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Diversification and Performance Over Ten Years

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Diversification comes from a very simple idea…don’t put all your eggs in the same basket.

2021 Performance Chart represents asset allocation quilt over the past 10 years:

EW = an equal-weighted portfolio of every asset on the quilt

The gap between the best and worst performing asset classes is huge. The best performing asset class (REITs) outperformed the worst (Emerging Markets (EM)) by more than 44% in 2021.

The average difference between the best and worst performer of the 10 asset classes used here since 2012 is 20.2%. The biggest difference between top and bottom performers came in 2013 when small cap stocks outperformed commodities by more than 52%.

This tells us diversification is not dead by a long shot but it also shows how many opportunities investors have to be either really right or really wrong if they go to the extremes in any one asset class or region.

The consistency of the S&P 500 is impressive over the ten year period. For this entire 10 year period large cap U.S. stocks have been in the top 3 of these asset classes every single year, including the top slot for two of the past three years.

And the crazy thing about the outperformance is the volatility of annual returns is lower for the S&P than its equity counterparts:

  • S&P 500: 12.3%
  • Small caps: 14.7%
  • Mid caps: 14.0%
  • Foreign stocks: 14.8%
  • Emerging markets: 18.8%

Every type of investment has risk attached to it. This risk can evolve over time, but it exists. Risk is something an investor should always consider.

For investors, one of the most important considerations is how to manage investing and portfolio risk. Diversification is a proven and efficient way to manage investment risks.

Diversification is the practice of building a portfolio with a variety of investments that have different expected risks and returns. Diversification aims at spreading investments across a variety of asset classes.

The benefit of diversification in your investment portfolio is that it helps smooth portfolio returns over time: as one investment increases, it offsets losses from another investment, thereby providing more regular returns on investment under various economic and market conditions.

You can diversify your portfolio by investing an equally-weighted return for all 10 asset classes (minus EW) listed in the Performance Chart. These asset classes have varying levels of risk and returns, so including investments across asset classes will help you create a diversified portfolio. Diversified investment portfolios generally contain at least two asset classes.

Diversification can help protect you against events that would affect specific investments. Yet, diversification means that every year you miss out on both home runs and strikeouts regarding your investments. Thus, diversification means that your portfolio is never going to be the best performer in a given year. The equal-weight portfolio is basically always in the middle of the pack.

But a fully diversified portfolio of all ten asset classes is never the worst performance either.

This is the trade-off you make when trying to control for risk. Being diversified means always investing in both the best and worst performers each year. But, you will never having the best or worst performance in your portfolio.

Most investors know diversification is a smart move and is a key part of risk management, with the goal to preserve your portfolio’s value.

Diversification does not guarantee returns or protect against losses and can help mitigate some, but not all, risk. For example, systematic risks – which include inflation, interest rates or geopolitical events – can cause instability in markets and affect the broader economy and market overall.

References:

  1. https://awealthofcommonsense.com/2022/01/updating-my-favorite-performance-chart-for-2021/
  2. https://www.usbank.com/financialiq/invest-your-money/investment-strategies/diversification-strategies-for-your-investment-portfolio.html

Discounted Cash Flow

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Investments are the discounted present value of all future free cash flow.

Discounted cash flow (DCF) is a method of investment valuation in which future cash flows are discounted back to a present value using the time-value of money.

Present value (PV) is a financial calculation that measures the worth of a future amount of money or an investment’s future cash flow in today’s dollars adjusted for interest and inflation. In other words, it compares the buying power of one future dollar to purchasing power of one today.

PV is an indication of whether the money an investor receives today can earn a return in the future. Investors calculate the present value of a firm’s expected cash flows to decide if the stock is worth investing in today.

An investment’s worth is equal to the present value of all projected discounted future cash flows.

Discounted cash flow is a way of evaluating a potential investment by estimating future income streams and determining the present worth of all of those cash flows in order to compare the cost of the investment to its return.

When an investor is trying to determine how to spend capital, it is important to determine whether or not investments will result in a positive return. The DCF method allows an investor to determine the value of the future projected cash flow in today’s dollars. An investor can subtract the amount spent on the investment from the present value of future cash flows to calculate the net present value of the investment.

In other words, they can calculate how much money the investment will make in today’s dollars and compare it with the cost of the investment. NPV and Internal Rate of Return are the methods used in Discounted Cash Flow.

The Net Present Value (NPV) represents the present value of cash flow. The NPV can also be called as the difference between the present values of cash inflow and cash outflow. To calculate the net present value of an investment using the discounted cash flows method:

Example – an investor is considering investing in property that would cost his LLC $1,000,000 and he hold it for 5 years. What is the net present value of this investment using the discounted cash flows method?

The investor determined the discount rate to be 10%. With this information, he calculated the following future discounted cash flows:

  • Year 1 = $130,000
  • Year 2 = $150,000
  • Year 3 = $200,000
  • Year 4 = $210,000
  • Year 5 = $200,000

The total projected cash flows is $890,000.

The net present value of this investment is $890,000-$1,000,000 which is equal to -$110,000.

In this example, an investor should not make this investment because the original cost (cost basis) is greater than the value of the future discounted cash flow creating a negative return over the time period.

As in this example, the DCF is compared with the initial investment. If the DCF is greater than the original cost, the investment is profitable. The higher the DCF, the greater return the investment generates. If the DCF is lower than the present cost, investors should rather hold the cash.

An investor’s expected cash flows are at a discount rate that is actually the expected return. The discount rate is inversely correlated to the future cash flows. The higher the discount rate, the lower the present value of the expected cash flows.

The NPV represents the present value of cash flow and is generally used for comparing both the internal and the external investments of a company. DCF is a method to calculate the value of an investment based on the present value of its future cash flow.

References:

  1. https://www.myaccountingcourse.com/accounting-dictionary/discounted-cash-flow
  2. https://corporatefinanceinstitute.com/resources/knowledge/valuation/discounted-cash-flow-dcf/
  3. https://www.myaccountingcourse.com/accounting-dictionary/present-value

Building Resilience

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“God, grant me the serenity to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference.” Reinhold Niebuhr

The author of “Healthy Brain, Happy Life” and “Good Anxiety” explains how to harness the power of anxiety into unexpected gifts.

We are living in the age of anxiety. There are about 40 million Americans— or 18% of the population—suffering from clinical anxiety disorders today.

Anxiety is a situation that often makes you feel as if you are locked into an endless cycle of stress, uncertainty, and worry. But, there are ways to leverage your anxiety to help you solve problems and fortify your wellbeing, explains Dr. Wendy Suzuki, PhD, a neuroscientist and professor of Neural Science and Psychology in the Center for Neural Science at New York University. Thus, instead of seeing anxiety strictly as a problem or curse to dread, you recognize it as the unique gift that it is.

Dr. Suzuki has discovered a paradigm-shifting truth about anxiety: yes, it is uncomfortable, but it is also essential for your survival. In fact, anxiety is a key component of your ability to live optimally. Every emotion you experience has an evolutionary purpose, and anxiety is designed to draw your attention to vulnerability. If you simply approach it as something to avoid, get rid of, or dampen, you actually miss an opportunity to improve your life. Listening to your anxieties from a place of curiosity, and without fear or worry, can actually guide you onto a path that leads to inner peace and joy.

Drawing on her own struggles and based on cutting-edge research, Dr. Suzuki has developed strategies for managing unwarranted anxiety and exercises you can do to build your resiliency and mental strength. The exercises include:

Visualize positive outcomes

At the beginning or at the end of each day, think through all those uncertain situations currently in your life — both big and small. Now take each of those and visualize the most optimistic and amazing outcome to the situation. Not just the “okay” outcome, but the best possible one you could imagine.

This process of visualizing “the most optimistic and amazing outcome” should build the muscle of expecting the positive outcome and might even open up ideas for what more you might do to create that outcome of your dreams.

Turn anxiety into progress

Our brain’s plasticity is what enables us to be resilient during challenging times — to learn how to calm down, reassess situations, reframe our thoughts and make smarter decisions.

Reach out

Asking for help, staying connected to friends and family, and actively nurturing supportive, encouraging relationships not only enables you to keep anxiety at bay, but also shores up the sense that you’re not alone.

The belief and feeling that you are surrounded by people who care about you is crucial during times of enormous stress — when you need to fall back on your own resilience in order to persevere and maintain your well-being.

When we are suffering from loss or other forms of distress, it’s natural to withdraw. Yet you also have the power to push yourself into the loving embrace of those who can help take care of you.

Practice positive self-tweeting

Lin-Manual Miranda sends out tweets at the beginning and end of each day. The tweets are essentially upbeat little messages that are funny, singsongy and generally delightful.

If you watch him, you’ll see an inherently resilient, mentally strong and optimistic person.

For you to be that resilient, productive and creative, it’s essential to come up with positive reminders. You don’t necessarily need to share them. The idea is to boost yourself up at the beginning and at the end of the day.

This can be difficult for those who automatically beat themselves up. Instead, think about what your biggest supporter in life — a spouse, partner, sibling, friend, mentor or parent — would tell you, and then tweet, remind or say it to yourself.

Although popular science continues to suggests that persistent, low-level anxiety is detrimental to your health, performance, and wellbeing, but if you could learn how to harness the brain activation underlying your anxiety and make it work for you, you could turn anxiety into superpower, says Dr. Suzuki.

Her research and her own experience demonstrate that this paradigm shift from bad to good anxiety can accelerate focus and productivity, boosts performance, lead to happiness, create compassion, and foster more creativity.

Twenty-five positive quotes and reminders to build resilience:

  1. You’re awesome, Bro.
  2. You can do all things through Christ which strengthens you!
  3. Believe in yourself; have faith in your abilities!
  4. Everyday, in every way, you’re getting better and better, dude!
  5. “Great minds discuss ideas.” Eleanor Roosevelt
  6. “Success is the sum of small efforts, repeated day in and day out.” Robert Collier
  7. “Be patient with yourself.” Stephen Covey
  8. “People will never forget how you made them feel.” Maya Angelou
  9. “Be content with what you have; rejoice in the way things are. When you realize there is nothing lacking, the world belongs to you.” Lao Tzu
  10. “If you want to be happy, set a goal that commands your thoughts, liberates your energy, and inspires your hopes.” Andrew Carnegie
  11. “Happiness is the spiritual experience of living every minute with love, grace, and gratitude.” Denis Waitley
  12. “Happiness never decreases by being shared.” Buddha
  13. “The secret of health for both mind and body…is to live in the present moment wisely and earnestly.” Buddha
  14. “Happiness…is appreciating what you have.”
  15. “We make a life by what we give.” Winston Churchill
  16. “Reflect upon your present blessings, of which every man has plenty.” Charles Dickens
  17. “He is a wise man who rejoices for the things which he has.” Epictetus
  18. “Be thankful for what you have; you’ll end up having more.” Oprah Winfrey
  19. “Open your eyes and your heart to a truly precious gift–today.” Steve Maraboli
  20. “This is the day the Lord has made, rejoice and be glad in it.”
  21. “Talk to yourself like you would to someone you love.” Brené Brown
  22. “Do not overestimate the competition and underestimate yourself. You are better than you think.” T. Harv Eker
  23. “Always remember you are braver than you believe, stronger than you seem, and smarter than you think.” Christopher Robin
  24. “Nothing can stop the man with the right mental attitude from achieving his goal.” Thomas Jefferson
  25. “Do what you can, where you are, with what you have.” Theodore Roosevelt

“Far better is it to dare mighty things, to win glorious triumphs–even though checkered by failure–than to rank with those poor spirits who neither enjoy much nor suffer much, because they live in a gray twilight that knows not victory nor defeat.” Theodore Roosevelt

References:

  1. https://www.cnbc.com/2021/08/31/do-these-exercises-every-day-to-build-resilience-and-mental-strength-says-neuroscientist.html
  2. https://www.wendysuzuki.com
  3. https://www.inc.com/jeff-haden/top-350-inspiring-motivational-quotes-to-tweet-and-share.html

Inflation…Highest Level in 40 years

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Inflation is at its highest level in 40 years as December prices rose 7 percent, compared to a year earlier

As a reaction to the COVID-19 pandemic and subsequent shutting down of the economy, Congress and the Federal Reserve responded with a wave of fiscal and monetary stimulus which was and remains without historical precedent.

Thus, we are in the midst of a fiscal and monetary experiment which has no direct antecedents. This renders all economic theories and financial forecasting hugely speculative.

As the second year of the pandemic fades away, Americans are experiencing the ravages of inflation. Prices, as depicted by the Consumer Price Index (CPI*), rose at the fastest pace in 40 years in December, increasing 7 percent over the same period a year ago, reported by the U.S. Bureau of Labor Statistics. The Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services.

Correspondingly, calendar year 2021 will go down as the worst year for inflation since 1981, as broken supply chains and higher energy prices collided with high consumer demand for used cars and construction materials, according to the Washington Post.

The energy index rose 29.3 percent over the last year, and the food index increased 6.3 percent, according to U.S. Bureau of Labor.

Higher prices have permeated into just about everything American households and businesses buy, raising alarms for policymakers at the Federal Reserve and White House that inflation has spread throughout the greater economy, the Washington Post reported. Additionally, officials within the Federal Reserve and President Biden administration expect high inflation will persist through much of calendar year 2022.

Federal Reserve Chairmen Jerome Powell said it was essential to get prices down to more sustainable and stable levels to ensure a lasting recovery. “If inflation does become too persistent, if these high levels of inflation become too entrenched in the economy or people’s thinking, that will lead to much tighter monetary policy from us, and that could lead to a recession and that would be bad for workers,” Powell told Congressional lawmakers.

References:

  1. https://www.bls.gov/news.release/cpi.nr0.htm
  2. https://www.washingtonpost.com/business/2022/01/12/december-cpi-inflation/
  3. https://www.bls.gov/cpi/
  4. https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category-line-chart.htm

* The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

Inflation: Biggest Threat to Investors and Market

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“Inflation is not going to be transitory.” Paul Tudor Jones, Tudor Investment Founder

Recently on CNBC, Paul Tudor Jones, founder and chief investment officer of Tudor Investment Corporation, was extremely critical of current Federal Reserve policy. He opined that current Fed monetary policy and Administration fiscal policy are creating persistent inflation, instead of fighting existing inflation.

In his opinion, inflation could be worse than feared and is not transitory. “I think to me the number one issue facing Main Street investors is inflation, and it’s pretty clear to me that inflation is not transitory,” Jones said on CNBC’s “Squawk Box”. “It’s probably the single biggest threat to certainly financial markets and I think to society just in general.”

Additionally, Jones opined that inflation will be the death to 60 percent stocks / 40 percent bond portfolios favored by retirees. In his opinion, the Federal Reserve policy is creating inflation instead of fighting it. Instead, the Fed should be aggressively fighting inflation.

Currently, the Fed is slow and late fighting inflation.

Jason Furman, the former chair of the White House Council of Economic Advisers and now a professor at Harvard University’s John F. Kennedy School of Government, contends that both economists, and the market, got inflation wrong in 2021. Furman explained that normal multipliers showed that the fiscal and monetary stimulus was well in excess of the economy’s potential to absorb. He expects inflation to remain “very elevated” because demand will be above trend, and the lag from Federal Reserve policy will mean any tightening won’t make an impact until next year anyway.

Consumer inflation expectations

A Sept. 2021 Federal Reserve Bank of New York survey shows Americans’ inflation rate expectations rising to their highest levels since the survey’s inception.

Consumer expectations for inflation rose to 5.3% over the next year and 4.2% over the next three years, according to the New York Fed. Both are the highest in the history of a data series that goes back eight years.

Powell has long held that inflation is being held in check by forces that the Fed has no control over – aging populations, lower productivity and advances in technology.

Powell’s five-point inflation checklist include:

  • Lack of broad-based pressures;
  • Lower moves in high-inflation items;
  • Low wage pressures;
  • Tepid inflation expectations, and
  • Long-lasting forces that have kept inflation low globally.

High technology companies stocks have underperformed the broader markets amid an increasing possibility of Federal Reserve rate hikes this year. Rising U.S. treasury yields have also recently put pressure on high growth tech names.

The valuations of many tech companies rely on the prospect of profits years in the future, and higher long-term Treasury yields typically discount the present value of future cash.

References:

  1. https://www.msn.com/en-us/money/savingandinvesting/here-s-the-market-move-cathie-wood-says-is-ridiculous-as-her-flagship-fund-sputters/ar-AASCrQL
  2. https://www.aeaweb.org/conference/2022/livecasts/inflation
  3. https://www.cnbc.com/2021/10/20/paul-tudor-jones-says-inflation-could-be-worse-than-feared-biggest-threat-to-markets-and-society.html

Brain-Changing Benefits of Exercise

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“The key to a happy life . . . is a healthy brain.” Wendy Suzuki

Exercise is the most transformative thing that you can do for your brain, says neuroscientist Dr. Wendy Suzuki, professor of Neural Science and Psychology at New York University.

Dr. Suzuki discovered through research and self examination that there is a biological connection between exercise, mindfulness, and action. With exercise, she believes that your body feels more alive and your brain actually performs better.  And, Dr. Suzuki states that “you can make yourself smarter. Exercising is one of the most transformative things you can do to improve cognitive abilities, such as learning, thinking, memory, focus and reasoning — all of which can help you become smarter and live longer.”

The way exercise boosts your brain health includes:

  1. It decreases feelings of anxiety – Studies have shown that every time your move your body, a number of beneficial neurotransmitters, including dopamine, norepinephrine, serotonin and acetylcholine, gets released into your brain. These substances can decrease feelings of anxiety and depression. And, It only takes between 10 and 30 minutes of daily physical activity to instantly lift your mood.
  2. It improves your focus and concentration – A single workout can help improve your ability to shift and focus attention. This is an immediate benefit that can last for at least two hours after 30 minutes of exercise. Activities that increase your heart rate, such as brisk walking, running, swimming, cycling, playing tennis or jumping rope are recommended.
  3. It promotes the growth of new brain cells – One of the most significant benefits of exercise, scientists have found, is that it promotes neurogenesis, or the birth of new brain cells. This is essential to improving cognitive function. Exercise also can improve the health and function of the synapses between neurons in this region, allowing brain cells to better communicate.
  4. It protects your brain from aging and neurodegenerative diseases – Imagine your brain as a muscle: the more workout you put into it, the stronger and bigger it gets. Longitudinal studies in humans suggest that regular exercise can increase the size of the hippocampus and prefrontal cortex, both of which are susceptible to neurodegenerative diseases such as dementia and Alzheimer’s. So while exercising won’t completely prevent or cure normal cognitive decline in aging, doing it consistently can help reduce or delay the onset of it.

So, get up and start your brain transformation journey.

Dr. Suzuki encourages people to get active and go to the gym since the science clearly demonstrates how working out boosts your mood and memory — and protects your brain against neurodegenerative diseases like Alzheimer’s.

To get the brain-changing benefits of exercise, you should do at least three to four 30-minute workout sessions a week, explains Dr. Suzuki. You’ll also get the most benefits out of aerobic exercise, which increases the heart rate and pumps more oxygen into the brain.

Essentially, exercise can improve your brain functions today and protect your brain from neurodegenerative diseases as you age.

References:

  1. https://www.wendysuzuki.com
  2. https://www.psychologytoday.com/us/blog/prime-your-gray-cells/201108/happy-brain-happy-life
  3. https://www.amazon.com/Healthy-Brain-Happy-Life-Everything/dp/B01LTHXL7Q/ref=nodl_

A Stock’s Price vs. a Company’s Intrinsic Value

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“Stock prices fluctuate unpredictably.  But company values stay relatively steady.” Kenneth Jeffrey Marshall,

Value investing is one of the most popular ways to find great stocks in any market environment. Value investing represents an approach to investing, where investors evaluate the fundamentals or intrinsic values of companies rather than estimating the future market prices of stocks. The definition of a value stock, for our purposes, is a stock that is underpriced by the market or due to volatility relative to its worth or fundamentals.

Value investing is about finding stocks that are either flying under the radar and are compelling buys, or offer up tantalizing discounts when compared to fair value (or intrinsic value). According to Investopia, intrinsic value is a measure of what an asset is worth. In short, it’s the underlying value of a company and its cash flow.

The idea of value investing involves purchasing great stocks of companies priced by the market well below their intrinsic values, which can give investors a margin of safety. The margin of safety comes from buying good companies at cheap prices. It comes from buying good companies that you understand, and to do so at a discount to companies estimated intrinsic value. That discount is where the margin of safety comes from.

Great stocks shouldn’t get cheap. But sometimes they are.

Value investing also allows traders to detach from their emotions of fear and greed when stock prices fluctuate. It enables them to hold the stocks for long-term rather than buying and selling if they’re feeling wildly optimistic or pessimistic because of stock price and market volatility.

Price and value differ:

  • Price is what something can be purchased or sold for at a given time. Price fluctuates.
  • Value is what something is worth, it fluctuates less.
  • Identify the right price at which to buy stock
  • Hold quality stocks fearlessly during market swings

Value investors understand that over time, the market price of a stock will converge with its actual fundamental worth or intrinsic value. But at a single point in time, it may not. And those single points are enough to purchase good companies cheap or below its intrinsic value.

Value investors also understand that there always comes a time when glamorous businesses stop getting priced like rock stars, and start getting priced like businesses.

Over time, the average price of an asset does converge to the average worth of that asset. But in the short term they can be wildly different, since stock prices fluctuate unpredictably.  But company values stay relatively steady.  This insight is the basis of value investing, according to Kenneth Jeffrey Marshall, author of the investing book, “Good Stocks Cheap: Value Investing with Confidence for a Lifetime of Stock Market”.

The occasions when a stock price is far away from a company’s intrinsic value is when a patient value investor acts.

Value investing is buying companies for less than they’re worth…their intrinsic value. According to the Kenneth Jeffery Marshall, professor, value investor, and the author of “Good Stocks Cheap”, best value investing procedures to utilize include:

  • Do you understand the company
  • Is it a good company:
    • Has it been historically good
    • Will it be good in the future
    • Is it shareholder friendly
  • Is the stock price cheap or at what price will the company’s stock become cheap (margin of safety)

The secret of successful investing: Staying invested and patience. Stock prices can be volatile and can fluctuate unpredictably in the short term.  But the intrinsic values of companies stay relatively steady. Thus, you should chose to invest in companies selling for less than they are worth (intrinsic value) and not over pay for a company.

One way to find companies is by looking at several key metrics and financial ratios, many of which are crucial in the value stock selection process. There are several key metrics that value investors look at, which include:

  • Price to Earnings Ratio (PE). PE shows you how much investors are willing to pay for each dollar of earnings in a given stock. The best use of the PE ratio is to compare the stock’s current PE ratio with: a) where this ratio has been in the past; b) how it compares to the average for the industry/sector; and c) how it compares to the market as a whole.
  • Price/Sales ratio. P/Sales compares a given stock’s price to its total sales, where a lower value is generally considered better. This metric is preferred more than other value-focused ones because it looks at sales, something that is far harder to manipulate with accounting tricks than earnings. The best use of P/S ratio to compare it to the S&P 500 average. Also, you can evaluate the trend of the stock’s P/Sales over the past few years.
  • Price/Earnings to Growth ratio (PEG). PEG ratio is another great indicator of value. PEG ratio is a stock’s price-to-earnings (P/E) ratio divided by the growth rate of its earnings for a specified time period. The PEG ratio is used to determine a stock’s value while also factoring in the company’s expected earnings growth, and it is thought to provide a more complete picture than the more standard P/E ratio. A lower PEG may indicate that a stock is undervalued.

The reality is that some of your selected stocks will lose money. That’s why it is important to diversify your investments, so that losses in a stock may be outweighed by gains in other stocks.

Strength of value investing

Deep value factors, such as book-to-price or tangible book-to-price, usually rally first, when actual levels of rates are still low, says Boris Lerner, Global Head of Quantitative Equity Research. Other value factors, such as earnings yield or free-cash-flow yield, tend to pick up later, as rates rise above trend.

Rising interest rates are the primary reason value investing has staying power. When inflation and rising interest rates are trending higher, it can clip the wings of pricey growth stocks, whose valuations are predicated on future returns, which make pricier growth stocks less appealing. When rates go up, it instantly raises the bar on far-out profits needed to justify today’s stock prices.

Because value names are typically mature companies with valuations based on current cash flow, rising rates don’t have the same impact. At the same time, many traditional value sectors, such as financials, directly benefit from rising rates.

Put the strength of value investing to work for you. In a nutshell, the basic tenet of value investing is paying less for a company than its worth.

  • References:
  1. https://growthwithvalue.com/wp-content/uploads/2020/12/Good-Stocks-Cheap-Book-Summary.pdf
  2. https://finance.yahoo.com/news/10-cheap-value-stocks-buy-140144393.html
  3. https://www.entrepreneur.com/article/397977
  4. https://www.morganstanley.com/ideas/value-stocks-forecast-2021
  5. https://www.gurufocus.com/news/949267/interview-holding-stocks-forever-with-professor-kenneth-jeffrey-marshall

Kenneth Jeffrey Marshall teaches value investing in the Masters in Finance program at the Stockholm School of Economics in Sweden, and at Stanford University. He also teaches asset management in the MBA program at the Haas School of Business at the University of California, Berkeley. Marshall is a past member of the Stanford Institute for Economic Policy Research; he taught Stanford’s first-ever online value investing course in 2015. He earned his MBA at Harvard Business School.

Margin of Safety

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“If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger the margin of safety you’d need. If you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay; but if it’s over the Grand Canyon, you may feel you want a little larger margin of safety.” Warren Buffett

Billionaire investor Warren Buffett, Chairman and CEO, Berkshire Hathaway, said, “The three most important words in investing are margin of safety.” Margin of Safety is a measure of how “on sale” a company’s stock price is compared to the true value of the company. You need to be able to determine the value of a company and from that value determine a “buy price”. The difference between the two is the margin of safety.

Effectively, margin of safety means you pay less for an asset than what it’s intrinsically worth. It means to buy $10 dollar bills for $5 dollars. That’s the secret to great and successful investing. The margin of safety is the difference between the intrinsic value of a stock and the current market price of the stock. The intrinsic value of an asset is its actual value, that is, the present value of the asset found by calculating the total discounted future income it’s expected to generate.

The intrinsic value is calculated based on the 10 year discounted free cash flow (DFCF).

In other words, if the stock price of a company is below the actual value of the free cash flow (income) and assets of a company, the percentage difference is the Margin of Safety.  This is the discounted price at which you are buying a share in the company.

A higher margin of safety will reduce your investment risk. If an investor can buy a stock below its intrinsic value, the potential for a bad outcome, risk, is usually lower.

Warren Buffett likes a margin of safety of over 30%, meaning the stock price could drop by 30%, and he would still not lose money. Margin of safety is only an estimate of a stock’s risk and profit potential.

Buffett determines margin of safety by estimating the current and predicted earnings from a company from today and for the next ten years.  He then discounts the cash flow against inflation to get the current value of that cash.  This is the Intrinsic Value of the company. He bases intrinsic value on the discounted future free cash flows. He believes cash is a company’s most valuable asset, so he tries to project how much future cash a business will generate.

Margin of Safety is a value investing principle strategy. If the total value of all shares of a company is 30% less than the intrinsic value of that company, then the margin of safety would be 30%. In other words, if the stock price of a company is below the actual value of the cash flow and assets of a company, the percentage difference is the Margin of Safety.  This is the discounted price at which you are buying a share in the company. Most value investors believe that the higher the margin of safety, the better.  In reality, a margin of safety between 30% and 50% is reasonable.

The Margin of Safety is the percentage difference between a company’s Fair Value per share and its actual stock price. If a company has profits and assets that outweigh a company’s stock market valuation, this represents a Margin of Safety for the investor. The higher the margin of safety, the better.

Margin of safety is only an estimate of a stock’s risk and profit potential. Most value investors believe that the higher the margin of safety, the better.  And, the larger the margin of safety, the more irrational the market has become. 

One of the keys to getting a great margin of safety is to understand that price and value is not the same thing. Price is what you pay for something, but the value is what you get.

The stock market rises about four out of every five years or about 80% of the time, according to Nick Murray. Said another way, the market only falls 20% of the time. You can fear that 20% or cheer for it.

No one ever got wealthy paying full price or top dollar for financial assets, according to Buffett. Most successful investors got that way buying assets that were distressed, out of favor, and therefore on sale. Unfortunately, few people see it that way. You need to take advantage of the sale during market selloffs and corrections when it occurs. Your money literally goes further because you can buy more share at lower prices that lead to market-beating returns later on.

If you want to make good long-term investment returns, you need to minimize your risk by purchasing companies selling at a significant discount to their intrinsic value due to market volatility. 

References:

  1. https://novelinvestor.com/10-lessons-learned-nick-murray/
  2. https://www.ruleoneinvesting.com/blog/how-to-invest/how-to-invest-margin-of-safety-the-growth-rate/
  3. https://www.liberatedstocktrader.com/margin-of-safety/

The Three C’s of Credit

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Borrowing (using credit) allows people to purchase goods and services that they can use today and pay for those goods and services in the future with interest.

Credit can be a powerful tool that helps you improve your finances, get access to better financial products, save money on interest, and can even save you from putting down a deposit. The benefits of a positive credit report and good credit score are extensive.

The biggest benefit of good to excellent credit is saving money. When buying a home, for example, good credit can easily save you tens or even hundreds of thousands of dollars in interest on a 30 year mortgage. Essentially, a lower interest rate means you pay less money. A higher interest rate means you pay more money.

Conversely, credit can be detrimental which entraps and burdens people financially. Access to credit may make it easier to pay for basic needs and cover emergency expenses, but it also simplifies buying expensive products you might want but not need. Psychologists have found that people often use credit unwisely due to natural human impulses.

Additionally, the interest rates on consumer credit are often staggeringly high and can force consumers to pay back several times the initial value of their purchases. The average annual interest rate on credit cards can be as high as 21 percent– more than five to eight times higher than the typical interest rate on a 30-year mortgage, which hovers around 2.5 to 4 percent.

Interest is what you pay for using credit or “someone else’s money”.

As you can see, using credit has both financial benefits and costs. At times, it can be a means to purchase assets with borrowed capital, but it can be also an indication that something has gone wrong with your money management and financial planning (spending too much and/or saving too little relative to your income). There are ways to use debt or credit sparingly and manage the use of credit.

People choose among different credit options that have different costs. Lenders approve or deny applications for loans based on an evaluation of the borrower’s past credit history and expected ability to pay in the future. Higher-risk borrowers are charged higher interest rates; lower- risk borrowers are charged lower interest rates.

Credit or loan providers may include banks, credit unions, car dealers, credit-card companies, or department stores. And, some things people often use credit or a loan to purchase vary but may include a house, car, college or travel.

The three C’s of credit (capacity, character, and collateral), assess the riskiness of lending to that individual based on these character- istics, and then decide whether or not to approve or deny the loan request.

Lenders expect all the money they lend to be fully repaid with interest. Thus, when deciding whether to make a loan or offer credit, lenders want to know the likelihood that the individual will repay the money. Thus, lenders want financial information about a person before lending that person money.

The three questions lenders generally want answered before granting a loan are factors known as the “Three C’s of Credit”: Capacity, Character, and Collateral:

  • Capacity: What is the individual’s ability to repay the loan?
  • Character: What is the individual’s reliability to repay the loan?
  • Collateral: What assets does the individual own that could be sold to repay the loan?

Each “Three C’s of Credit” factor attempts to provide a measure to help a lender answer each question about a borrower. The results vary from person to person, with a wide range of possibilities.

  • Capacity: The amount of debt a borrower has relative to his or her income is an indication of “capacity,” that is, that person’s ability to repay debt. For example, an individual with debt payments that are a large percentage of his or her monthly income would be less able to take on more debt than someone with debt payments that are a smaller percentage of his or her income.
  • Character: A credit score is an indication of “character” because it indicates a person’s reputation for paying bills and debts based on past behavior. A credit score is a number based on information in a credit report, which indicates a person’s credit risk. Credit scores are often called FICO scores. FICO is an abbreviation for Fair Isaacs Company—the first company to develop credit scores. Credit scores generally range from 350 to 850, with 350 indicating low reliability and 850 indicating high reliability. A low credit score indicates that a person has not been responsible with credit in the past.
  • Collateral: Collateral is property required by a lender and offered by a borrower as a guarantee of payment on a loan. Also, it can be a borrower’s savings, investments, or the value of the asset purchased that can be seized if the borrower fails to repay a debt. For example, a borrower who owns many other assets such as stocks, bonds, or real estate would be able to sell some of those assets to repay a loan if necessary. As such, lenders will see the loan as less risky than a loan to someone with few or no assets.

The three C’s affect each other by having a favorable rating on one C may help you have favorable ratings on others; for example, capacity may make collateral more likely. Lenders use this type of background information to make some lending decisions.

Borrowers who repay loans as promised show that they are worthy of getting credit in the future. A reputation for not repaying a loan as promised can result in higher interest charges on future loans, if loans are available at all.

Loans can be unsecured or secured with collateral. Collateral is a piece of property that can be sold by the lender to recover all or part of a loan if the borrower fails to repay. Because secured loans are viewed as having less risk, lenders charge a lower interest rate than they charge for unsecured loans.

Lenders make credit decisions based in part on consumer payment history. Credit bureaus record borrowers’ credit and payment histories and provide that information to lenders in credit reports.

Lenders can pay to receive a borrower’s credit score from a credit bureau. A credit score is a number based on information in a credit report and assesses a person’s credit risk.

“Debt is a trap, especially student debt, which is enormous, far larger than credit card debt. It’s a trap for the rest of your life because the laws are designed so that you can’t get out of it. If a business, say, gets in too much debt, it can declare bankruptcy, but individuals can almost never be relieved of student debt through bankruptcy.” Noam Chomsky

References:

  1. https://www.stlouisfed.org/~/media/education/curriculum/pdf/making-personal-finance-decisions-complete-unit.pdf
  2. https://www.self.inc/blog/benefits-of-credit

Getting Started Investing

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“Every investment is the present value of all future free cash flow.” Everything Money

Many people want to learn how to get started investing, but they allow emotion, fear of loss, and doubts about making a mistake stop them from taking that initial step of purchasing stocks and bonds.

Some common concerns regarding investing, according to Phil Towns, founder The Rule #1, include:

  • “I’m afraid I’ll fail and lose all my money.”
  • “There’s no way I can make time for investing in my day! I’m busy!”
  • “I don’t have the skills to invest.”

These are all popular rationalizations for why you may be dragging your feet on investing in assets, particularly equity stocks, bonds, mutual funds and exchange traded funds ((ETF).

Yet, investing in the stock market continues to be the best way to grow your wealth and to achieve financial freedom. To begin, you might consider investing in well-known companies’ or blue-chips stocks that are less volatile, which can avoid big stock price swings.

Many people started investing for the first time during the COVID-19 pandemic. While some people prefer trading stocks over short periods of time, you might want to consider long-term investing. The stock market on average produces around a 10% annual return. While this may seem easy, not many people actually achieve such returns. And one of the main reasons is because investors don’t stay invested long enough. 

Admittedly, choosing the right stocks to invest in can be a time-consuming endeavor. This is true even for many seasoned investors. If you are new to the stock market, buying companies that you are familiar with, like Apple or Walt Disney, maybe a good place to start. It would be beneficial to have an idea of how the companies make its money. Besides, picking stocks with strong balance sheets and stellar growth prospects below its intrinsic value or worth could increase your chances of success.

Value investing

Great investors never stop learning

Value investing is buying companies for less than they’re worth…their intrinsic value. According to the Kenneth Jeffery Marshall, professor, value investor, and the author of “Good Stocks Cheap”, best value investing procedures to utilize include:

  • Do you understand the company
  • Is it a good company:
    • Has it been historically good
    • Will it be good in the future
    • Is it shareholder friendly
  • Is the stock price cheap or at what price will the company’s stock become cheap (margin of safety)

The secret of successful investing: Staying invested and patience. Stock prices can be volatile and can fluctuate unpredictably in the short term.  But the intrinsic values of companies stay relatively steady. Thus, you should chose to invest in companies selling for less than they are worth (intrinsic value) and not over pay for a company.

The reality is that some of your selected stocks will lose money. That’s why it is important to diversify your investments, so that losses in a stock may be outweighed by gains in other stocks.

If you had invested $1,000 in stocks like the S&P 500 or Apple (AAPL) 10 years ago, it would have grown and be worth $4,528.52 (S&P 500) and $11,149.68 (Apple) today, respectfully. Effectively, the S&P 500 rose 229.91% and Apple gained 1,062.82% gain. Theses returns exclude dividends but includes price increases.

Anyone can and should be invested in assets, but building a successful investment portfolio requires research, patience, and a little bit of risk. Thus, it’s essential to learn how to study and value companies to invest.

So, if you had invested in Apple ten years ago, you’re likely feeling pretty good about your investment today.

“The historic price of a stock does not determine the future price of that stock.” Kenneth Jeffrey Marshall,.

Additionally, according to the Kenneth Jeffery Marshall, there are four reasons in which a stock should be sold. The reasons are:

  1. When company’s stock price flies past intrinsic value,
  2. When a company thought to be good turns out not to be,
  3. In buyouts, or
  4. When a clearly better opportunity emerges.

Buy with a margin of safety means buying companies inexpensively which both increases investment returns and lowers risk. Basically, stocks tend to realize their fundamental value and potential in the long term. You have to be patient and stick with them.

References:

  1. https://www.nasdaq.com/articles/if-you-invested-%241000-in-apple-10-years-ago-this-is-how-much-youd-have-now-2021-06-23
  2. https://myfintalk.com/good-stocks-cheap-review/
  3. https://www.nasdaq.com/articles/15-best-stocks-to-buy-for-beginners-2020-11-12
  4. https://wtop.com/news/2021/11/9-best-cheap-stocks-to-buy-under-10/