liability that the companies somehow understating but let's not get too complicated right now I'll do a bunch of videos on that but when the when the market value or the market cap is below the book value the book equity that's the market to say hey we're calling your bluff something here doesn't smell right something here isn't worth what you say it's worth and I just realized that I'm out of time and I will continue this in the next video