Category Archives: Building Wealth
Warren Buffett’s Lessons Learned
Net Income vs. Free Cash Flow
The world of free cash flow (FCF) and net income are intriguing. These two financial metrics often dance around each other, but they’re not quite the same:
- What Is Net Income?
- Net income (profit or earnings) represents the bottom line on a company’s income statement. It’s the total profit a company has made after accounting for all expenses, taxes, and interest.
- Net income is calculated as:
Net Income=Total Revenue−Total Expenses
- What Is Free Cash Flow (FCF)?
- FCF is a powerful metric that goes beyond net income. It measures the cash a company generates from its operations minus the necessary capital expenditures (like buying new equipment or expanding facilities).
- FCF considers both cash inflows (from operating activities) and cash outflows (such as asset investments).
- The formula for FCF is:
FCF=Cash Flow from Operations−Capital Expenditures
- Why Might FCF Be Higher Than Net Income?
- FCF can exceed net income for several reasons.
- Non-Cash Expenses:
- Depreciation and amortization are non-cash expenses that reduce net income but don’t directly impact cash flow. If these expenses are significant, FCF can be higher.
- Working Capital Changes: Changes in working capital (like accounts receivable, inventory, and accounts payable) affect cash flow. If a company efficiently manages its working capital, FCF can surpass net income.
- Capital Expenditures: FCF can be higher if a company has minimal capital expenditures (e.g., it doesn’t need to invest heavily in new equipment).
- Timing Differences: FCF considers the actual timing of cash flows, whereas net income is based on accrual accounting. Timing differences can lead to variations between the two.
- Why Does It Matter?
- Investment Decisions: Investors often focus on FCF because it reflects a company’s ability to generate usable cash. Higher FCF means more flexibility for growth, dividends, or debt reduction.
- Sustainability: A company with consistently positive FCF is better positioned to weather economic downturns or invest in future projects.
Media Perception: Media reports often emphasize net income, but understanding FCF provides a deeper insight into a company’s financial health.
Remember, while net income is essential, FCF tells us whether a company can use that income to fuel growth or weather storms. So, next time you analyze financial statements, watch net income and FCF—they’re like two dancers performing different moves on the same stage!
The Magic Number Rises
More Americans say they don’t feel financially secure…rising inflation and incomes that aren’t keeping pace get most of the blame. ~ Northwestern Mutual
The “magic number” for retirement has surged in recent years thanks to high inflation. According to Northwestern Mutual’s 2024 Planning & Progress Study, Americans now believe they need $1.46 million in savings and investments to retire comfortably.
Yet, this number reveals more about Americans’ anxiety than precise planning. We often overestimate our financial needs
This ‘magic number’ figure has leaped 15% in a year and an astonishing 53% since 2020. Meanwhile, retirement savings have dwindled to a mere $88,000.
The “Silver Tsunami” of retirement approaches, with millions of Baby Boomers riding the waves into retirement.
Track and prioritize your spending is vitally critical. This involves prioritizing the spending that’s most important to you and letting things that are less important fall off. You’re saying no to some things so that you can say yes to others. You might even want to employ loud budgeting.
Loud budgeting gives you permission to say no to social engagements by saying you don’t have the money for it. To put loud budgeting to work, you commit yourself and share that you’re doing it. Loud budgeting lets you spend money on true priorities while skipping things that won’t really provide or align with your values and priorities.
Loud budgeting can be a simple way to push back when you’ve spent too much. But it works best when it starts with a solid budget and a financial plan that helps you balance future goals with what you need for today. The idea isn’t to say no to everything, but loud budgeting should help you say no when needed.
Ultimately, your financial goal is to have more income coming in each month than expenses going out.
But make sure that you’re thoughtful about your spending so that you feel good about what you’re getting when those dollars leave.
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Retirement Planning
Planning for retirement is a way to help you maintain the same quality of life in the future.
You should start retirement planning as early as financially and emotionally possible, like in your early twenties or thirties. The earlier you start, the more time your money has to grow.
That said, it’s never too late to start retirement planning, so don’t feel like you’ve missed the proverbial boat if you haven’t started.
Keep in mind, every dollar you can save now will be much appreciated later. Strategically investing could mean you won’t be playing catch-up for long.
Additionally, retirement planning isn’t merely about counting the days until you hang up your work boots and calculating your magical financial number.
It’s about ensuring that your golden years exudes comfort, financial security, personal relationships, meaning and purpose. Here are five financial steps to guide you as you prepare for career and life transition:
- Know When to Start: Determine when you want to retire. Will it be an early retirement at 62 or a grand finale at full Social Security benefits age (around 67)? Remember, the earlier you claim Social Security, the less you will receive monthly, but delaying it can enhance your benefits.
- Calculate Your Magic Number: Calculate how much wealth or nest egg you need to sustain your desired lifestyle. Consider living expenses, healthcare costs, and the joys you wish to indulge in during retirement.
- Prioritize your financial goals: Pay off debts, build your savings, downside if necessary, and calculate your monthly expenses.
- Choose Your Accounts: Explore retirement accounts. Will it be a 401(k), an IRA, or both? Each has tax advantages, contribution limits, and investment options. Mix and match wisely.
- Invest Wisely: Your investments must propel you toward your financial destination. In your youth, invest aggressively. As you approach the retirement, dial back to a more conservative mix.
Whether you’re a few decades or a few years away from retirement, having a plan can help you feel confident that you’ll be prepared when the time finally arrives.
Source: https://www.nerdwallet.com/article/investing/retirement-planning-an-introduction
Small-Cap and Micro-Cap Stocks
Small-cap and micro-cap stocks outperform large-cap counterparts in the long term but show particular strength after economic shakiness
A small-cap stock is defined as shares of a company with a market capitalization between $300 million and $2 billion.
Small-cap stocks offer an attractive risk-reward profile, as these companies usually have a higher growth potential than large-cap stocks. Although small-cap stocks have a high amount of volatility, they appear to be lucrative bets when the economy is expected to boom.
Micro-cap stocks represent companies with a market capitalization between $50 million to $300 million. Micro-cap stocks have a world of potential. Often they are in niche markets with emerging business ideas or technologies, so there’s a massive growth window for a company that can manage to it its stride.
Also, micro-cap stocks aren’t nearly as well-known as the blue-chip names. If you’re an astute investor, you can get in early before the average investor buys in.
Small-cap and micro-cap stocks are inherently more volatile than those blue-chip established names. That means potentially greater reward and greater risk. To invest in these micro-cap stocks, you should have a pretty high risk tolerance and be ready to ride the waves.
Most companies start out as small-caps or micro-caps, but by continually growing their earnings, their share prices appreciate. This can increase the market capitalization (share price times shares outstanding) of the company to large, or even mega-sized, while investors along for the ride reap the profits.
Big names like Microsoft, Apple and Amazon were all small-caps at one point. But not all small-caps flourish like those giants have. Many fail or stop growing, which means losses or little profit for investors. Great companies reveal themselves over many years and decades by continually producing quality earnings and sales growth.
You can find the best small-cap stocks by looking for companies with strong earnings and sales growth. Analysts must also be forecasting continued growth into the future. In addition, weed out companies with erratic earnings or that are issuing shares excessively, which dilutes earnings and shareholders’ equity.
All stocks should trade on U.S. exchanges, have a share price above $2, a market cap between $250 million and $2.5 billion and have three-month average daily volume of at least 200,000 shares.
Expected EPS growth. Companies are only included if analysts predict at least 7.0% yearly average growth over the next five years. Current-year EPS growth is also expected to be positive (above 0%).
Recent EPS and sales growth. Earnings and sales have increased an average of at least 7.0% per year over the last five years. Earnings were also higher than the prior year for each of the last three years.
Profitable. All stocks on this list have had positive earnings for the last three years.
This methodology focuses on companies that are already profitable. While unprofitable companies can see their share prices rise too, profitable and growing companies have already proven they can do it. It is a less speculative way to play this segment of the market, as opposed to hoping a struggling company can eventually turn it around.
investing in stocks is all about returns, the next step when analyzing small cap stocks is to see how their performance differs from large or mega cap behemoths.
Purchasing Power Risk
“Inflation is taxation without legislation.”
Inflation reduces the value of money held by the public, similar to a tax. The impact of inflation on purchasing power acts as a hidden cost on consumers’ wealth.
Inflation functions like a tax because it diminishes the real value of money. When prices rise, the same amount of currency buys less, effectively reducing people’s wealth if their income doesn’t increase at the same rate. This erosion of purchasing power affects everyone who holds money, making it a universal ‘tax’.
However, unlike traditional taxes imposed by governments, which are debated and legislated, inflation can occur without any direct legislative action. It’s often the result of complex economic factors, including monetary policy decisions by central banks, supply and demand dynamics, and changes in production costs.
Purchasing power risk, also known as inflation risk, refers to the potential decrease in the value of money over time due to inflation. When inflation occurs, the general price level of goods and services rises, meaning that each currency unit can buy fewer items than before. This risk is particularly relevant for investors holding cash or fixed-income securities, as the real return on their investments may be reduced when inflation is high.
In simpler terms, if you have a certain amount of money today, you might be able to buy a basket of goods with it. However, if prices increase over time due to inflation, that same amount of money will buy you a smaller basket of goods in the future. This erosion of purchasing power can affect not only personal finances but also investment returns and overall economic health.
Central banks often adjust interest rates to try to control inflation and maintain the currency’s purchasing power. One common measure of purchasing power in the U.S. is the Consumer Price Index (CPI), which tracks the average price change over time for a basket of goods and services, including transportation, food, and medical care3. Monitoring CPI and other economic indicators can help individuals and policymakers understand and mitigate the impact of purchasing power risk.
2024 SoFi NBA Play-In Tournament
The 2024 SoFi NBA Play-In Tournament will include teams with the 7th through 10th-highest winning percentages in each conference and take place April 16-19.
The SoFi NBA Play-In Tournament will determine the teams that fill the seventh and eighth playoff seeds in each conference for the 2024 NBA playoffs.
The Play-In Tournament will take place Tuesday, April 16 – Friday, April 19, with the games played after the regular season concludes and before the first round of the NBA playoffs begins.
While the teams that finish Nos. 1-6 in the standings of each conference are guaranteed a playoff spot, the teams that finish Nos. 7-10 in the standings will enter the Play-In Tournament. These teams will battle for the seventh and eighth playoff seeds.
Each conference’s No. 7 team in the standings will host the No. 8 team. The winners secure the No. 7 seed in the playoffs. The losers will get another chance to earn a playoff spot.
Each conference’s No. 9 team in the standings will host the No. 10 team. The winners will advance to the final stage of the Play-In Tournament. The losers are eliminated.
The losers of the No. 7 vs. No. 8 matchups will host the winners of the No. 9 vs. No. 10 matchups. The winners secure the No. 8 seed in the NBA playoffs for its conference. The losing teams are eliminated.
If the regular season ended after games played on April 7, the matchups would be:
Western Conference: (7) Pelicans vs. (8) Kings and (9) Lakers vs. (10) Warriors
Eastern Conference: (7) 76ers vs. (8) Heat and (9) Bulls vs. (10) Hawks
How to Trust Yourself More
‘You have to want to ‘learn to trust yourself more.’ It is way easier to stay in our comfort zone.” ~ Jamie Kern Lima
Warren Buffett’s Investment Strategy
An initial investment of $10,000 in Berkshire Hathaway when Warren Buffett took over in 1964 would now be worth more than $438 million!
Despite his reputation for picking winning stocks, Berkshire chairman and CEO Warren Buffett wrote to investors in his 2022 Berkshire Hathaway letter: “Charlie [Munger] and I are not stock-pickers; we are business-pickers.”
Over the decades, Buffett has refined a holistic approach to assessing a business—looking not just at earnings but also at its overall health, deficiencies, and strengths. He focuses more on a company’s characteristics and less on its stock price, waiting to buy only when the cost seems reasonable.
In short, Warren Buffett’s investing strategy is not complicated:
- Buy businesses, not stocks. In other words, think like a business owner, not someone who owns a piece of paper (or, these days, a digital trade confirmation).
- Look for companies with competitive advantages that can be maintained or economic moats. Firms fending off competitors have a better chance of increasing intrinsic value over time.
- Focus on long-term intrinsic value, not short-term earnings. What matters is how much cash a company can generate for its owners in the future. Therefore, value companies use a discounted cash flow analysis.
- Demand a margin of safety. Future cash flows are, by their nature, uncertain. Always buy companies for less than their intrinsic values to compensate for that uncertainty.
- Be patient. Investing isn’t about instant gratification; it’s about long-term success.
Other investing virtues prized by Buffett include candid communication with shareholders, patience in letting an investment bear fruit and emphasizing practical vehicles over investing fads.
Patience Pays: An initial Investment of $10,000 in Berkshire Hathaway when Warren Buffett took over in 1964 would have purchased approximately 808 company shares at a stock price of just $12.37 per share.
As of the end of 2023, Berkshire Hathaway’s Class A shares (which have existed since 1964) traded for just over $542,625 per share. The stock has produced an overall gain of 4,386,621% from 1964 to 2023. Your initial $10,000 investment would now be worth more than $438 million!
While Berkshire Hathaway’s past 60 years have been an impressive growth story, Buffett cautions that the company’s size has become too large to sustain the same 20% growth rates over the long term. He believes future gains will not be as dramatic as those of the past 60 years.
Nevertheless, Buffett’s core investment strategy prioritizes thinking like a business owner and viewing investments as actual companies, not just as stocks.
He has long advocated for “boring” investing and the notion that real moneymaking happens when you sit back and trust in a long-term plan instead of strapping in for a wild ride seeking short-term profit. He continues to focus on lifelong learning, whether that means unpacking what a new product is all about or reading up on interdisciplinary subjects.
And he intends to give away 99% of his wealth to philanthropy.
Source: Susan Dziubinski, How to Invest Like Warren Buffett, Morningstar, March 13, 2024.