Every fourteen years, the purchasing power of the U.S. dollar is cut in half due to inflation, states billionaire investor Ron Baron, chairman of Baron Capital. Furthermore , he said that he was “amazingly bullish” on the market and was buying assets “every day.”
Category Archives: Building Wealth
Buffet’s Owner’s Earnings
Owner earnings (OE) is a valuation method detailed by Warren Buffett in Berkshire Hathaway’s annual report in 1986. He stated that the value of a company is simply the total of the net cash flows (owner earnings) expected to occur over the life of the business, minus any reinvestment of earnings.
Owners’ earnings, also known as cash flow for owners, remains one of the more accurate measures of how much money we can make from an investment and helps calculate intrinsic value.
The formula for owners’ earnings is as follows:
OE = Net income + Non-cash charges – Maintenance Capex +/- Changes in working capital Where the below:
- Non-cash = depreciation, amortization, impairment + other charges
- Maintenance Capex = Cash a company spends to maintain normal biz operations.
- Changes in working capital = adding the items under “Change in operating assets and liabilities” from the CF statement.
We will use a combination of cash flow statements to find the numbers.
To simplify some of this maintenance, the capex is an imprecise number that Buffett didn’t define precisely.
Many suggest different calculation methods; we will use the CF number to simplify.
Using $MSFT as our guinea pig for the year ending 2022. Below are the numbers taken from the financials:
- Net income = $72,738
- Non-cash = $16,260
- Capex = ($23,866)
- Changes in working capital = $446
Plugging in the numbers for $MSFT, we get:
Owners Earnings = $72,738+$16,260-$23,866+$446 = $65,578
Per share = $65,578 / 7,496 = 8.74
When compared to current P/FCF equals 8.70
Use these criteria to eliminate 95% of stocks:
Revenue growth 12%
Shares outstanding <2%
Net debt to FCF below 5x
Free cash flow growth +15%
Return on Invested capital +15%
Earnings per share growth +15%
12 companies that qualify:
Cap Rate
The cap rate, an abbreviation for “capitalization rate,” is a real estate metric that reflects the expected rate of return on rental property investments.
The Cap Rate, or “Capitalization Rate,” is a fundamental real estate valuation ratio that compares a rental property investment’s annual net operating income (NOI) to its current market value.
The cap rate formula is the ratio between a rental property’s net operating income (NOI) and its fair market value (FMV) as of the present date, expressed as a percentage.
- The cap rate is defined as the potential rate of return on a rental property building, such as a commercial real estate investment.
- The cap rate formula divides the net operating income (NOI) of a rental property at stabilization by the property’s market value as of the present date.
- < UNK> Real estate practitioners frequently use the cap rate to compare different investment opportunities to determine the property with the most attractive risk-return profile.
- The higher the cap rate, the higher the risk and potential return – all else equal.
- There is no reasonable cap rate, per se, because the decision is subjective and contingent on the specific investor’s risk-return profile. Still, most commercial real estate investors target a cap rate between 4% to 10%.
Story of Two Men in a Hospital Room
There were two men, both seriously ill, who shared the same hospital room. One man got a seat next to the room’s only window. The man was also allowed to sit in his bed for an hour each afternoon to help drain fluids from his lungs. The other man spent all his time lying flat on his back.
The two roommates quickly bonded and started talking for hours on end. They spoke of their lives, their job, children, and wives. Then, one day, the man on the other side of the window expressed how he envied the man near the window. From that day, the man near the window started describing everything he could see outside the window.
The window overlooked a lovely park with a lake. Ducks played on the lake while children sailed their model boats. Young lovers walked arm in arm amidst flowers of every color, and a fine view of the city skyline could be seen in the distance. The man on the other bed began to live for those one hour where he could hear and visualize the world outside the hospital room. The one hour of every day would broaden his world and be enlivened by all the activity and color of the outside world.
One fine afternoon, the man by the window described a parade passing by. Although the other man could not hear the band, he could visualize it as vividly illustrated by the man by the window.
Days and weeks passed by.
One morning, a nurse arrived to examine the condition of the two patients. She found the lifeless body of the man by the window. The man had peacefully embraced his death in his sleep. The nurse sadly called the hospital attendants to take the body away.
The other man grieved the death of his roommate. But, as the day passed, he started missing how his roommate described the view from the window. In the hope of having a peek out of the window and the beautiful world outside, the other man asked if he could be moved next to the window. The nurse happily made the switch. As soon as he was comfortable in his new bed, the man slowly and painfully propped himself to take his first look at the world outside. The nurse delightfully watched as the man attempted to sit on the bed after weeks. But as he strained to turn to look out of the window beside him slowly. He was stunned to see a blank wall outside the window. The agitated man asked the nurse what could have made his roommate lie about the view outside the window.
“There is nothing to see from here. Where are all the wonderful things he saw? He described everything so vividly. Is this a new and recent wall? Why did he give me such vivid details that don’t exist?” He asked
The nurse shook her head and answered his questions, “Perhaps he just wanted to encourage you and make you happy. But, you see, your roommate was blind.”
ATM Scam
Chase customers lose money to ATM thieves using glue and the ATM’s ‘tap’ feature to steal money from customers’ accounts.
Scammers are using glue to jam the card reader. A nearby stranger would then remind the person looking to take out money to use the tap feature on the ATM.
When you use an ATM’s tap feature, your account remains open for more transactions unless you proactively log out.
https://abc7news.com/atm-thieves-use-glue-and-tap-function-to-drain-accounts-at-chase/12905397/
Also, look for skimmers at gas pumps and ATMs. Please always look over the card reader before inserting your card, and if possible, use tap to pay!
Lessons from Charlie Munger
Lessons from Charlie Munger’s latest podcast interview: I have added some context to the interview to help you better understand the stories Munger shared.
1. On retail investors gambling in the stock market,
“They don’t know anything about the companies or anything. They just gamble on going up and down in price. If I were running the world, I would have a tax on short-term gains with no offset for losses on anything, and I would just drive this whole car of people out of business.”
2. Why algorithmic-driven trading firms like Renaissance technology are taking excessive risk
“The easiest trade is to front run what you know, what the average is, what the index funds have to buy, and you know what it is. Exactly. They all know that. And they get their returns year after year by taking the leverage, the midday leverage, up higher and higher and higher and higher. So, they’re making smaller and smaller profits on more and more volume, which gives them this big peak leverage risk, which I would not run myself. And that’s the only way they make these big returns, is to have this huge leverage that would make you crazy if you were already rich.”
3. How Warren and Charlie changed their mind quickly with Diversified Retailing after they realized it was too competitive (and how they made a ton of money after changing their mind) Some context: On January 30, 1966, Buffett, Munger, and Gottesman formed a holding company, Diversified Retailing Company, Inc., to “acquire diversified businesses, especially in the retail field.” Buffett and Munger then went to the Maryland National Bank and asked for a loan to make the purchase. The lending officer looked at them goggle-eyed and exclaimed,
“Six million dollars for little old Hochschild-Kohn?” Even after hearing this, Buffett and Munger—characteristically—did not question their judgment and ran screaming out the door.
“We thought we were buying a second-class department store at a third-class price” is how Buffett describes little old Hochschild-Kohn.
“We made nothing but money at Diversified. We didn’t exactly make it in retailing, but we made a lot of money. What happened was very simple. We bought this little department store chain in Baltimore. Big mistake. Too competitive. We realized we’d made a terrible mistake as the ink dried on the closing papers. So, we decided just to reverse it and take the hits to look foolish rather than go broke. You just told us how to get us out of this. By then, we’d already financed half of it on covenant-free debt. And they had all this extra cash, and our stocks got down to selling at enormous (discounts). In the middle of one of those recessions, we just bought, bought and bought and bought, and all that money went right into those stocks, and of course, we tripled it.”
4. How wonderful early years gave them a good head start. “Yeah, we bought a little savings and loan company for maybe $20 million. And when we left that thing, we had taken out of our little $20 million investment over $2 billion in marketable securities, which went into Nebraska insurance companies as part of their bedrock capital. So, we had some wonderful early years, which everybody needs. It is a wonderful early year.“
5. Charlie Munger’s Costco thesis – They sold cheaper than anyone else in America – Big, efficient stores – Huge parking spaces – Gave special benefits to people who come to the store in the way of reward points – Make suppliers wait (for payment) until they’ve been paid What made Costco so successful?
“Well, it takes a lot of good execution to do it. You have to set out to do it and then do it enthusiastically every day, every week, every year for 40 years. It’s not so damned easy. So, do you think success is the magic of the business model and culture? Yes. Culture plus model. Yes, absolutely. And very reliable, hardworking, determined execution for 40 years.“
Why did it take Costco decades to open its first store in China?
“The first store they tried to open in China, somebody wanted a $30,000 bribe Chinese culture, and they just wouldn’t pay it. And that made such a bad impression on Jim Senegal. He wouldn’t even talk about going into China for about 30 years after that.”
6. Advice for investors on finding great investments A caveat from me: While Munger advocates heavy concentration (and leverage), most investors still need his IQ or emotional control with volatility.
“You may find it five years after you bought it. Knowing these things may work into it, or your understanding may improve, but when you know you have an edge, you should bet heavily. You know, you’re right. And most people don’t teach that in business school. It’s unbelievable. Of course, you got to bet heavily on your best bets.”
7. Why did he and Warren become partners, “Both kind of similar, and we both wanted to keep our families safe and do a good job for our investors and so on. We had similar attitudes. His advice for an enduring partnership is, “Well, it helps if you like one another and enjoy working together. But I don’t use any one formula. Many partnerships that work well for a long time happen because one’s good at one thing and good at another. They just naturally divided, and each one likes what he’s doing.”
8. Munger feels that Berkshire could’ve taken on more leverage. “Warren still cares more about the safety of his Berkshire shareholders than anything else. If we used a little more leverage throughout, we’d have three times as much now, and it wouldn’t have been that much more risky either.”
9. Munger’s thoughts on VC: “It’s challenging to invest money well, and I think it’s almost impossible to do time after time in venture capital. Some deals get so hot, and you have to decide quickly. You’re all just sort of gambling. [VC] is a very legitimate business if you do it right. If you want to give the right people the power and nurture them, help them. You know a lot about the game’s tricks, so you can help them run their business yet not interfere with them so much. They hate you. By and large, having bumped into many people in businesses with venture capital financing, I would say the ordinary rule is the people in the business doing the work; they, more often than not, hate the venture capitalists. They don’t feel their partner trying to help them because they’re only taking care of themselves and don’t like them.”
10. How could VCs be better? “[At Berkshire], they know we’re not trying to discard them to the highest bid. See, if some asshole investment banker offers us 20 times earnings for some lousy business we don’t sell. If it’s a problem business we’ve never been able to fix, we’ll sell it. But if it’s a halfway decent business, we never sell anything. And that gives us this reputation of staying with things that help us. You don’t want to make money by screwing your investors, and that’s what many venture capitalists do.”
11. Why Warren’s investment in Japan was a no-brainer: “If you’re as smart as Warren Buffett, maybe two or three times a century, you get an idea like that. The interest rates in Japan were half a percent per year for ten years. These trading companies were entrenched old companies, and they had all these cheap copper mines and rubber foundations so that you could borrow all the money for ten years ahead and buy the stocks, which paid 5% dividends. So, there’s a huge cash flow with no investment, thought, or anything. How often do you do that? You’ll be lucky if you get one or two a century. We could do that [because of Berkshire credit]. Nobody else could.”
12. Why he loves companies with a strong brand—the ability to raise prices: “Well, it’s hard for us not to love brands since we were lucky enough to buy the Sees candy for $20 million as our first acquisition, and we found out fairly quickly that we could raise the price every year by 10%, and nobody cared. We didn’t make the volumes go up or anything like that; we just increased the profits. So, we’ve been raising the price by 10% annually for all these 40 years. It’s been a very satisfactory company. We didn’t acquire any new capital. That was what was so good about it. Very little new capital.“
13. What it takes to build Berkshire from scratch today – Intelligence – Work very hard – Be very lucky
14. His view on China: “My position in China has been that the Chinese economy has better prospects over the next 20 years than almost any other big economy. That’s number one. Number two, the leading companies of China are stronger and better than any other leading companies anywhere, and they’re available at a much cheaper price. So naturally, I’m willing to have some China risk in the Munger portfolio. How much is China risk? Well, that’s not a scientific subject. But I don’t mind. Whatever it is, 18% or something.”
15. What about BYD that captivated Munger?
“Guy (Wang Chuanfu) was a genius. He was at a Ph.D. in engineering, and he could look at somebody’s part, make that part, look at the morning, and look at it in the afternoon. He could make it. I’d never seen anybody like that. He could do anything. He is a natural engineer and gets it-done type production executive. And that’s a big thing. It’s a big lot of talent to have in one place. It’s advantageous. They’ve solved all these problems on these electric cars and the motors and the acceleration, braking, and so on.” Comparing Elon with Wang Chuanfu, “Well, he’s a fanatic that knows how actually to make things with his hands, so he has to he’s closer to ground zero. In other words, the guy at BYD is better at making things than Elon.”
16. Advice about building families “Well, of course, you’ve got to get along with everybody. You have got to help them through their tough times, and they help you, and so forth. But I think it’s not as hard as it is. Looks. I think half of the marriages in America work pretty damn well. And will it work just as well if both of them had to marry somebody else? And you’ve got to have trust with your spouse when it comes to things like the education of the children and so forth.“
Source: https://x.com/SteadyCompound/status/1718861611904241789
Stocks Beat Bonds as Inflation Hedge
“Stocks are great long-term inflation hedges if you are still worried about inflationary risks.” ~ Jeremy Siegel, Wharton School Economist
“If you are worried about the inflationary impacts, stocks are far better hedges than bonds — as companies can pass along their own input cost spikes to consumers,”Jeremy Siegel, Wharton School Economist, wrote in his weekly commentary published Monday for WisdomTree, where he is senior economist.
“If you bought the inflation-hedged bonds at 2% yields, it would take 36 years to double your purchasing power,” wrote Siegel, an emeritus professor at The Wharton School. “The S&P 500, however, is priced around 18 times next year’s earnings, giving a 5.5% earnings yield. This takes just 13 years to double purchasing power.”
“Stocks at the present time—with earnings of just under $250 for the S&P 500,” are preferred states Siegel. “This giving just under an 18x earnings per share valued market. I think that is a favorable multiple for the market. I believe stocks are great long-term inflation hedges if you are still worried about inflationary risks. I think stocks can handle another quarter point rise by the Fed if they deem it necessary.”
References:
5 investing mistakes you may be making right now
Fidelity Wealth Management
Key takeaways
- Risk is an essential part of investing, and investors should have the appropriate amount of risk in their portfolio so they don’t feel compelled to flee the market when volatility arises.
- Regular rebalancing and tax-management techniques may substantially impact a portfolio’s long-term performance.
- Investors with neither the time nor inclination to maintain their portfolios actively may consider whether engaging with a professional manager might be worth it.
- Investing can sometimes seem complex and confusing, and you may often be wondering whether or not you’re doing everything you can to help keep things on track—or whether something you’re doing may be hurting your ability to achieve your goals.
Here are 5 things you may be doing that might be having a detrimental effect on your portfolio, and some thoughts on how you might be able to turn things around.
1. Getting out when the going gets tough. When markets become volatile or experience significant declines, it’s natural to want to try to cut your losses and retreat to what seems like safe territory. But rather than preserving your wealth, you may actually be undermining the long-term growth potential of your portfolio.
In general, market declines have tended to be relatively shallow and short-lived compared to expansionary periods. Over the past 72 years, markets have risen an average of 15% per year during expansions—and even 1% per year during recessions.1 So even when things seem most dire, there’s still a chance for positive returns.
Furthermore, because it’s not possible to predict exactly when the market may shift from negative to positive, there’s a chance that you may end up missing out on a rally or recovery when it occurs if you were to take your money out of the market. Being uninvested for even a short time could have a profound impact: For instance, missing just the 5 best days in the market between 1980 and 2022 could have reduced portfolio returns by as much as 38%.2
2. Taking on too much (or too little) risk. Though the very idea of “risk” can be scary, it’s an essential part of investing. The amount of risk you decide to take on could determine how much growth you may be able to achieve in your portfolio and how much volatility you may need to endure to get there.
While there are no guarantees in investing, the key is to take on just enough risk to give your portfolio a chance of reaching your long-term goals, but not so much that it introduces enough volatility to scare you into withdrawing from the market. And one way to achieve that is by diversifying your portfolio, investing in a mix of different asset classes that may behave differently in different market conditions—that way, when some of your investments are down, others may be up, helping to smooth out the bumpiness in the market that can be so disconcerting.
Important information about performance returns. Performance cited represents past performance. Past performance, before and after taxes, does not guarantee future results and current performance may be lower or higher than the data quoted.
Investment returns and principal will fluctuate with market and economic conditions, and you may have a gain or loss when you sell your assets. Your return may differ significantly from those reported. The underlying investments held in a client’s account may differ from those of the accounts included in the composite. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment.
The above example (of various asset allocations) is for illustrative purposes only and does not reflect actual PAS data. Asset mix performance figures are based on the weighted average of annual return figures for certain benchmarks for each asset class represented. Historical returns and volatility of the stock, bond, and short-term asset classes are based on the historical performance data of various indexes from 1926 through 12/31/22 data available from Morningstar.
How your assets are allocated across these different asset classes can provide a solid foundation upon which your portfolio may be able to grow over time. It can be a major factor in long-term performance: In fact, up to 90% of the variability of a fund’s return over time can be explained by how its assets are allocated.3
3. Not rebalancing your portfolio regularly. Asset allocation is not a one-and-done exercise or something you can “set and forget.” Over time, the appreciation and depreciation of your investments may result in your portfolio drifting from your initial allocation. As this happens, the amount of risk you’re exposed to could change in ways you may not have expected.
For example, consider a hypothetical portfolio that begins with an asset allocation of 70% stocks and 30% bonds. If over the course of 6 months, stock values were to surge and bond values were to decline, that portfolio might end up closer to something like 80% stocks and 20% bonds—a much riskier allocation—just due to market activity. It can work the other way as well: Were stocks to dip to 60% and bonds to rise to 40%, the portfolio may end up being more conservative than the investor initially intended.
Historical standard deviation in conjunction with historical returns to decide whether an investment’s volatility would have been acceptable given the returns it would have produced. A higher standard deviation indicates a wider dispersion of past returns and thus greater historical volatility. Standard deviation does not indicate how an investment actually performed, but it does indicate the volatility of its returns over time. Standard deviation is annualized. The returns used for this calculation are not load adjusted.
Unless the investor proactively monitors and reallocates assets, perhaps by adding more funds to the account in the desired asset class or moving assets from one class to another, they could potentially experience more volatility than they are comfortable with or less growth than they need to help achieve their goals.
4. Paying too much in taxes
Taxes are a part of life, but nothing says you need to pay any more than is required of you. And yet, many investors may do just that because they don’t realize that there are techniques they can employ to help invest more efficiently and potentially reduce their overall tax burden.
“Most investors don’t realize how much they’re paying in taxes,” says Bullard. “Capital gains distributions from mutual funds, for example, can surprise investors when the tax bill arrives.”
Cutting your tax bill can have a big impact on your portfolio over the long term, by allowing you to keep more of your money and keep it invested, where it can potentially benefit from compounding growth in the market.
Techniques such as tax-loss harvesting or tax-efficient asset location, which places particular types of investments in the accounts most suitable for their tax treatment, can potentially pay off. In fact, the average client with a Portfolio Advisory Services professionally managed account using tax-smart strategies4 could save $3,900 per year in taxes.5
5. Going it alone. It’s not always easy to stay on top of these tasks and keep everything running smoothly on your own. And even when you know what you should be doing intellectually, it can be hard to stay the course and keep your emotions in check when markets become challenging. That’s why some investors are more comfortable engaging with a professional investment manager who, for a fee, can oversee many of these important investing duties and provide investors with a backstop of support and guidance that may be able to help them weather the difficulties they encounter on their path to their goal.
The truth is, mismanaging your portfolio has a cost. And whether the mismanagement is the result of an honest mistake, an understandable overreaction, or a simple oversight, ultimately the cost is coming out of your pocket.
Life is complicated enough as it is. There’s no need to make it any more complicated than it needs to be. With just a little more attention to these important portfolio practices and reaching out for professional help when you need it, you may be able to help ensure that these potential mistakes don’t keep you from reaching your important investing goals.
Value vs Growth Stocks
Value investors want to buy stocks for less than they’re worth. If you could buy $100 bills for $80, wouldn’t you do so? ~ Motley Fool
Most public equity stocks are classified as either value stocks or growth stocks. Generally speaking:
- A value stock trades for a cheaper price than its financial performance and fundamentals suggest it’s worth.
- A growth stock is a stock in a company expected to deliver above-average returns compared to its industry peers or the overall stock market.
Value stocks generally have the following characteristics:
- They typically are mature businesses.
- They have steady (but not spectacular) growth rates.
- They report relatively stable revenues and earnings.
- Most value stocks pay dividends, although this isn’t a set-in-stone rule.
Growth stocks generally have the following characteristics:
- They increase their revenue and earnings at a faster rate than the average business in their industry or the market as a whole.
- They developed an innovative product or service that is gaining share in existing markets, entering new markets, or even creating entirely new industries.
- They grow faster than average for long periods tend to be rewarded by the market, delivering handsome returns to shareholders in the process.
Regardless of the category of a stock, economic downturns present an opportunity for a value investor. The goal of value investing is to scoop up shares at a discount, and the best time to do so is when the entire stock market is on sale.
References:
A Majority of American Workers are Living Paycheck to Paycheck
According to a New CareerBuilder Survey, 78% of Americans live financially paycheck-to-paycheck. That means almost 8 out of 10 people probably can’t afford the home they’re living in and the car they’re driving. They might not even have the cash to cover the next emergency.
Study Highlights:
- 78 percent of U.S. workers live paycheck to paycheck to make ends meet
- Nearly one in 10 workers making $100,000+ live paycheck to paycheck
- More than 1 in 4 workers do not set aside any savings each month
- Almost 3 in 4 workers say they are in debt today – more than half think they will always be
- More than half of minimum wage workers say they have to work more than one job to make ends meet
Americans want what they don’t have to impress people they probably don’t even like.
Today, a fancy car and a big house are perceived as the standards of financial success and wealth. But true success is about contentment and being in control of your time. If you’re content with what you have and control your time, you’ll likely not look for the next best thing to bring you “happiness.”
References: