Hi, I hope you have had some time to think about this, but not too much time, because this is not that difficult. So P naught has to be DIV1 over r minus g. And I repeat again, take the time to figure out this formula. The key is if you know this formula, you know every other formula, pretty much you can derive on your own. DIV1 over r minus g, the first number is 20, the r minus g is what, 0.15 minus 0.05. Look how I have chosen numbers very neatly. What's the answer to this,200. So the price of Moogle should be $200, why? Because DIV1 is 20 over 0.15 minus 0.05. Just remember though that 0.05, when you are doing this in the real world, has nothing, is a percentage, not in dollars. It has everything to do with the cash flows. So this is pretty straight forward. And now let me tell you something about myself. So, do you think this is an easy division, 20 divided by 10? I mean 0.1 or 20 multiplied by 10. So this was several years ago and my daughter was just maybe a year old or whatever. And so I stopped and she was really hungry, and we were driving somewhere. So I said I'll run into the store and pick up a little carton of milk and I'll get it for her and she'll be fine. So I'm running out and I put it on the counter and obviously I was a little anxious that she's crying and so on. So I put it down and the guy was punching it on the machine and $1 and it cost $0.73 with taxes. But he's doing 1 minus, I said give me $0.27. And he stared at me, and I said, I'm not joking, he stared at me and said. Man, you must have a PhD in finance, and [LAUGH] I’m standing there I said, actually I do and that was my thesis. Was that that I just told you, so I’m just telling you I’m making fun of you. If you don’t like numbers, try to like them. Once you have a comfort level with multiplying and dividing, that's all we're doing. So if you don't take my jokes personally. You can have fun at my expense and somehow I'll get to know you are doing that. So now that you know the examples and all, let me now spend time. And I'm gong to take about 15 minutes to 20 minutes on this to set up what is the most interesting piece about stocks. And the last major piece for today's session. But it is extremely important that you understand this. So just hang on with me, and this is a point where, once if you get this, then you will be able to go back to other resources and understand. And that's the purpose of the video. The purpose of the video is to motivate you to learn, by showing you the essence of what's going on, why things are working. So what's the engine of growth? The first thing you must remember is that I have said this several times, but one more time. A real asset, your business create value, and they can be financed by either debt or equity. But equity is the one that's taking on all the risk. Giving your own money for your business, or to other people through markets, without any promise in return. Turns out that kind of giving leads to growth, leads to value creation. A contract is not value creating, why? Because if you tell me, show me what you'll give me back, you can't participate in the value creation. Obviously, equity will suffer from value destruction too. But that's where the risk comes in. So, let's start off and I'm going to introduce some terms. I will assume you agree that you need capital to start a business. Remember what I told you when we did cash flows? What happened at time zero? You had to make some investment minus I naught. I will do everything per share. Why am I doing that? Because the way stocks are created, and we'll see today we'll go to the website right at the end. The way stocks are created are created per share, the whole company doesn't trade. If that were the case it would be really difficult for trading to occur. So I will call this invested capital per share. So please write this down, as I said my videos are supposed to introduce you to ideas. And then you make your own notes. So capital per share is invested capital per share, is the terminology. And you'll see this in books and so on. Okay, and this is a, please pay attention to this. You need invested capital per share. So I have put some money in my idea. And remember, for convenience I'm going to use perpetuities why? Not because I know perpetuities would give me the right answer, but just as a framework of understanding what the heck is going on. And as it turns out most long lived ideas are approximately priced very well by perpetuities. The second idea I'll give you is, so you have done your capital investment. But in order to at least survive, what do you need to do? You need a return on investment. So let me repeat that. You made invested capital per share, you can call it return on capital. Many people call it return on investment. That needs to be some positive number. So we'll assume that's greater than zero. Why have I laid these two things out? Because, turns out that if I take my invested capital per share and multiply it by my ROI what will I get? I'll get my cash flow. That's the beauty of a perpetuity formula, that invested capital per share multiplied by ROI gives me. So we'll do an example in a second. So what does cash flow? In finance, we call it earnings per share, but I must warn you about this. When I say earnings per share, I mean cash flow per share. The reason I'm warning you is, the earnings per share you see in accounting statements as I told, you even we did cash flows. Accounting statement have to be used to create cash flows. Not that they're trying to cheat. Their way of recalling stuff is very different from actually what when the cash flow is happening, we know how to do this. The only reason I'm saying this is because in real world earnings per share is used. The same language is used, it may mean different things to different people. But in finance, earnings per share is cash flow per share, is equal to ICPS times ROI. So what do I mean by engine of growth? What am I trying to explain here? One thing very simple. I'm first starting off that if you don't have any resources put in you cannot have cash flows. That's a very simple, if you don't have assets, you cannot generate a business. Whatever the business may be, whatever the cash flow source may be. All I've done is I made it per share. But I'm making a second point, which hopefully everybody recognizes. That if I don't make any money on my capital cash flow, nobody's going to finance it and I won't want to. And you'll see this condition is not really that strict. But what is my cash flow then? If I'm using perpetuity cash flow becomes very simple, and we'll do problems in a second. And I again repeat tell you right now, just think about it. So I've generated my cash flows. So this times this gives me my cash flows. Now comes the really fun part. We have our cash flows, who generates our cash flows? Assets, real assets. n creating these cash flows, do you ever go to the liability side or do you remember MC Hammer, Can't Touch This? Can't touch this. So remember the cash flows have nothing to do with the financing. So what the heck is that ROI? There is another word for it we used earlier, it's called? Your rate of return, internal rate of return. We are just throwing lingo now that you're comfortable with the basics, all over the place, there's lingo. And many things mean the same thing. And many things are slightly deceptive, like unexpressed share mean one thing in accounting and another in finance. But remember the finance person is the cool person. We are dealing with reality and not just languages. Languages are awesome but they are not necessarily real. So unless I have generated my cash flow. Now here is the cool thing, at any point, you have two choices. And let us just make a simple assumption, which I think I made at the beginning, that we have no debt right now. And the reason is that we are focused on valuing stocks. So if you bring in debt, it's only going to make you a little bit confused. The other good news is, that a lot of companies have only stocks, and you'll see that in a second. The final things is, if you don't have stocks, if you don't have invested capital. If people haven't put up their money for risk, nobody is going to give you money. No bank should give you money, because it will create perverse incentives. And by the way, a lot of the crisis, partly that happened, so just remember that. The first thing you could decide to do is pay out the dividends. Suppose I was making $10 bucks this year. My cash flow was $10 bucks and I had one share, simple. I could give all $10 out, and what do I call that, dividend. But if I had paid all $10 out, how would I grow. So there is a second thing I can do, it's called retained earnings. Let me write it out, retained earnings. Now you see what's going on. Very simple, I have generated some money from my previous assets. I have generated say 10 bucks this year, and we'll do detailed examples. I could do two things, I could either pay it out or then retain it. It seems like a naive person would say, give me all the 10 bucks right away, I'm a stockholder. That's not quite the smart thing to do under some circumstances. So, question is when would you retain earnings? You're the shareholder you're the investor, when would you want the company you've invested in to retain part of their earnings? When it has great ideas for the future? Or not so good ideas for the future? When it has good ideas for the future. So retained earnings goes back and that's why I said this is an engine of growth. So let me just make one thing which will make our life simple. I'm going to divide this by earnings per share and divide this by earnings per share. And these become fractions. And this fraction I'll call b, and this fraction I'll call 1 minus b. So if I add b and 1 minus b, what do I get, 1. So the fractions have a very cool thing about them, I can just multiply, it's like a factor. So of every dollar, how much is this company reinvesting, b. If it's reinvesting b how much is paying out? 1 minus b times the total cash flow. Does it make sense? So one last step, where does this b go? This goes back and I'm going to do a circle, it goes back to replenish your capital. But for what purpose? The purpose should be to create more capital, more assets with good ideas so that you grow. One last step and we are done with the concept. So now you understand what's happened. You had initially put some capital, invested capital per share. That capital is earning a positive rate of return. You're getting some cash flows which is a product of the two. Suppose that cash flow is $10. You have two choices as a company. Either pay all of them out of dividend or pay part of dividend and part retained. Or [LAUGH] don't pay anything. Microsoft didn't pay any dividend for more than two decades so plus some, why? Because if it paid dividends people would say what the heck, why are you doing this. You've got such an awesome ideas, just use it! Take my shirt, too, you know what I mean? So, there's something called negative dividends. I was a shareholder, if I was and I knew Microsoft could grow so fast, I would give more to them. Because dividends is a way for the company to pay me. But I may want to pay more, to buy more shares, get more money. Anyways, so it's not the case that you want to think, getting dividends is good, or bad, it depends. So now suppose b is retained and it goes back and replenishes capital. What will it generate? It will generate the g we have always looked at. The g the growth rate in our cash flows. And I'm going to write the formula here which is very intuitive. And that's it pretty much, this is the engine of growth. So what is the growth coming from? If I do not put any money back in the company, if b is 0, growth can't happen. It can happen organically by chance, I'm talking about growth by design. So for example, If iPad wasn't produced, could Apple have grown to be as big as now? Probablilities law, but it could have happened. Suddenly, some accident happened to every other company producing phones and Apple just took off. I'm not talking about that kind of growth, I'm talking about sustained, thought out, planned growth. So you have to put b has to be positive. But suppose I put b back and my ROI is 0 on that b, additional b, will I grow? No, it's very intuitive I'm now going to derive it. I have now shown you the engine of growth. So when you use the formula of a company with growth, what are the things they use? First dividend over r, you already know those two, minus g, and this is how g is calculated. So I think a stock reflects the engine of growth. What I'm going to do now is, I'm going to take a break. But I will let the slides stay and stare you in the face so that you have the time, five minutes or so. To just stare at it, look at it, derive it for yourself, think about it. And then later I would even encourage some of you to go to a book and see how they'll do it in a very detailed fashion for you. You have the ability to take care of resources outside of this video. But I want this video to be the process through which you get the essence of what's going on and just leave the details a little bit out. So I'm going to take a break now and come back and wrap up what we did with examples and show you something quite startling. See you soon.