Measuring Security Performance

Measurment Metrics. The following are used commonly to measure performance of funds. It does not imply, however, that they are meaningful, useful, or correct. Most of them compare risk to return

1. Measuring Security PerformanceMeasuring Security Performanceio]]
2. Jenson’s Alpha. Measures performance against CAPM’s Predictions.

$$\alpha =(r_i-r_f)-\beta (r_m-r_f)$$

Sharpe Ratio §

def. Sharpe Ratio. The sharpe ratio for portfolio with return $R_p$

$$\begin{array}{rl}SP& =\frac{E[R_p-{\mu }_f]}{{\sigma }_p}\\ & =\frac{{\mu }_p-{\mu }_f}{{\sigma }_p}\end{array}$$

• Used to compare securities given their risk & returns
• Measures the “risk-normalized return”
• Higher means a better risk/return profile

Treinor’s Ratio §

Measures the return per unit of market risk taken. Higher is better.

$$\text{TM}=\frac{E[\text{Excess return}]}{\beta }$$

Reminder: Market Beta is about how correlated the asset is to the market.

EBITDA Multiple §

def. Enterprise value. The amout of money you have to pay to buy off the company, including its financial oblications (net debt)

$$\text{Enterprise Value = Equity Value + Net Debt}$$

where $\text{Net Debt = SR,LR debt + min.inst.pref.stock}-cash$

• Net Debt > 0 when firm has more debt
• Net Debt < 0 when firm has more cash

def. EBITDA Multiple.

$$\text{EBITDA Multiple}=\frac{EV}{EBITDA}=\frac{\text{Value}}{\text{Profit}}$$

⇒ Think: For two firms…

• …if the market values one firm higher [=EV is higher] than another firm,
• …even if their profit is relatively smaller [=relative EBITDA], it implies that:
• …the market thinks the firm has growth potential.

The EBITDA Multiple is a good measure of how good the operations are of a company because…

• EBITDA doesn’t deduct financing costs.
• EBITDA can compare companies in similar industries about how good their operations are.