Glossary of Rule #1
Financial Terms
# B
10-10 rule
A concept used when determining whether a busi-
ness has Meaning (one of the Four Ms) to you as a
Rule #1 investor. The rule states that you should not
“Own a business for 10 seconds if you are not willing
to own it for 10 years.”
A
Analyst consensus
growth rate
A forecasted earnings growth rate that is de­rived
from the forecasts of all the professional analysts
following a particular company
Asset
Resources controlled by a company from which
future economic benefits are expected to be gen-
erated. In a business, an asset is something the
business owns that has a dollar value. (An asset in
general is anything of value that can be traded.) An
intangible asset is an asset that has a dollar value
but may not be worth anything unless the business
is successful. Typically this is an asset that was
acquired through buying another business. The
price paid in excess of that business’s net worth is
often called “goodwill” and is treated as an asset
for GAAP purposes.
Glossary of Rule #1 Terms
BAG
Big Audacious Goal -- Coined by author Jim Collins
in the book Good to Great, Rule #1 investors seek
businesses led by CEOs driven by BAGs. These goals
are bigger and more meaningful than mere mission
statements in that BAGs are about passion and
relentless drive to change the world in some small
or big way.
Balance sheet
The financial statement that presents a company’s
current financial position by disclosing the assets,
liabilities and equity claims as of a particular point
in time.
Basic EPS
Net earnings that are available to common share-
holders. This is calculated as net income minus pre-
ferred dividends, divided by the weighted average
number of common shares outstanding.
Bearish
An investor who acts on the belief that a security
or the market is falling or is expected to fall.
Beta
A standardized measure of risk.
1
 Big Five Book value Equity
The five financial calculations help to confirm the Per Share
existence of a Moat (see definition) in a business,
The amount of book value of common equity per
which translates to the business being protected
share of common stock. This is calculated as book
from competition and thereby having a predictable
value of shareholders’ equity divided by the number
future. Rule #1 investors only invest in businesses
of common shares outstanding.
if all five of the Big Five numbers are equal to
or greater than 10 percent per year for the last
10 years.
Bullish
An investor who thinks the market or a specific secu-
The Big Five numbers are:
rity or industry will rise. A bull market is an extended
1. Return on Investment Capital (ROIC) period in which the market consistently rises.

2. Sales growth rate

3. Earnings per Share (EPS) growth rate

C
4. Equity, or Book Value per Share (BVPS),
growth rate

5. Free Cash Flow (FCF or Cash) growth rate

Call option
A contract that gives the holder the right to buy an

Bond underlying asset from another party at a fixed price

over a specified period of time
A debt investment, as in your loaning money to the

Capital Gains Tax

U.S. government, which borrows from you for a
defined period of time at a specified interest rate.
The government issues you a certificate, or bond,
that states the interest rate (coupon rate) that will be
paid and when the loaned funds are to be returned
(maturity date). These are often called T-bonds or
T-bills, short for treasury bonds or bills.
A tax on the increase in the value of an asset; the
difference in what you paid to purchase that asset
and what you sell it for. (The gain is not realized until
the asset is sold.) A capital gain may be short-term
(one year or less) or long-term (more than one year).
Long-term capital gains are usually taxed at a lower

Book Value rate than regular income. So, if you sell stocks six
months after you purchased them and take profits,
The net asset value of a company, calculated by total
you’ll be taxed at a higher rate than if you sell them
assets minus intangible assets (patents, goodwill)
one year and one day after you originally bought
and liabilities. It’s what the business is worth if you
them (assuming you can still take profits).
shut it down.

Glossary of Rule #1 Terms 2

 Commodity
A bulk good that’s traded on an exchange or in
the cash market. Examples include grain, oats,
coffee, fruit, gold, oil, beef, silver, and natural gas.
A “commodity business,” on the other hand, is what
we call any company that produces a product that
anyone else can similarly produce, thus eliminating
a Moat. If you own a strawberry patch, for example,
chances are a neighboring strawberry patch can
easily compete with you. A strawberry from your
patch is not going to be all that different from a
strawberry from your neighbor. It’s very difficult
and expensive to create a Moat and protect it with
a commodity business.
Compounded annual
growth rate (CAGR)
The year-over-year growth rate of an investment
over a specified period of time. It’s an imaginary
number that describes the rate at which an invest-
ment would have grown if it grew at a steady rate.
Consistency
Score (0-100)
A measure of how constant a company’s growth has
been. Companies with high consistency scores are
ones that have expand­ed their operations and value
without demonstrating a significant amount
of variability in their growth rates.
Glossary of Rule #1 Terms
Covered call
An option strategy where the holder of an asset
sells a call op­tion on a previously purchased stock.
The two potential scenarios at option expiration are
to create cash flow equal to the option premium
received or to effectively sell the stock at a price
equal to the stated strike price plus the premium
received. This is an alternative way to sell stocks
especially when the stock is not currently trading
in the red zone.
Credit spread
A limited risk option strategy that is implemented by
selling one naked option, which incurs an obligation
to perform and offsetting that obli­gation by buying
a second option at a different strike price that gives
you the right to make someone else perform.
Current liabilities
Short-term obligations that are expected to be
settled in the near-term.
Current ratio
Liquidity ratio calculated as current assets divided by
current li­abilities.
3
 D
Debt-to-equity ratio
Solvency ratio calculated as total debt divided by
total debt plus total shareholders’ equity.
Debt–to-earnings ratio
The amount of years it would take a company to pay
off its debt using its current annual earnings.
Debt Score (0-100)
Companies with high scores are ones that have very
little debt or that can pay off their current debt load
using their earnings in a rela­tively short period of
time. Scores of 100 indicate no current debt load,
while lower scores indicate increasingly higher levels
of debt in relation to earnings.
Depreciation
The systematic allocation of costs of long-lived
assets to the pe­riod during which the assets are
expected to generate economic benefits.
Diluted EPS
The EPS (Earnings Per Share) that would
result if all dilutive securities were converted
into common shares.
Glossary of Rule #1 Terms
Dividend
A distribution of cash, stock, or property by a
company, based on its earnings, to its shareholders.
Dividends are usually quoted per share. They are
typically the “thank-you” notes for owning stocks in
a stable company (which usually doesn’t have stock
prices that move rapidly).
Dividends per share
The dollar amount of cash dividends paid during
a period per share of common stock.
Dollar Cost Averaging
(DCA)
The practice of buying a certain number of shares in
a given stock periodically, so you buy a certain dollar
amount of shares regardless of the price per share.
This allegedly helps reduce their risk of investing a
large amount in a single stock at the wrong time.
You buy more shares when the prices are low, and
fewer shares when the prices are high. In long side-
ways markets, DCA will not reduce the risk of a zero
rate of return. For Rule #1 investors, however, you
already know what price you are willing to pay, so
DCA isn’t necessary. Dow Jones Industrial Average.
A price-weighted average of 30 significant stocks
traded on the NYSE and the Nasdaq. Examples of
DJIA companies include General Electric, Disney,
McDonald’s, and Coca-Cola. Invented by Charles
Dow in 1896.
4
 E

Earnings growth rate Equity

(EGR) (1) Stock or any other security representing owner-
ship (“equities” are stocks). (2) On the balance sheet,
The compounded growth rate that is used to fore­
equity refers to the amount of the funds contributed
cast potential future earnings per share. This is used
by the owners (the stockholders) plus the retained
in connection with other valuation assumptions to
earnings (or losses). Thus, equity is essentially
forecast the future value of the firm and calculate
ownership in an asset after all debts associated with
sticker price.
that asset are paid off. The importance of equity to

Earnings per share a Rule #1 investor is in its growth rate. The growth
rate of equity represents the growing surpluses,
(EPS) which in turn increase the value of the business.

The amount of income earned during a period per

share of common stock. Exchange
A market where securities, commodities, options, or
Earnings surprise futures are traded. Examples of exchanges include
the NYSE, Nasdaq, and AMEX.
A company announcement of earnings that differs
from analysts’ forecasts.

Earnings Yield
The income return that a full owner would receive
from the earnings of the company if the company
was purchased at the current market price. It is
determined by dividing the current earnings per
share by the current market price.

Glossary of Rule #1 Terms 5

 F G
Four Growth Rates
A subset of the Big Five that includes:
1. Sales growth rate
2. Earnings per Share (EPS) growth rate
3. Equity, or Book Value per Share (BVPS),
growth rate
4. Free Cash Flow (FCF or Cash) growth rate
Four Ms
Meaning, Moat, Management, and Margin of Safety.
Free cash flow
The actual cash that would be available to the com-
pany’s investors after operational investments.
Glossary of Rule #1 Terms
Gamma
Measures how sensitive an option’s delta is to a
change in the un­derlying asset.
Green Zone
Delineates the beginning of the potential purchase
zone. When­ever a particular stock trades below
the green zone price then it may be con­sidered for
purchase. The green zone price can be either the
Margin of Safety Price, The Payback Time Price, the
lesser of these two prices or for more experi­enced
investors, 80% of sticker price.
Gross profit margin
This is calculated as gross profit divided by revenue.
6
 I L

Index Large-Cap
An imaginary portfolio of securities (stocks and Stocks with large market capitalization, between $10
bonds) representing a particular market or a portion billion and $200 billion.
of it. The S&P 500 is one of the world’s best-known
indexes, and is the most commonly used benchmark Last
for the stock market. Technically, you can’t actually
The last actual price at which a stock was sold.
invest in an index. Rather, you invest in a security
such as an index fund or ETF that attempts to track
an index as closely as possible.
M
Index Fund
A portfolio of investments that are weighted the
same as a stock-exchange index, such as the S&P
MACD
The Moving Average Convergence Divergence is a
500, in order to mirror its performance.
trend-following momentum indicator that shows the

Industry relationship between two moving aver­ages of price.

To calculate the MACD, subtract the 26-day expo-
A group of companies that provides similar product nential mov­ing average from the 12-day exponential
and services. moving average. A nine-day dotted exponential
moving average called the signal line is then plotted
Insider trading on top of the MACD.

When corporate insiders—officers, directors, and

employees—buy and sell stock in their own com-
panies. When corporate insiders trade in their own
securities, they must report their trades to the SEC.
Intrinsic Value
Management
One of the Rule #1 Four Ms that qualify a business
you are considering investing in. Having good
management means the business is led by skilled,
experienced individuals that you respect.

The current value of a business based on its future

surplus cash flow. Also known as “Sticker Price”.

In-the-money
Options that if exercised would result in a profit.

Glossary of Rule #1 Terms 7

 Management Score
(0-100)
A high management score means that the Re­turn
on Equity and Return on Invested Capital over the
last ten years have been high, indicating that the
company may have quality management. Those with
the highest scores are those that have had consis-
tently high returns over the last ten years.
Margin of safety (MOS)
The difference between the sticker price and margin
of safety price. This reduction in the sticker price
helps to insulate investors from possible valuation
mistakes.
Margin of safety price
(MOS Price)
A potential purchase price for a particular stock that
is determined by reducing the sticker price by the
margin of safety.
Margin of safety yield
(MOS Yield)
The return that a full owner of a company would
receive from the earnings of the company if the
company was pur­chased at the MOS price. It
is calculated by dividing the current Earnings per
share (EPS) by the MOS Price.
Glossary of Rule #1 Terms
Market Capitalization
The total dollar value of all outstanding (sold and
held by investors) shares. A business’s “market cap”
is calculated by multiplying its number of outstand-
ing shares times the current market price.
Market order
An order to buy or sell a security immediately at the
best price available.
Meaning
One of the Rule #1 Four Ms that qualify a business
you are considering investing in. Meaning is that you
understand the business enough to want to own the
whole thing if you could, that you’d be proud to own
it, and that it reflects your values.
Mid-Cap
Stocks with middle-range market capitalization,
between $2 billion and $10 billion. Moat. First coined
by Warren Buffett, Moat refers to the competitive
advantage a company has over other companies in
the same industry.
Minimum Acceptable
Rate of Return (MARR)
The rate at which an investor should expect to earn
on an investment. In the Payback Time system, this
typi­cally equals 15% annually.
8
 Moat
One of the Rule #1 Four Ms that qualify a business
you are considering investing in. Moat means that
the business must meet certain criteria in terms
of financial strength and predictability, creating a
symbolic Moat to surround and protect it from com-
petitors. The strength of a business’ Moat, or lack
thereof, will surface in one of The Big Five numbers
(see definition in this glossary).
The five types of Moats include
Brand – A product you’re willing to pay more for
because you trust it. The company is consistent in
high quality services.
Secret – A business that has a patent or trade secret
that makes direct competition illegal or very difficult.
Commonly pharmaceutical and technology compa-
nies.
Toll Bridge – A business with exclusive control of
a market—giving it the ability to collect a “toll” from
customers needing that service or product.
Switching – A business that is so much a part of
your life that a switching is not worth the trouble.
Price - Companies with prices so low no one else
can compete.
Moat Score (0-100)
A company with a high moat score is one whose
finan­cial numbers indicate that it may have a sus-
tainable and durable moat. Com­panies that have
significantly grown their earnings per share, book
value per share, sales per share, and operating cash
flow per share at greater than 10% per year will have
the highest score. The higher scores suggest that
Glossary of Rule #1 Terms
these com­panies have the highest probability of
having a significant competitive advan­tage over their
peers, which has allowed them to grow significantly
over time.
Money Flow
The amount of capital that is being invested in
or conversely mov­ing out of a particular security,
industry, or industry sector.
Moving average
Frequently used to show the average value of a
security’s price over a period of time. A simple
moving average is the average price of the stock
over a specific period of time. An exponential
moving average is weighted to give more emphasis
on recent activity.
Mutual Fund
A financial entity that allows a group of investors
to pool their money for investing in the market,
usually with a predetermined investment objective.
A fund manager is responsible for taking that pooled
money—usually billions—and buying securities
(usually stocks or bonds). When you invest in a
mutual fund, you are buying shares (or portions)
of the mutual fund and become a shareholder of
the fund. The vast majority of mutual funds fail
to beat the market, as well as broad indexes like
the S&P 500.
9
 N Option Chain
Naked Puts
An option strategy where a put option is sold. The
two possible outcomes at option expiration are an
income return from receiving the option premium
or the potential to purchase the stock at a price
equal to the stated strike price minus the premium
received. Selling naked puts is an alternate method
for purchasing stock especially when the stock is not
currently trading in the green zone.
Net income (or net loss)
The difference between revenues and expenses.
Noncurrent assets
Assets that are expected to benefit the company
over an extended period of time.
O P/E
Operating cash flow
per share (OCPS)
Denotes the amount of usable cash from operations
that is allocated to each share of a company’s stock.
Options
The privilege to buy or sell an asset, such as a stock,
at a specified price within a specified time. Options
are typically for the advanced investor.
Glossary of Rule #1 Terms
For each underlying security, the option chain tells
investors the various strike prices, expiration dates,
and whether they are calls or puts.
P
Payback Time (PBT)
The amount in years it would take a full owner of a
com­pany to recoup the capital investment using the
forecasted earnings stream of the company.
Payback Time Price
(PBT Price)
The price that can be paid for a particular stock to
receive the forecasted Payback Time. The investor
selects the amount of years that determines the
price. The default is 8 years.
A ratio of price to earnings (market value per share,
divided by earnings per share). Sometimes the PE
is referred to as the “multiple” because it shows
how much investors are willing to pay per dollar of
earnings. If Company X has a PE of 10, that means
an investor is willing to pay $10 for every $1 of
earnings. In general, a high PE means the analysts
are projecting higher earnings in the future. When
comparing PEs, it’s best to compare PEs within the
same industry, or against a company’s own historical
PE. The PE of the entire stock market—“market PE”—
has historically been about 16.
10
 Peers Price to sales (P/S) ratio
Other businesses that form a company’s The price of a share per the company’s sales. This is
competitive set. calculated as price per share divided by sales.

PEG
Price to Earnings multiple divided by the forecasted
growth rate. It de­notes the amount of the PE multi-
ple that the market is paying for every per­centage of
forecasted growth.
Portfolio List
A list of businesses that you have bought and may
wish to sell. Rule #1 investors use a portfolio list to
track the MOS and the Tools.
R
Red Zone
Delineates the beginning of the potential sales zone.
Whenever a particular stock trades above the red
zone price, then it may be considered as a potential
sales candidate. The red zone price is determined by
multiplying the sticker price by 120%.

Price to book value REITs (Real Estate

(P/BV) ratio Investment Trust)
The price of a share per the company’s book value of A security that sells like a stock on the major

equity. This is calculated as price per share divided exchanges and invests in real estate directly, either

by book value per share. through properties or mortgages. This is how you
can invest in real estate, without actually buying a

Price to cash flow piece of property.

(P/CF) ratio Return on Assets (ROA)

The price of a share per the company’s cash flow. Gives an idea as to how efficient management is at
This is calculated as price per share divided by cash using its assets to generate earnings. This is calcu-
flow per share. lated by dividing a company’s annual earnings by its
total assets.
Price to earnings
(P/E) ratio
The price of a share per the company’s earnings.
This is calculated as price per share divided by
earnings.

Glossary of Rule #1 Terms 11

 Return on Equity (ROE)
The amount of net income returned as a percentage
of shareholders equity and a measure of manage-
ment’s effectiveness in ap­plying equity capital. One
way of calculating ROE is to divide net income by
shareholder’s equity.
Return on Investment
(ROI)
The percentage return you’ve made on your
investment. The ROI for a savings account is 2
percent a year. It’s the total you got back from your
investment, less the investment itself, divided by
the investment. If I got back $120 from selling
lemonade and my investment was $100, to find
my ROI, I subtract $100 from $120 to get $20.
And $20 ÷ $100 = 20%.
Return on Invested
Capital (ROIC)
The return on invested capital measure gives a
sense of how well a company is using its money to
generate returns. One way to calculate ROIC is to
subtract dividends from net income and then divide
that number by total capital.
Revenue
The amount a company makes for providing
goods and services.
Glossary of Rule #1 Terms
Rhu
The sensitivity of the option price to the
risk-free rate.
Rule of 72
A method for estimating an investment’s doubling
time. The number in the title is divided by the inter-
est percentage per period to obtain the approximate
number of periods (usually years) required
for doubling.
Rule #1 Score
The Rule #1 Score helps you determine the com-
panies that have a high probability of meeting your
definition of a “wonderful company.” If this company
has meaning for you, look to the other scores to
help you identify companies that may meet your
expectation for the three M’s: Moat, Manage­ment
and Margin of Safety.
Rule #1
Don’t lose money
Attributed by Warren Buffett to his teacher, Benja-
min Graham. The essence of Rule #1 is the idea
of certainty and low risk from buying businesses,
not stocks, that are wonderful and only at an attrac-
tive price—in other words, buy a dollar of value
for fifty cents.
Rule #2
Don’t forget Rule #1
12
 S

Sales per share Stochastics

The amount of a company’s sales allocated to each
share of company stock.
Scans
A screening method applying a set of criteria to
An indicator that compares where a security’s price
closed rela­tive to its price range over a given time
period. In theory, prices tend to close near their high
in an upwardly trending market and closer to their
low in a downward trending market.

reduce a set of poten­tial investments to a smaller
set having specified desired characteristics.
SEC filings
A financial statement or other formal document
submitted to the U.S. Securities and Exchange
Commission (SEC). Public companies, certain in­sid-
ers and broker-dealers are required to make regular
SEC filings.
Sustainable growth
rate
The rate of earnings and dividend growth that can
be sustained over time for a given level of return on
equity, assuming a con­stant capital structure and
no common stock dilution.

Sector
A group of related industries.

Sector Fund
A type of mutual fund that invests in a particular
industry or sector of the economy.

Sticker Price
The value of a business, despite the selling price
on the market. Rule #1 investors seek to buy busi-
nesses at 50 percent of their Sticker Price, when
they are undervalued. Sticker Price is determined by
performing calculations on the Four Growth Rates
(see definition).

Glossary of Rule #1 Terms 13

 T
Technical analysis
A method of evaluating securities by analyzing statis-
tics generated by market activity, such as past prices
and volume. Technical ana­lysts do not attempt to
measure a security’s intrinsic value. Technical ana-
lysts often use charts to identify patterns that can
suggest future activity.
Technical indicator
Used to predict future financial or economic trends.
An in­dicator is a mathematical calculation based on
a security’s price and/or volume.
Theta
The rate at which an option’s time value decays.
Ticker Symbol
Denotes a particular stock on an exchange. Ticker
symbols for companies trading on the NYSE or Amex
have three letters while companies trading on the
NASDAQ have four.
Trailing Twelve Months
(TTM)
Denotes that the number or metric being dis­played
is for a period that equals the previous twelve
months of operation.
Glossary of Rule #1 Terms
Town Beta (0-100)
A measure of how well each of the growth rates
(EPS, Sales, OCPS) explains the growth in book value
per share. High betas suggest that the companies
have similar patterns of growth in all of the signifi-
cant growth rates. Since book value per share is the
most difficult number to manipulate through finan-
cial engineering, a significant variation in the growth
of EPS, Sales, OCPS, in relation to book value (low
beta score) can signal an issue with some aspect of
the company’s operation that should be noted and
researched.
Treasury shares
Shares that were issued and subsequently repur-
chased by the company.
Trend
A direction that’s discerned by trading data.
14
 V

Vega
The relationship between option price and volatility.

Watch List
A list of businesses that you don’t own but may wish
to buy. Rule #1 investors use a Watch List to track
the MOS and the Tools.

Withholding
percentage
The percentage amount of an investment that a
bro­ker will hold to insulate against potential losses.

Zacks
A Chicago-based firm that provides institutional and
individual investors with analytical tools and finan-
cial information. You’re likely to find financial data
through outlets such as Microsoft Money, Reuters,
Quicken, and Bank of America, which originated
from Zacks.

Glossary of Rule #1 Terms 15