Enjoyed this video? Then subscribe to the channel, and find out more about how financial leverage fits into the Return On Equity (ROE) calculation ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-6fA5N4giHrM.html
Leveraged is the bubble in an economy collapse. Leveraged is the noun. Bubble is a noun. The same noun. Stop blaming krakens on our economic bubble. There are people who con our banking system called leveraged and need to be arrested. It's in their taxes. Why would we let anyone create an economic bubble? AKA leveraged. My landlord is using a not-for-profit mortgage banking to rent to me in a for-profit banking from. This is a con job. The con; borrow from a not-for-profit bank (such as a mortgage) and at the same time, loan money in a for-profit banking. AKA leveraged, AKA a economic bubble. One can't have a Cognitive dissonances in borrowing money from a not-for-profit bank than at the same time be lenders in a for-profit banking. This is fraud. This is the bubble in an economy that colaspes. This is the Glass-Steagall Act.. One should not have a cognitive dissonance. One receives the same interest rates on their mortgage and that in their retirement. Otherwise. Everyone of us can be $1 trillion leveraged. Why is my landlord only $1 million leveraged? Why am I renting from someone with a mortgage? No krakens. Arrest my landlord for being leveraged, borrowing money from not-for-profit banking and lending to a for-profit banking.
Hello Alejandra! Thank you very much for the kind words. Yes, financial leverage can be a great thing when things go well, but can REALLY hurt when things go dramatically wrong.
You're welcome! :-) I think you will like my ROA example as well: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-2j8bfR8KqJ0.html Sometimes it's not financial leverage, but an item in the income statement, or the assets side of the balance sheet, that produces unusual results.
You're welcome, Katelyn! Happy to help. Please subscribe to the channel, and share with your friends! I put together a playlist of DuPont analysis / ROE related videos (financial leverage is one of the elements in there) that might help you as well: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-bhbDDSohJ84.html
So happy to hear that, Sakshi! Have you seen my other videos about various parts of the DuPont equation (ROE, ROA, ROS, etc.): ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-bhbDDSohJ84.html
If I were a CEO of a company, I wouldn't "lever" my debt only to raise ROE and drop the net income (maybe others do, I guess), also I personally avoid debting to others
Same here, Surya! Sadly, some CEOs maximize profit while taking on huge hidden risk, and/or take the bonus in the good years, but refuse to pay back that bonus when the business subsequently "blows up".....
Actually some correction, the $80,000 annual net income would have to be split in the event of leverage as some will go to paying off the loan and the balance to the investor.
Calculating net income happens in the income statement (also sometimes called profit and loss statement): ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-Hq-44PHgAiU.html while paying down debt and paying dividends occur in the Cash From Financing Activities (CFFA) section of the cash flow statement: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-xw67FIeVsj8.html Those are separate things.
So is bigger return on equity (%) seen as better in the financial world? Or is it the opposite? I assume that the factory owner wants the largest possible net income (100 000$) but do the investors want larger ROE % or largest possible income aswell.
Thank you for the kind words! I use PowerPoint and add an audio track: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-iIMmS-5W3v4.html For some of the visuals, I take screenshots from annual reports using the snipping tool in Windows 10.
If you want to learn more about DuPont Analysis (return on assets, return on equity), then the videos in this playlist will help: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-bhbDDSohJ84.html&pp=gAQBiAQB If you are interested in the risk of taking on too much debt and "blowing up" when overleveraged, then understanding liquidity and solvency are key: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-XtjS7CfUSsA.html&pp=gAQBiAQB
Such a good explanation, thank you very much. I recently finished my MBA and I want to get more knwoledge in accounting and finance. What are some good books that you reccomend? Thank you very much!
Hello Gerardo! No books, go with real world examples, by picking up annual reports from companies you are interested in (or even better: invested money in) and connect their strategy and "narrative" to their financial statements. Whenever you come across terminology that you need help with, check the videos on my channel! Here are some examples of case studies walking through income statements, balance sheets and cash flow statements: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-PI9X5Ybek_E.html
Hello Philippe! The bigger the leverage, the bigger the chances of a "blow up".... It might improve ROE in the short term, but if you go out of business then there will no longer be ANY ROE or ROA.
Thank you, Moizzkhan! I did reviews of the income statement, balance sheet, and cash flow statement of Alphabet Inc: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-ToE-oggQiqQ.html I also did an ROE (Return On Equity) analysis, which includes the financial leverage component, of Apple: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-DQgEoz8izxY.html as well as ROA (Return On Assets) analysis of Verizon vs Walmart ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-2j8bfR8KqJ0.html Hope these are helpful for you!
@@TheFinanceStoryteller I watched the Income Stateement, Balance sheet and cash flow statement analysis videos. I'll definitely watch the others you just mentioned. Thank you so much for taking the time to link the videos. Thank you so much. 👍👍
Is this roe/roa method a better way compared to Debt to Equity ratio to figure out how a company finances their assets ? For example if i get 1.5 from dividing roe/roa , would that effectively mean that the assets are financed by 67% equity then 33% debt ?
I think both of the methods can get you an understanding of the financing structure. I have never consciously divided ROE by ROA before, but you can get some multiples at the end of the video near ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-GESzfA9odgE.html A multiple of 2 means 50/50 financing between debt and equity. A multiple of 10 means 9-to-1 debt to equity.
I know that we can check whether the debt is low or high by comparing to its capital structure and equity. But is there any other ratio or financial metric which can be used to relate company's debt to it earnings or EBITDA, which will tell us whether the company will be able to pay its debt if it has lesser % of equity and larger % of debt.? And what you think what the ideal Net debt / EBITDA ratio should be (i.e. how much debt a company should take in comparison to its EBITDA)?
Hi Krishan! You could use the interest coverage ratio, but there are some limitations to its use: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-P19tw3Hb7TA.html I have no specific "guidelines" for an ideal Net debt / EBITDA ratio, this could depend on the level of maturity of the company and its industry. You could look up some articles in the financial news around debt covenants... sometimes these terms are disclosed publicly. In general, taking on significant amounts of debt increases a company's fragility. On the other hand, companies can accelerate their growth (through more R&D, or more selling and marketing efforts) by borrowing money at fairly low interest rates.
Those are great questions, for which I have made specific videos to answer them. What is equity ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-Q1z395u60xU.html What is return on equity ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-6fA5N4giHrM.html Enjoy!
Hello Saj! There are several definitions of leverage "in circulation". The definition I use in this video is linked to how it is defined in the DuPont analysis: assets divided by equity. You use debt-to-equity (as in: total liabilities divided by total equity), which would indeed be 1 at that timestamp in the video. Some people use debt-to-equity as interesting bearing debt (in other words excluding accounts payable, accrued liabilities, etc.) divided by equity. Always check the definition carefully when you see any of these calculations!
Then the outcome of the calculation is NMF: Not MeaningFul. It tells you absolutely nothing. Other than the company potentially being in significant financial trouble.
In general, investors prefer companies with a higher ROE, so demand for the stocks of companies that have a high ROE should be higher. However, ROE is a metric that looks back at historical financial performance. Most of the value of a stock depends on its prospects for the future. If a company achieved a high ROE in the past, then that is not an absolute guarantee for it to repeat that high ROE in the future.
I used 4% after-tax interest on the debt. I took $100K net income when the asset is 100% financed by $1MM equity. So when you move to $500K equity and $500K debt, then the additional interest charge is 4% of $500K = $20K. The net income drops by that $20K to $80K. You could even argue that the interest % needs to go up in a more highly leveraged situation, but I wanted to keep the calculation as simple as possible.
But how about the face value of the debt?? At some point you will not only have to pay the low interest, but the big face/par value of the debt, which would reduce substantially your income and make ROE very low?? What am I missing?
Hello Patrick! Yes, at the end of the borrowing period, you pay back the principal amount. This does not have an effect on income. The journal entry for it is debit debt, credit cash. To be able to pay back the loan, you have to generate enough cash from operations, or to take out a new loan to replace the old one. See the video on the cash flow statement ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-mZBjsIYrLvM.html and the one on cash flow patterns in a business lifecycle ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-UGd2llFBiMA.html
They are related, but not the same. When a leverage buyout happens, there will always be very high financial leverage. However, not every situation where a company has high financial leverage is a situation where a leveraged buyout occured.
Thank you, Dilantha! Yes, that's why I love DuPont analysis so much... figure out whether the high ROE comes from operational drivers or from financial leverage! ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-bhbDDSohJ84.html
Could somebody explain to me why, when the scenario is $500K to the shareholder, and $500K to the bank, that the shareholders get ALL the income that the factory is outputting? (It's at around 1:00 into the video)
There is an interest charge on the debt to the bank, and the shareholders get the "residual income", what is left after you deduct all expenses from revenue: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-9j8HQg7YxXw.html
Hi David! Maybe it helps to start off with the DuPont equation, and then "zoom in" to financial leverage afterward: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-bhbDDSohJ84.html
Same way. Bear Sterns blew up in March 2008. Lehman Brothers blew up in September 2008. Too much leverage was a huge factor in it. As we never ever want to have to bail out banks again, the solvency requirements have gone up significantly. For example, when the pandemic hit, financial institutions in many countries were not allowed to pay any dividends to shareholders (temporarily), to keep the equity in the bank in uncertain times.
@@TheFinanceStoryteller So I just read that Lehmann Brothers was 44 times levered at time of bankruptcy. Makes me wonder how they would have gone through the whole winding up process.That would have been a completely different challenge. I am just curious about if there is any ideal financial leverage ratio for banks and non-banks.
Hello Hussain! Sadly, they do (to a certain extent). More painful is that trading platforms offer this to inexperienced investors, leading to blowups on the personal level.
@@TheFinanceStorytellerIn the real estate scenario.....I can just borrow money from the bank....buy a house with it and rent it....pay the debt from the rent.......and within 7 to 10 years the house is mine......what is the problem here!?
As assets are $1MM, and I keep lowering the amount of equity, the amount of debt is growing in each step. The lower the equity, the higher the debt. I used a 4% after-tax interest charge on the debt, that's why the net income drops in each of the subsequent scenarios. My apologies if that was not totally clear when watching the video!
Equity is a term used in accounting, in real estate and home-ownership, in investing, as well as in startup financing and valuation. In accounting, equity is a term that you will find on the balance sheet: the book value of the shareholder capital. See my video "What is equity": ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-Q1z395u60xU.html
I used an after-tax interest charge of 4% on $800,000 of debt, which leads to an annual interest expense of $32,000. NOPAT of $100,000 minus interest expense of $32,000 equals net income of $68,000.
ROE is Net Income $ divided by Equity $ (at book value, taken from the balance sheet). EPS is Net Income $ divided by the number of outstanding shares. Same numerator, different denominator. ROE and EPS should be highly correlated (if one goes up, the other is also likely to go up). ROE explanation ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-6fA5N4giHrM.html EPS explanation ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-TXjkQy5KJog.html
In order to get there, it might be good to first watch one or more videos on the DuPont ROE equation (including examples of how to calculate it based on the numbers of real world companies), and only once that is fully clear dive into the specifics of financial leverage (which is an element of it): ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-bhbDDSohJ84.html
@@saurabhmaurya94 That's a fascinating case study! I think you might like my video on IPOs, it covers WeWork and others.... ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-4t62BEH9Ajs.html
