Block H · Metrics, valuation & risk
‹ NadirAlpha financial markets handbook: overview
Independent NadirAlpha working reference. Product and feature names mentioned are trademarks of their respective owners. No investment advice.
Metrics are condensations; useful for comparison, dangerous without context; each metric answers exactly one question and no other.
95 · P/E ratio
Price per share / earnings per share; based on past (trailing) or expected earnings (forward).
The fastest valuation comparison within an industry.
Meaningful only against peers and history; growth and rate levels co-determine the "fair" P/E.
Comparing P/E ratios across industries; considering cyclicals cheap at peak earnings.
96 · P/B ratio · 104 · Earnings growth (EPS growth, PEG) · 35 · Value vs. growth
96 · P/B ratio
Price / book value of equity.
Banks, insurers, capital-intensive firms; a substance measure.
<1 signals market doubt about the substance or earning power; of little value for tech (intangibles).
Applying P/B to asset-light business models.
97 · P/S ratio
Market capitalization / revenue.
Young/loss-making firms without earnings; crisis comparisons.
Meaningful only together with the margin path; revenue is not profit.
Dismissing high P/S ratios with "growth justifies everything".
98 · EV/EBITDA
Enterprise value (market cap + net debt) / operating income before depreciation and amortization.
Capital-structure-neutral comparison; the M&A standard measure.
More robust than P/E with differing leverage; EBITDA ignores investment needs.
Confusing EBITDA with cashflow; capex is missing.
99 · Dividend yield & payout ratio
Dividend/price and dividend/earnings respectively.
Income planning; sustainability check of the payout.
A ratio >80-100% is rarely sustainable; always read the yield together with the ratio.
See Block C; reading record yields as a gift.
100 · Free cashflow & FCF yield
Operating cashflow minus capital expenditure; FCF/market cap as a yield.
The "most honest" earnings metric; cash rarely lies.
Persistently positive FCF funds dividends, buybacks, debt reduction; negative FCF needs the capital market.
Believing earnings without looking at cash conversion.
101 · ROE/ROIC
Earnings / equity, and after-tax operating income / invested capital respectively.
A quality measure; does the company earn its cost of capital?
ROIC > WACC creates value; ROE can be levered by debt (distorted).
Celebrating a high ROE that stems only from leverage.
102 · Leverage (net debt/EBITDA)
Net debt / operating income; years to theoretical deleveraging.
The standard credit measure; a covenant metric.
<1 comfortable, >3-4 strained (industry-dependent); IG ratings typically demand low values.
Overlooking leasing/pension liabilities.
103 · Interest coverage
Operating income / interest expense.
A short-term check of debt-servicing capacity.
<2 critical; rate-sensitive with heavy floater exposure.
Extrapolating coverage measured in a low-rate era.
104 · Earnings growth (EPS growth, PEG)
Growth rate of earnings per share; PEG = P/E / growth.
Comparing the growth-to-valuation relation.
PEG ~1 as a rough rule of thumb; check the quality of the growth (organic vs. buyback).
Extrapolating analyst estimates unexamined.
105 · Yield to maturity (YTM) / yield to worst
Internal rate of return of a bond to maturity (YTM) or to the least favorable call date (YTW).
THE comparison measure for bonds.
Assumes reinvestment of coupons at the same rate; for callable paper only YTW counts.
Quoting YTM for callables (see Block B).
106 · Coupon vs. yield (the difference) · 107 · Duration & modified duration · 19 · Subordinated bonds (Tier 2)
106 · Coupon vs. yield (the difference)
Coupon = contractual interest payment on the nominal; yield = total return including the price difference to the purchase price.
Fundamental understanding for any bond decision.
Price above 100: yield below coupon, and vice versa.
Confusing a high coupon with a high yield (purchase price!).
105 · Yield to maturity (YTM) / yield · 23 · Floaters (floating rate)
107 · Duration & modified duration
Capital-weighted commitment period, and the rate sensitivity derived from it (see the introduction to ch. 5-B).
The central interest rate risk measure for securities and the portfolio.
Portfolio duration = weighted average; actively steerable via futures/swaps.
Treating duration as exact instead of a first-order approximation (large rate moves: convexity needed).
108 · Convexity · 146 · Duration management & bond laddering · 27 · Long-dated bonds (>10 years)
108 · Convexity
Curvature of the price-yield relationship; the second-order correction to duration.
Precision for large rate moves; comparing structures (callables: negative convexity).
Positive convexity = the price rises more than it falls; valuable and included in the price.
Ignoring the negative convexity of MBS/callables.
107 · Duration & modified duration · 29 · MBS/ABS (securitizations)
109 · Spread (G-spread, Z-spread, OAS)
Yield pickup over the reference; over the government curve (G), over the swap curve in present value terms (Z), option-adjusted (OAS).
The price of credit risk; relative value between bonds.
A spread change acts on the price like a rate change times spread duration.
Mixing spreads over different reference curves.
15 · Corporate bonds investment grade · 16 · High yield · 118 · S&P Global Ratings (AAA-D scale)
110 · Volatility (historical/implied)
Fluctuation intensity of returns; implied = the expectation derived from option prices.
Risk measure, option valuation, market sentiment (VIX).
Annualized; implied > historical vol = the market pays a fear premium.
Equating volatility with loss risk; it measures both directions.
112 · Sharpe ratio · 116 · Value at Risk (VaR) · 160 · Tail risk, skewness & kurtosis
111 · Beta & alpha
Beta = sensitivity to the market; alpha = return beyond the beta-consistent return.
Risk classification (beta) and manager performance (alpha).
Beta 1.2 = 20% stronger market moves; alpha measurable only against a suitable benchmark.
Reporting alpha that is merely beta to another factor.
114 · Information ratio & tracking error · 137 · Indices & benchmarks (construction)
112 · Sharpe ratio
(Return - risk-free rate) / volatility.
Risk-adjusted comparison of strategies/funds.
>1 good, >2 rarely sustained; comparable only among similar strategies.
Taking Sharpe at face value with skewed distributions (option selling!).
113 · Sortino ratio · 114 · Information ratio & tracking error · 110 · Volatility (historical/implied)
113 · Sortino ratio
Like Sharpe, but only downside volatility in the denominator.
A fairer view of asymmetric strategies.
Clearly > Sharpe = the fluctuation comes mainly from the upside.
Ignoring the downside threshold (0% vs. target return); values are otherwise not comparable.
114 · Information ratio & tracking error
Active return / active risk (standard deviation of the deviation from the benchmark = tracking error).
Quality of active managers; mandate steering (TE limits).
An IR > 0.5 over years is strong; TE shows how "actively" the fund is really managed.
Paying for a low TE as if it were active management ("closet indexing").
111 · Beta & alpha · 137 · Indices & benchmarks (construction)
115 · Maximum drawdown
Largest loss in value from a high to the following low.
Loss tolerance check; a more realistic way to address risk than volatility.
Consider together with the recovery period.
Viewing the historical max drawdown as an upper bound for the future.
162 · Drawdown management & stop-loss logic · 110 · Volatility (historical/implied)
116 · Value at Risk (VaR)
The loss that with x% probability is not exceeded in period t (e.g. 99%/10 days).
The standard risk measure in regulation and limit systems.
Says NOTHING about the size of losses beyond the threshold (for that: expected shortfall).
Communicating VaR as the "maximum loss".
158 · Stress tests & scenario analyses · 160 · Tail risk, skewness & kurtosis · 151 · Risk types at a glance
117 · Correlation & diversification effect
Co-movement of two return series (-1 to +1); the basis of the diversification benefit.
Portfolio construction; detecting concentrations.
Correlations are unstable and rise in a crash ("correlation goes to 1").
Planning for the storm with fair-weather correlations.
142 · Diversification & concentration risks · 161 · Risk budgeting & risk parity