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Buffett and Beyond: Uncovering the Secret Ratio for Superior Stock Selection, + Website, 2nd Edition by Joseph Belmonte

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Chapter 8

The Equity Portion of the Return on Equity

Note: The return numbers (both earnings and net income) we just finished discussing are found on the income statement. The book value or owners’ equity is found on the balance sheet. The book value or owners’ equity supposedly represents the value of the company.

There are two terms we must understand before we go on. You continually hear the terms “book value” and “owners’ equity.” Let's discuss the definitions.

Book value is defined as “assets minus liabilities.” Think of your house. You bought it for $100,000 with a $20,000 down payment. You owe the bank $80,000. The book value of your asset (the house) is the value of the asset, which is $100,000, minus the liability, which is the $80,000 you owe the bank. Your book value (net worth) is, of course, the $20,000 you put down.

Owners’ equity is defined as “the amount of equity (money) investors have put into the company.” Owners’ equity equates to common stock sold by the company plus all the retained profits (earnings after dividends are paid out), which are put back into the company year after year so the company can grow.

Please notice that using the house example, the owners’ equity is also equal to the book value of $20,000. It is the amount of your equity money that you put into the house. The problem with accounting is that our example of the house is where the similarity ends between book value and owners’ equity.

The definition for book value is different than the definition ...

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