Choosing a Financial Advisor

Posted on November 17, 2021 by admin

Choosing a financial advisor is a major life decision that can potentially determine your financial net worth trajectory for years to come.

A 2020 Northwestern Mutual study found that 71% of U.S. adults admit their financial planning needs improvement. However, only 29% of Americans work with a financial advisor.

The value of working with a financial advisor varies by person and advisors are legally prohibited from promising returns, but research suggests people who work with a financial advisor feel more at ease about their finances and could end up with about 15% more money to spend in retirement, according to SmartAsset.com.

A recent Vanguard study found that, on average, a $500K investment would grow to over $3.4 million under the care of an advisor over 25 years, whereas the expected value from self-management would be $1.69 million, or 50% less. In other words, an advisor guided portfolio would average 8% annualized growth over a 25-year period, compared to 5% from a self-managed portfolio.

But, it essential that you do your homework in selecting a financial advisor. There are several key questions to ask and factors to consider regarding anyone who may advise you in money matters:

What’s your philosophy of investing?” If they can’t articulate their philosophy in a few simple paragraphs, in plain English, then keep looking.
“What has been one of your greatest triumphs in the market? And what was the decision making that brought you to it? What did you learn from the process?” Then ask, “What about one of your biggest mistakes? What went wrong and what did you learn from it?”
“What do you own yourself? Where do you put your own money?”
Hire an advisor who is a Fiduciary. By definition, a fiduciary is an individual who is ethically bound to act in another person’s best interest. This obligation eliminates conflict of interest concerns and makes an advisor’s advice more trustworthy.
Pick an advisor with an compatible strategy. Each advisor has a unique strategy. Some advisors may suggest aggressive investments, while others are more conservative. If you prefer to go all-in on stocks, an advisor that prefers bonds and index funds is not a great match for your style.
Ask about credentials. To give investment advice, financial advisors are required to pass a test. Ask your advisor about their licenses, tests, and credentials. Financial advisors tests include the Series 7, and Series 66 or Series 65. Some advisors go a step further and become a Certified Financial Planner, or CFP.

Many people who want to oversee and manage your money probably don’t have significant assets of their own. You would want a money manager to have skin in the game, to be eating their own cooking.

References:

Planning and Achieving Financial Freedom

Posted on November 16, 2021 by admin

Financial freedom can be an elusive—and hard-to-define—goal.

Financial freedom is often said to be in the eye of the beholder. To some it may mean freedom of debt and being able to fund your lifestyle with your cash flow; to others it may mean early retirement on a Caribbean island. Whatever your financial goals or definition of financial freedom, there are ways and things you can learn to help you get your financial house in order.

Once you’ve decided that financial freedom is one of your top goals, you can start taking steps to achieve it. Thus, the first step toward achieving financial freedom is to define exactly what it means for you. You can’t generally achieve something that you haven’t defined. So, once you’ve defined what financial freedom means to you, you can start taking steps toward your goals.

“What then is freedom? The power to live as one wishes.” Marcus Tullius Cicero

Just because you have money does not mean you have financial freedom. There have been numerous people, especially professional athletes and entertainers, who have earned millions of dollars and subsequently lost it all through reckless spending and debilitating debt. Thus, even if you have a lot of money, if you don’t know how to manage and make your money work for you, it will more than likely disappear.

Financial freedom typically means having enough savings, financial assets, and cash on hand to afford the kind of life you desire for yourself and your families. It means growing savings and investments to a level that enables you to retire or pursue the career you want without being driven to earn a wage or salary each year. Financial freedom means your money and assets are working hard for you rather than the other way around…you’re working hard for your money.

In other words, financial freedom is about much more than just having money. It’s the freedom to be who you really are and do what you really want in life. It’s about following your passion, making choices that aren’t influenced by your bank account, net worth or cash flow, and living life on your terms.

Track your expenses

It’s difficult to know how to save money if you don’t have a good idea of where your money is going. Carefully track your spending habits for a typical month. Doing this will help you to become more conscious of your discretionary expenditures. It will also reinforce what expenses are essential and remind you to plan for unexpected expenditures, like medical emergencies and car repairs. Therefore, it is vital to understand and to know where your money is going.

Make a budget

Once you’ve taken inventory of your expenses, next step is to create a budget. While budgeting can sound like a cumbersome task, you may want to start by using a budgeting calculator to get a feel for how you are currently spending your money and how you’d like to change your spending.

One popular budgeting method is the 50/30/20 rule. The 50/30/20 rule is a way to divide your post-tax income based on your needs, wants and savings. The rule states that people should spend 50% of their income on their needs. This includes health insurance, housing, transportation, and groceries. Then, the guideline states that people should spend 30% of their income on wants or non-necessities such as entertainment, travel, and more. Finally, the last 20% of a person’s income should be saved or invested. This might include retirement savings and building a stock portfolio.

Once you have created a budget, don’t put it in a drawer and forget about it. Instead, make it a working and living document that you check and refer to often. Spend a half-hour per month reviewing how your actual expenses match your budget and make adjustments as necessary.

Automate your savings

Automating your savings and investing is one of the easiest steps you can take to ensure that you are on the path to financial freedom. You can set automated contributions to your employer-sponsored investments, including your 401(k) contributions and employee stock options.

When your savings and investing are automated, your money will continue to grow without you having to think about it. This will help you to reach your financial goals easily and quickly.

Have some percentage (10% to 20%) of your paycheck automatically deposited into a separate account—whether it’s a savings account, a 401(k) or an IRA. Money that isn’t easily accessible is not easily spent.

Unfortunately, many Americans are not saving enough to maintain their current standard of living during their retirement years. It was found that about 21% of Americans have nothing saved for retirement, according to the Northwestern Mutual’s 2018 Planning & Progress Study.

Start investing early

Follow the adage, the best time to start investing was twenty years ago; the second best time is today. You should start investing in a tax deferred account, preferably with your employer matching a portion or all of your contribution.

Planning for retirement is a marathon and not a sprint. Even if you are starting small, the most important thing is to get started. Therefore, it will likely take decades to reach your goal. Therefore, it is important to remember why you want to achieve financial freedom. Keeping your purpose, goals and the bigger picture in mind will help you navigate the day-to-day financial decisions.

Once you become financially free, you have more choices of how to live your life and spend your days.

When you decide that you want to start working toward financial freedom, it is important to remember that you will not become financially free overnight. However, according to certified financial planner David Rae, in a 2018 article in Forbes magazine, there are eight hierarchies of financial freedom that you can work towards:

Level 1: Not Living Paycheck to Paycheck – The first level of financial freedom is building up an emergency fund and paying off any credit card debt. Unfortunately, living paycheck to paycheck is the reality of millions of Americans. According to the Federal Reserve’s Report on the Economic Well-Being of U.S. Households in 2017, some 40% of households could not cover a $400 unexpected expense.
Level 2: Enough Money to take a sabbatical from your work – Accumulating enough money to be able to take a break away from work can be rewarding. This does not mean you have to quit your job, but it sure is a good feeling to know you can.
Level 3: Enough to be Financially Happy and still Save – it’s about enjoying your life and having the money to do it. There can be peace when you are earning enough to save, doing the things you enjoy and still having extra at the end of the month.
Level 4: Freedom of Time – Many people desire more flexibility with their schedules. Freedom of time and financial independence go hand in hand. Together, they are about following your passion, or spending more time with family, and not going completely broke doing it.
Level 5: Enough for a Basic Retirement – Think about what your bare minimum retirement would look like. By knowing your bare minimum retirement, and knowing that you have enough money saved to at least cover some standard of living in your retirement, will also influence other life choices you may make along the way.
Level 6: Enough to Actually Retire Well – Knowing you are on track to accumulate a nest egg to support that lifestyle is a big win. Well done to those who have accumulated enough assets, or passive income streams, to be in a position to retire well.
Level 7: Enough for Dream Retirement – It would feel great knowing that you are on track to have enough money to retire and be able to live your dream life. What is stopping you from getting there.
Level 8: More Money Than You Could Ever Spend – Having more money than you expected to spend is great. Building enough wealth so that you could not possibly spend all of it is another.

Bottomline is that if you want to be financially free, if you want to be able to live the lifestyle of your choosing while responsibly managing your finances, you need to become a different person than you are today and let go of the financial mindset that has created your current financial predicament and has held you back in the past.

Attaining financial freedom, which means having enough savings, investments and cash flow to live as you desire, both now and in your later years, requires a continuous process of growth, learning and emotional strength. In other words, whatever has held you back and provided you comfort in the past or kept you less than who you really are will have to be replaced. You will have to become comfortable for awhile being uncomfortable. And in return, the financially empowered, purposeful, and successful you will emerge — like a butterfly shedding its cocoon.

References:

Black Student Loan Debt Regrets

Posted on November 14, 2021 by admin

66% of Black borrowers say they regret taking out student loans

Student debt in America disproportionately affects Black borrowers, as reported by CNBC. Currently, 86.6% of Black college students take out federal loans to attend four-year colleges, compared to just 59.9% of white students.

Many Americans believe that student loan debt is beneficial, however, a large number of Black borrowers aren’t reaping these benefits, and the ongoing pandemic has only worsened this crisis. Instead, Black borrowers “believe income-driven repayment plans are a lifetime debt sentence”.

For many Black borrowers, student loans are not considered to be “good debt,” according to a study titled Jim Crow Debt by The Education Trust’s Senior Research Associate Jonathan Davis, PhD and Jalil Bishop, PhD.

Black borrowers liken student loan debt to 'Jim Crow,' https://t.co/C9C3UMR0Jg

— Portia Faces Life (@PortiaColorado) November 9, 2021

The study, based on nearly 1,300 Black borrowers, highlights the parallels between student debt and the racial wealth gap. More than half of Black borrowers in the study disagree that student loans contribute to racial equality (58%) or help them to build wealth (61%). Sixty-six percent regret taking out education loans that now seem unaffordable.

The desire for high paying jobs and financial freedom puts Black students in a bind, as their need for affordable access to higher education leads them to attend colleges with “less resources and lower endowments,” and take out more loans than someone at a better-funded institution, according to Dr. Bishop.

And after graduation, Black borrowers are “navigating labor markets, where they’re increasingly facing discrimination that then requires them to have to return back to higher education because they believe a graduate degree will help them be a buffer against some of that labor market discrimination,” he tells CNBC Make It. According to the Economic Policy Institute, even Black workers with an advanced degree experience a significant wage gap compared with their white counterparts, with Black workers being paid 14.9% less than white workers.

For decades, federal policymakers have “ignored the racial and economic evidence of inequality in student loan debt…insisting that canceling all student debt is the best solution to the crisis”, according to to report released by The Education Trust. Advocates believe limiting student loan debt cancellation harms Black borrowers the most and would prefer that the government cancel the loans rather than offer lower interest rates.

References:

U.S. Middle Class Owns Few Financial Assets

Posted on November 13, 2021 by admin

U.S. Middle Class Households Have Few Financial Assets, According to New Analysis from the National Institute on Retirement Security (NIRS)

New analysis finds that across generations, middle class households in the U.S. own few financial assets and the median amounts held fall far short of the assets needed to fund a secure retirement.

In 2019, middle class Millennials owned only 14 percent of their generation’s financial assets. The numbers are even worse for middle class Gen Xers and Baby Boomers, which owned eight percent and six percent, respectively, of their generation’s financial assets.

“In America, the middle class can no longer afford retirement. Middle class Americans face sharp economic inequality, with ownership of financial assets highly concentrated among the wealthy,” explained Tyler Bond, National Institute on Retirement Security (NIRS) research manager. “Now that we have a retirement system largely built around the individual ownership of financial assets in 401(k) accounts, middle class Americans are struggling to accumulate sufficient financial assets during their working years. This means the retirement outlook for many in the middle class is bleak at best.”

The research also finds low numbers when examining the mean and median financial assets owned.

For middle class Millennial households in 2019, the mean financial assets owned were $17,802, and the median was $7,800.
Middle class Generation X households had mean financial assets of $62,944, and median financial assets of $39,000 in 2019.
For middle class Baby Boomers, the mean amount of financials assets held was $93,298 in 2019, while the median was only $51,700.

Baby Boomer households are retired or near retirement, but their assets fall far short of what’s required to finance a secure retirement,” Bond explained. “A nest egg of $51,700, the median amount middle class Boomers hold, would generate only $2000 of income annually over 30 years. This means that many middle class Boomer households may struggle in retirement and could face a sharp reduction in their standard of living.”

The research indicates that implementing pragmatic fiscal policy solutions can help middle class households get on a better path to saving for retirement including strengthening and expanding Social Security; protecting defined benefit pensions; and ensuring access to a retirement savings plan through an employer.

For this research, the middle class is defined as those between the 30th and 70th percentiles of net worth, or the middle 40 percent. The research is based upon data from the Federal Reserve’s Survey of Consumer Finances (SCF). It examines financial asset ownership, a broader category than retirement assets.

According to the SCF, the category of financial assets consists of liquid assets, certificates of deposit, directly held pooled investment funds, stocks, bonds, quasi-liquid assets, savings bonds, whole life insurance, other managed assets, and other financial assets. It does not include physical assets such as a home or a car.

The data for this research is for households rather than individuals.

References:

https://www.nirsonline.org/2021/10/middle-class-u-s-households-have-few-financial-assets/

Long Term Investing

Posted on November 12, 2021 by admin

“For the vast majority of folks, set it and forget it is the best long-term investment strategy.” John Stoj, OVerbatim Financial founder

Long term investing may not be glamorous, but it works.

Investing consistently over a long period of time will give you a chance to profit from the growth in the stock market. And, the longer your capital money is invested in assets, the more potential it has to grow. ”

Think in terms of decades when investing instead of days and you’ll be wealthy before you know it!

When you sell a stock and earn a profit in the stock market, you are required to pay capital gains tax at either short-term or long-term rates.

If you held your investment for a year or less, you pay a short-term capital gains rate that that can be as high as 37%.

If you invested for the long term (over a year), you’ll unlock lower tax rates of 0%, 15%, or 20% depending on your income and filing status. By holding your investments over the long-term, you have the potential to make more money and pay less in taxes.

10 long-term investing strategies that work:

Have a financial plan – Having a plan is one of the most important considerations to make before investing for the long term. A plan puts your financial goals, as well as when and how you want to reach them, into context. It can also assist you to avoid being swayed by emotions when making investment decisions or during periods of high market volatility.
Start investing as early as possible – When you start early … not only do you get the compounding effects of the capital, but you also create the opportunity to buy at an average cost over time.
Don’t try to time the market.
Invest in what you understand.
Add a 401(k) match to your mix – free money is the only guaranteed, risk-free home run you’ll ever get. Yet many people still don’t participate even when they have access to a 401(k) with an employer match.
Set up and stick with sound cash-flow management – Setting up automatic retirement savings contributions is one way to establish a cash flow strategy. But you can also apply the strategy of automatically investing money (each month at least) during your working years to other areas. You may want to establish a rainy day fund of three to six months.
Set it and forget it with funds.
Make stocks a cornerstone of your strategy.
Diversify for a smoother ride.
Rebalance only when necessary.

References:

Investing Rules and Criteria

Posted on November 10, 2021 by admin

“One of the best ways to make progress towards your financial goals is to make your money work for you—or, in other words, investing.” SoFi

Investing your hard-earned money can seem challenging. After all, there’s an overwhelming amount of information, choice of accounts, and strategies out there. Plus, the markets fluctuate, and the idea of potentially losing money can create stress and fear.

By learning more about the process, understanding the business, and knowing what you are investing in— you’ll gain more confidence that you are on the right path. It’s important to know what you need to know to get started, and how investing can help you achieve your goals

Before you invest, it’s important to understand your goals. Selecting an investment strategy depends on your goal amount (how much you want to save) and the time horizon (when you’d like to use that money). First, almost everyone should have these two goals:

Create an emergency fund, and
Save for retirement.

These are called “bookend goals”—your primary short-term and primary long-term goal. Your emergency fund is your primary short-term and a lump sum that you can easily access should an emergency ariset. This fund should be 6-12 times the amount you spend monthly, depending on how risk-averse you are. Retirement is your primary long-term goal and largest financial goal. Even if it feels very far away, it’s important to start saving early.

If you want to invest like Warren Buffett, you would need to invest in great businesses trading for less than their intrinsic values, and then hold on to these investments for as long as they remain great businesses and their fundamentals do not change.

“It’s better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price.” Warren Buffett

Begin saving, investing and building wealth early. Live below your income.
Buy pieces of a business. A stock is a single share of ownership in a public company. When you buy stock, you become a part owner of the company.
Buy a business you know on Main Street and investigate it thoroughly.
Have a margin of safety and circle of competence. Draw a circle around the businesses you know or are capable of knowing. Also, own a business with a competitive advantage.
Be a business analyst and concern yourself with what is going on inside a business. Read and study businesses over many decades before you invest.
Learn to value businesses and buy pieces of businesses far below what you think they’re worth.
Set goals: 20% return on investments.
Buy a business with good economics and financial strength (free cash flow, revenues, earnings that will grow and less than it’s worth ( intrinsic value).
Look for and invest in a business with a history of earnings, little debt, and management that manages the business for the benefit of owners.
Buy a business with a strong and enduring moat.
Buy a a lot of a few businesses and buy to keep. Buy very few things, but buy very big positions. “Buy so we’ll, you don’t have to sell.” By holding, you save on taxes and avoid transaction costs. Also, “diversification serves as protection against ignorance. “
Power of compounding works best when you concentrate your investments and you buy to keep.
Keep it simple.
Sell only if something fundamental changes within the business or if a better quality investment presents itself.

Learn the basics of value investing

Warren Buffett is widely considered to be the world’s greatest value investor. Value investing prioritizes paying low prices for investments relative to their intrinsic values. Value investors seek out and invest in companies with intrinsic values that are well above the enterprise values implied by the prices at which the companies’ stocks trade. Value investors like Buffett expect that the market will eventually recognize the full value of a currently undervalued company, resulting in an increase in the company’s stock price and a profit for the value investor.

Essentially you’re looking for outstanding businesses, operated by top notch managers, and selling at an attractive price. The most successful investing involves lifetime ownership and concentrating your wealth. Know what you own, own a few, and buy a lot. “Money will not change how healthy you are or how many people love you,” Warren Buffett says. A man is rich according to what he has; he is wealthy according to who he is.

To be the best, you must study and learn from the best.

References:

Posted on November 9, 2021 by admin

M2 Money Supply and Inflation

Posted on November 9, 2021 by admin

Money Supply M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money.

The “M2 Money Supply” is a measure for the amount of currency in circulation. M2 includes M1 (physical cash and checkable deposits) as well as “less liquid money”, such as saving bank accounts.

M2 is an excellent measure of liquid money that is available to be spent. It is a much better measure of money demand than it is of money supply.

Money Supply M2 in the U.S. increased to $20,982.90 Billion in September from $20,797 Billion in August of 2021. Source: Federal Reserve

Many economists believe excessive monetary growth is a primary cause of recent high inflation. Behind the 35.7% monetary increase in M2 money supply lies $5.5 trillion of net fiscal spending power injected by the federal government. Milton Friedman famously said “inflation is always and everywhere a monetary phenomenon.”

“Inflation is always and everywhere a monetary phenomenon.” Milton Friedman

Effectively, inflation can happen if the money supply grows faster than the economic output under otherwise normal economic circumstances. Inflation, or the rate at which the average price of goods or services increases over time, can also be affected by factors beyond the money supply, such as supply chain constraints and labor shortages.

According to the monetary theory of inflation, inflation occurs when the supply of money exceeds the demand for it; in other words, when the Fed supplies more money to the economy than the economy wants.

The Fed’s quantitative easing changes the form of the “money” (purchasing power) that deficits create, not the amount.

The consumer-price-index report reveals that big relative price shifts, notably for energy, food and vehicles, and base effects lie behind the rise in inflation.

Wages in the third quarter were up 4.2% from a year earlier, according to Wall Street Journal, the fastest increase since 1990 as labor shortages in a widening range of industries prompted employers to raise pay. Meanwhile, inflation has topped 5% for the past four months, the hottest in decades.

At first blush, this looks like the start of a process where wages push up prices, which then prompt employees to ask for, and receive, higher wages. That sort of wage-price spiral has historically been a key ingredient in persistently high inflation.

Wages and prices are often thought to have “an iron lockstep relationship and that’s just not the case here,” said Peter Matthews, economics professor at Middlebury College. While firms will attempt to pass on higher labor costs to customers, differences in how various sectors tend to respond will determine the impact on inflation, he said.

Prices have surged even more for factory goods, but those increases seem linked to key materials, energy and shipping rather than wages.

Decades ago widespread unionization and cost-of-living adjustments meant wages responded relatively quickly to higher inflation. Since then declining unionization, slower-to-adjust minimum wages and lower productivity growth have restrained wage growth except when unemployment is low. Even in the third quarter wage growth lagged behind inflation.

References:

Free Cash Flow (FCF) Valuation

Posted on November 8, 2021 by admin

“Free Cash Flow is the cash remaining after making investments in capital assets.”

Free cash flow (FCF) measures a company’s financial performance. It shows the cash that a company can produce after deducting the purchase of assets such as property, equipment, and other major investments from its operating cash flow.

FCF measures a company’s ability to produce what investors care most about: cash that’s available to be distributed in a discretionary way. The ways a business can use their free cash flow include:

Pay dividends
Buy back shares
Make an acquisition
Pay down debt

Free cash flow (FCF) is the cash that remains after a company pays to support its operations and makes any capital expenditures (purchases of physical assets such as property and equipment.

Free cash flow is related to, but not the same as, net income. Net income is commonly used to measure a company’s profitability, while free cash flow provides better insight into both a company’s business model and the organization’s financial health.

Many analysts believe that FCF is one of the key financial indicators for measuring business performance over the long term and provides useful information regarding how cash provided by operating activities compares to the property and equipment investments required to maintain and grow the business.

In addition to other financial measures, free cash flow (FCF) can be used to manage a business, make planning decisions, evaluate performance, and allocate resources.

There are two definitions of free cash flow:

Free cash flow to equity (FCFE) is the cash flow available for distribution to a company’s equity-holders. It equals free cash flow to firm minus after-tax interest expense plus net increase in debt.
Free cash flow to firm (FCFF) (also referred to as free cash flow) of a company is the cash flow in an accounting period which is available for distribution to the company’s debt-holders and equity-holders.

FCFE differs from FCFF in that the free cash flow to firm is the cash flow that is available for distribution to both the debt-holders and equity-holders while the free cash flow to equity is the cash flow that’s available only for distribution to equity-holders.

Free cash flow to firm (FCFF) valuation model is appropriate when the company do not pay dividends or where the dividends are disproportionate to the company’s earnings.

Free cash flow enables management to decide on future ventures that could improve the shareholder value. Additionally, having an abundant FCF indicates that a company is capable of paying its monthly dues. Companies can also use their FCF to expand business operations or pursue other short-term investments.

When compared to earnings, free cash flow is more transparent in showing the company’s potential to produce cash and profits. FCF serves as an important basis for determining the intrinsic value of a company and pricing its stock.

The formula below is the most commonly used formula for levered free cash flow:

Free Cash Flow = Operating Cash Flow (CFO) – Capital Expenditures

Most information needed to compute a company’s FCF is on the cash flow statement.

As an example, let Company A have $22 million dollars of cash from its business operations and $6.5 million dollars used for capital expenditures, net of changes in working capital. Company A’s FCF is then computed as:

FCF = $22 – $6.5 = $15.5m

DCF Analysis and Stock Valuation

Stock valuation is the process of determining the intrinsic value of a share of common stock of a company. The purpose of stock valuation is to find the value of a common share which is justified by the company earnings and growth potential, identify undervalued and overvalued stocks, overweight or underweight them in an investment portfolio and generate alpha i.e. excess return.

Discounted Cash Flow (DCF) analysis is an intrinsic value approach where an analyst forecasts the business’ unlevered free cash flow into the future and discounts it back to today at the firm’s Weighted Average Cost of Capital (WACC).

The weighted average cost of capital (WACC) is the minimum return a company must earn on its projects. It is calculated by weighing the cost of equity and the after-tax cost of debt by their relative weights in the capital structure.

WACC is an important input in capital budgeting and business valuation. It is the discount rate used to find out the present value of cash flows in the net present value technique.

The absolute valuation approach attempts to find intrinsic value of a stock by discounting future cash flows at an discount rate which reflects the risk inherent in the stock.

Free Cash Flow Models

The free cash flow valuation models can be used to value a majority i.e. controlling ownership based on free cash flows of the company which equals the cash flows from operating activities less any expected changes in working capital less any expected capital expenditure.

The single-stage free cash flow model discounts the expected free cash flows at the end of Year 1 at the weighted average cost of capital.

Stock Value = FCF1 / (WACC − g)

Where FCF1 is the free cash flow at the end of Year 1, WACC is the weighted average cost of capital and g is the growth rate of free cash flows.

Another back of the envelop valuation method is to take product of the five year average of free cash flow and multiply by twenty. Compare the product to the company’s market cap for a quick valuation model.

A business ability to generate significant amounts of free cash flow for years, which will support debt repayments, dividend payouts, share buybacks, and acquisition, is an essential valuation metric. Free cash flow can demonstrate a company’s ability to reward investors. It can provide useful information to help investors better understand underlying trends in a business.

Free cash flow is not perfect and has limitations, but it is more difficult to manipulate than net income or earnings per share.

FCF has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of other financial measures, such as return on invested capital (ROIC) and earnings. One of the limitations of FCF is that it does not reflect future contractual commitments.

FCF, as compared with net income, gives a more accurate picture of a firm’s financial health and is more difficult for a company to manipulate, but it isn’t perfect. Because it measures cash remaining at the end of a stated period, it can be a much “lumpier” metric than net income.

For example, if a company purchases new property, FCF could be negative while net income remains positive. Likewise, FCF can remain positive while net income is far less or even negative. If a company receives a large one-time payment for services rendered, its FCF very likely may remain positive even if it incurs high amortization expenses (like the costs of software and other intangible assets for a cloud computing company).

In a nutshell, free cash flow is what a company has left over at the end of the year — or quarter — after paying all its employees’ salaries, its bills, its interest on debt, and its taxes, and after making capital expenditures to expand the business.

References:

Best Business to Own When Inflation Spikes

Posted on November 7, 2021 by admin

Invest in asset-light businesses with pricing power.

In a letter to Berkshire Hathaway shareholders, the best type of business to own when inflation spikes, according to Berkshire Hathaway Chairman and CEO Warren Buffett, have two characteristics that make a business well adapted to an inflationary environment:

An ability to increase prices easily, and
An ability to take on more business without having to spend too much in order to do it.

In other words, aim to invest in asset-light businesses with pricing power.

Buffett also stated that the best business to own is one that doesn’t require continuous reinvestment of capital because it becomes more and more expensive as the value of a dollar drops.

“The best businesses during inflation are the businesses that you buy once and then you don’t have to keep making capital investments subsequently,” Buffett said, adding that “any business with heavy capital investment tends to be a poor business to be in inflation and often it’s a poor business to be in generally.”

Businesses like utilities or railroads “keep eating up more and more money” and aren’t as profitable, he explained. He prefers to own companies that people have a connection to. That is why “a brand is a wonderful thing to own during inflation,” Buffett said. Owning part of “a wonderful business,” as Buffett said in 2009, is useful because no matter what happens with the value of the dollar, the business’ product will still be in demand.

Buffett also said that it’s particularly handy to own real estate during times of inflation because the purchase is a “one-time outlay” for the investor, and has the added benefit of being able to be resold.

Inflation quietly eats away at earnings and purchasing power.

When the economy exhibits strong economic growth, there is a higher demand for goods and services, which in effect increases prices of those goods and services; that’s attributed to inflation. Essentially, the rate of inflation increases when demand in the economy is higher than supply, causing an overall price rise.

Inflation also impacts money sitting in the bank. While you may be receiving interest on savings from a money market account, the growth of inflation can outpace that of the savings rate offered by the bank. Keeping all your savings in cash is warranting your liquid assets a definite loss to inflation.

Effectively, your money does not grow at a higher rate, but loses purchasing power over time compared to if it was properly invested in equity assets.

Inflation

“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of [all] their citizens.” John Maynard Keynes

Inflation is tracked using the Consumer Price Index, known as the (CPI). This index, reported by the U.S. Bureau of Labor Statistics each month, measures the average change over time of prices consumers pay for goods and services.

The immediate effects of inflation are the changes in the behavior of consumption habits. In the long-term, inflation erodes the purchasing power of your income and accumulated wealth.

“Inflation reduces the ‘power’ of each dollar you have,” says Rob Isbitts, co-founder of The Hedged Investor in Weston, Florida. “A dollar is a dollar, but what it buys can be less in the future than it is today.”

Purchasing power risk – also known as inflation risk – is when the real interest rate, which accounts for adjusted inflation, shows the gain or loss in purchasing power.

How inflation is impacting your paycheck: 'The earnings of workers have eroded in recent months' https://t.co/DGdqIl2clG

— CNBC Make It (@CNBCMakeIt) November 5, 2021

Assets That Protect Against Inflation

Inflation can pose a threat to investments since prices that increase over time can decrease the value of your savings.

And, financial experts agree that there is no way to fully protect your investments against inflation. Nonetheless, there are ways to help protect against this risk. These experts say having a substantial allocation to stocks is important for growth potential while offsetting against inflation risk.

In the long term, the stock market is expected to outperform the inflation rate. Stocks are commonly thought of as an inflation protection asset since, over time, stock performance will outpace inflation. These assets are seen as a hedge against inflation:

TIPS, or Treasury Inflation-Protected Securities, which are bonds backed by the full faith of the U.S. government and protect against rising prices, make a very safe asset
REITs, or real estate investment trusts, are an organic hedge against inflation. When prices increase, real estate values increase as well. This asset is highly correlated with inflation, which means REIT returns are higher when inflation increases.
Gold is an asset that might provide protection against inflation and a good safeguard of inflation over the long run,

Inflation can significantly weaken your purchasing power and the performance of your investments and thus impact their value. That’s why acting to suppress the dangers of inflation is important to preserve the value of your cash flow and wealth in the long run.

References:

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