Stock Market Math

Michael C. Thomsett, Business and investment writer

Chapter 1: Rates of Return on Investment: What Goes In, What Comes Out  1

Judging the Outcome – What Did You Expect?  2

The Basic Equation: Return on Cash Invested  4

Calculating Option Trading Returns  10

Taxes and Investment Return  13

Conclusion  17

Chapter 2: Returns on Capital: Putting Cash to Work  19

Calculating Returns from the Corporate View  19

Calculating Average Net Worth  22

Net Worth Versus Total Capitalization  24

Preferred Stock as Hybrid Capitalization  27

The Importance of “Use of Capital”  31

Conclusion  33

Chapter 3: Leverage and Risk Analysis: Maximizing Other People’s Money  35

Calculating the Cost of Money  35

Annualized Return  38

Leverage-Based Risk—the P/E Ratio as a Way to Quantify  40

Using Options as a Form of Leverage  44

Conclusion  48

Chapter 4: Long-Term Trends: Patience Rewarded  49

A Realistic View: Long-Term Returns and Annual Rates  50

Total Net Annualized Return  53

Carryover Losses and Net Return  56

Realistic Expectations: Inflation and Taxes  58

Compound Return Calculations  60

Other Cash Flow Trends  63

Return Formulas  65

Useful Return Shortcuts  70

Estimating the Value of Deposits over Time  72

Conclusion  76

Chapter 5: Core Earnings and Net Worth Adjustments: Making the Numbers

Real  77

The Problem with Today’s Accounting Rules  78

Flaws in the GAAP System – a Passive Approach to Reporting  80

Examples of Material Expenses  82



Balance Sheet Problems – Inaccurate Valuation  84

Recalculating the Key Ratios  85

Recalculating Net Worth  89

Finding Core Earnings – Comparative Analysis  92

Conclusion  93

Chapter 6: Fundamentals: Balance Sheet Tests You Need to Know  95

The Nature of Fundamental Analysis  96

Basics of the Balance Sheet  98

Working Capital Tests  101

Accounts Receivable Tests  105

Inventory Tests  108

Long-Term Asset Tests  110

Capitalization  112

Tangible and Total Book Value  116

Chapter 7: Fundamentals: Operating Statement Tests You Need to Know  121

The Basics of the Operating Statement  123

Revenue Trends  128

Earnings Trends  129

Revenue Compared to Direct Costs and Expenses  131

Conclusion  138

Chapter 8: Market Trend Calculations  139

Index Weighting  139

Breadth of the Market  143

Short Interest Ratio  146

New Highs and New Lows  148

Put/Call Ratio  151

Mutual Fund Ratios  152

Chapter 9: Price Indicators  159

The Basics of Technical Analysis  159

The Random Walk Hypothesis and the Efficient Market Theory  162

Basic Price Calculations  165

Chart Patterns and Interpretations  167

Technical Tests of Market Sentiment  171

Breadth of Trading  171

Chapter 10: Volume Indicators  175

Change in Volume  176

On Balance Volume (OBV)  178



Accumulation/Distribution (A/D)  180

Money Flow Index (MFI)  183

Large Block Ratio  186

Conclusion  187

Chapter 11: Momentum Oscillators and Moving Averages  189

Overview, Momentum Oscillators  189

Relative Strength Index (RSI)  192

Moving Average Convergence Divergence (MACD)  195

Stochastic Oscillator  197

Moving Averages  199

Bollinger Bands (BB)  201

Conclusion  204

Chapter 12: Combined Testing: Merging Price and Financial Tests  205

Effective Use of Combined Analysis  206

Valid Versus Invalid Forms of Testing  208

Identifying Important Combined Tests  209

Additional Price-Based Combined Tests  211

The Oddities of Hybrid Analysis  215

Appendix A Stock Market Formulas: Summarizing the Essentials  219

Appendix B: Excel Program Entries: Automating the Formulas  247

Index  267