Monday, March 7, 2011
For a top professor, you might expect he uses very complicated models or high level mathematics... well he doesn't:
"I look for obvious things when looking for bargains, not something terribly obscure ... wouldn’t involve higher mathematics or special sleuthing talents."
"When doing in depth analysis of companies, I care very much about long term earnings power, not necessarily so much about the volatility of that earnings power but about my certainty of “normal” earnings power over time. My goal is to buy a company at a low multiple to normal earnings power several years out and that the company earns good returns on capital at that level of normal earnings ... I usually just look at a simple multiple to normalized earnings. If I can buy something at a very low multiple and I have confidence in the earnings stream, I don’t have to calculate a DCF to know whether I want to buy it."
As you may have noticed in the video I posted on him in an earlier post, he uses a simple approach that works.
Sunday, March 6, 2011
Let's imagine we have 5,000,000 monkeys all taking part in a coin toss contest. The rules? Each monkey is paired with another and they flip a coin. The one to guess it correctly moves on to round 2 where it will face another monkey who also guessed correctly in round 1. This continues for 20 rounds where all the remaining monkeys are the final winners.
Since in each pairing, 1 monkey wins and 1 monkey loses (eliminated) we will end up with 1/2 the # of monkeys in each successive round. We also know that a coin toss gives you a 50% chance of guessing correctly.
Round 1: 5,000,000 monkeys remain
Round 2: 2,500,000 monkeys remain
Round 3: 1,250,000 monkeys remain
Round 14: 610 monkeys remain
Round 15: 305 monkeys remain
Final winners: 153 monkeys (do me a favour and forget that we can't have 1/2 monkeys .. just assume the numbers work out well)
So what are the odds of being one of the 153 final winners? Probability of 0.00305% (0.5^15). Basically extremely low odds. Think of this as a metaphor for investors now. Academics say that yes, there will be some major winners (such as Warren Buffett), but it's just a very low probability and entirely luck.
But what would you think if I told you that 100 of the 153 winning monkeys all came from the same zoo and had the same trainer? You would think that had something to do with them all winning! You would think they actually had better odds than the 0.00305% probability. Well this is what Warren Buffett argues is the case with value investors. Of the "unlikely" group of investors that consistently beat the market averages, a large majority of them are value investors following the principles of Benjamin Graham. Buffett goes on to show the records of several such investors/friends who all use value investing but have significantly different looking portfolios, but they all beat the market consistently.
How can the efficient market hypothesis hold water in light of this argument? "Buffett's argument has never, to my knowledge, been addressed by the efficient-market theorists; they evidently prefer to continue to prove in theory what was refuted in practice" - Seth Klarman
For more information, check out this WikiPedia page. I haven't checked the numbers given there to confirm they are correct but you get the point of the article.
Friday, March 4, 2011
I was on campus today and there was a big student initiated campaign against the cost of tuition/student loans. They claimed that student loans from the ~650 people who participated with them totaled a bit over $16.8 million. They claimed the average loan per student in our province is $26,680, up from $20,500 10 years ago.
They are complaining about this increase, which I look at and think it isn't very much given that its over 10 years. So I calculate it out, and it turns out to be an average increase of 2.67% per year. Seems about in line with inflation... what are they complaining about?
Moreover, no one is being forced to get student loans. If you don't want to be in debt, but you want a degree then you had better stretch it out over a couple more years so that you can work at the same time. I'm graduating this semester and guess how much student debt I have? ZERO. Now these people who got interest free (while in school) money from the government want their debt loads to be decreased? I'm starting to feel like the US home owner who was responsible with their mortgage/home only to see their irresponsible neighbour crying for help from the government because of their own stupidity/mistakes when the real estate market tanked in 2008.
Thursday, March 3, 2011
I pay too much money to have such a bad internet connection...
Wednesday, March 2, 2011
Auditors must work hard to narrow the gap as much as possible, so I'll do what I can by explaining what it is that the auditors provide.
Auditors do NOT prepare the financial statements of their clients. The clients themselves do that. The auditors come in and examine the financial statements that have been prepared, checking to make sure the accounting standards (e.g. Generally accepted accounting principles -- GAAP) have been applied properly and that everything is fairly presented.
The second part of an auditors job is to provide an opinion (unqualified, qualified, adverse, and I can't even recall the 4th one because it is rarely even used -- you will generally see unqualified or qualified opinions) on the statements. If everything looks great and any potential issues were cleared up (adjusted) with management, then an unqualified opinion will be issued (as weird as it sounds, this is the best opinion a company can hope for).
Notice, though, that the auditor does NOT go through every single transaction and balance to ensure they are 100% correct and free of error. They use sampling methods to test them. This means that the auditors do NOT provide 100% assurance (i.e. they are not providing insurance on the financial health of the company). There will be some small percentage of misstatements that are not caught by the auditors.
So, does that mean if I'm an investor and I invest in the company based on the audited financial statements and lose money due to the misstatement then I can sue the auditor for negligence? Well, it depends. It depends if they followed GAAS (generally accepted auditing standards) or not. If the auditor followed GAAS, then they provide reasonable assurance that the statements are fairly presented and have sufficiently done their job. If the auditor failed to comply with GAAS, then an investor could sue them!
This is a good place to explain the difference between business failure and audit failure. Business failure is where a business fails to make it's debt payments and could result in bankruptcy. Audit failure, on the other hand, is the failure of the auditor to comply with GAAS. They are NOT the same. As was explained above, business failure could occur while there was no failure in audit.
So do we want 100% assurance from the auditors? It would sure be nice, but it just means that it will cost the company more money in audit fees. More assurance = more work for the auditor = higher fees. The level of assurance that is currently provided is sufficient enough that investors can have confidence in it and make informed decisions based on the audited financial statements. It's currently cost-effective.
Monday, February 28, 2011
Today I've got a midterm on Environmental Economics, which is an absolutely terrible class. The material is at times interesting, but my professor is horrendous. He should not be giving lectures! I won't bore you too much ranting about him though.
Tomorrow I've got another midterm on Audit and Assurance. As investors, we love the auditors. They dig into the financial statements of a company and ensure that everything is in order. I'm going to post tomorrow more about auditing and what is called the expectation gap.
Until then, wish me luck! For any of my followers that are currently in the midst of midterms, good luck to you too!
Saturday, February 26, 2011
Buffett’s $2.6 Million Lunch Auction Shows Reputation
June 14, 2010, 8:46 AM EDT
(Updates with Moody’s in seventh paragraph.)
By Andrew Frye
June 14 (Bloomberg) -- Warren Buffett’s annual charity- lunch auction reached a record $2.63 million after a year in which the billionaire defied an economic slump by completing his biggest takeover and boosting Berkshire Hathaway Inc.’s profit.
Bidding outpaced last year’s during the first days of the weeklong event and ended in a frenzy June 11 with 77 offers, according to EBay Inc., which ran the online sale. Proceeds go to the San Francisco-based Glide Foundation, a favorite charity of Buffett’s first wife, Susan, who died in 2004. The winner asked to remain anonymous, the organization said.
As a global credit crisis accelerated in 2008, firms seeking capital appealed to Buffett, 79, for support, and Barack Obama enlisted his economic expertise during the presidential- election campaign. Omaha, Nebraska-based Berkshire prospered without a U.S. bailout, providing Buffett with funds for a $27 billion buyout of railroad Burlington Northern Santa Fe in February.
“Warren Buffett’s reputation, if anything, has been enhanced over the last couple of years” as Berkshire was sustained by the $44 billion cash cushion that he built through the end of 2007, said David Kass, a professor at the University of Maryland’s Robert H. Smith School of Business. “For those who can afford it, this lunch can have great value.”
New York Steakhouse
Buffett, the world’s third-richest person, rose to prominence through five decades of investing success. Like in previous years, he will meet the winner and as many as seven guests for lunch at Smith & Wollensky, the steakhouse on New York’s Third Avenue with the commercial tagline “Nice to see you again.”
Berkshire’s investments in firms that were blamed for contributing to the housing slump have increased pressure on Buffett to publicly discuss the financial crisis, assign blame and recommend remedies.
At his company’s annual meeting in May, shareholders pressed Buffett about his investment in Goldman Sachs Group Inc., which was sued by regulators in April for misleading investors. Buffett on June 2 defended credit-ratings firm Moody’s Corp., another Berkshire holding, at a hearing by the Financial Crisis Inquiry Commission.
Moody’s management shouldn’t be singled out for failing to anticipate the nationwide decline in housing prices, Buffett said. John Taylor, chief executive officer of the National Community Reinvestment Coalition, said after Buffett’s testimony that ratings firms deserve blame for assigning top grades to securities created by Wall Street that plunged in value.
Investment banks “walked into the room with a bagful of stinking garbage and the rating agencies not only embraced it but put their best sale of approval on it,” Taylor said.
Diners at the charity lunch may leave the table with investment ideas, business contacts and career advice, said Kass, who accompanied 48 students to Omaha for a lunch with Buffett five years ago. After that meal, Buffett picked up the tab, Kass said.
The auction’s previous record was set in 2008, when hedge fund manager Zhao Danyang of Hong Kong won it for $2.11 million. A group led by Courtenay Wolfe of Salida Capital paid $1.68 million last year. Greenlight Capital Inc.’s David Einhorn prevailed in 2003 with a $250,100 bid. Including this year, Buffett has raised more than $8 million with the auctions to help Glide, which serves meals to the needy.
“It’s actually a remarkable calibration of his value,” said Jeff Matthews, author of “Pilgrimage to Warren Buffett’s Omaha” and founder of hedge fund Ram Partners LP. “It measures what people think his worth to them is.”
Profits Amid Crisis
Berkshire’s earnings increased 61 percent to $8.06 billion in 2009, helped by Buffett’s investments during the crisis. The company got a coupon of 12 percent on an investment of 3 billion Swiss francs ($2.6 billion) in Swiss Reinsurance Co. and of 10 percent on a $3 billion allocation to General Electric Co.
The $5 billion that Buffett injected in Goldman Sachs 2008 yields $500 million a year for Berkshire, and the warrants he negotiated as part of the deal show a paper profit of more than $897 million. Weeks before he invested in the New York-based bank, he rebuffed a request for funds from American International Group Inc., which then needed a U.S. rescue.
Buffett’s fortune was estimated at $47 billion by Forbes magazine in March, placing him behind telecommunications investor Carlos Slim and Microsoft Corp. co-founder Bill Gates in the worldwide rankings. Buffett’s stock picks and takeovers turned Berkshire from a failing textile mill to a $184 billion seller of bricks, power and hurricane insurance.
His views on markets are followed by investors around the world, and tens of thousands of people gather in Omaha each year at Berkshire’s annual meeting to hear Buffett expound on the economy and public policy. He advised Obama during his successful 2008 campaign, and the president seized upon Buffett’s characterization of derivatives as “weapons of mass destruction” to rally support for reform.
In 2006, Buffett pledged 85 percent of his Berkshire holdings, a commitment valued at about $37 billion at the time, to the Bill & Melinda Gates Foundation and charities of four of his family members. The Gates donation is being made in annual installments, and will continue after Buffett’s death. The charity, established by Gates and his wife, combats disease and global poverty, and funds U.S. education initiatives.
--With assistance from Dakin Campbell in San Francisco. Editors: David Scheer, Dan Reichl
To contact the reporter on this story: Andrew Frye in New York at firstname.lastname@example.org
To contact the editor responsible for this story: Dan Kraut at email@example.com.
Friday, February 25, 2011
Buffett is not suggesting that it is possible for you to provide 100% assurance against loses. It's all about calculated risks. However, there are some methods that can be used to help reduce the potential for loses (remember the all important principle of margin of safety?).
You've got to read between the lines here. It's really showing you Buffett's view when it comes to investing. Since I know a little more than the average person I'll tell you a few things about him:
- He's not into taking gambles. He likes to invest in companies that are solid and have a proven record of success -- not placing wagers on start-ups.
- He looks for situations where heads he wins, tails he wins too (yes, they exist). If that is not possible, then heads he wins, and tails he doesn't lose much.
- Buffett often remarks that his strategy involves significantly less risk than other methods of investing (and we can all see that it returns significantly more as well).
- Early in his investing career (there are 2 general phases: 1. partnerships, 2. Berkshire Hathaway -- that's a story for another time) he told his shareholders that he planned to achieve a long-term above average return that will likely be made up of 1. returns that approximately equal the average during prosperous periods, and 2. returns that are better than average during down markets (don't lose money!). This would work out to above average returns.
I could list more, but I just got home from an exam and I am tired. And you're probably all tired of this topic already! Have a good night everyone.
Thursday, February 24, 2011
"Rule No. 1: Never lose money.
Rule No. 2: Never forget rule no. 1."
I would conclude by saying don't forget these 2 rules... but rule no. 2 already covers that.
Wednesday, February 23, 2011
Graham: “A stock doesn’t become a sound investment merely because it can be bought at close to its asset value. The investor should demand, in addition, a satisfactory ratio of earnings to price, a sufficiently strong financial position, and the prospect that its earnings will at least be maintained over the years”
You'll notice that this quote pretty much summarizes my last post. Don't worry, there will be a better profile on Ben Graham to come.
I'd also like to point out that EVERY investor I mention in this blog has a LONG record of beating the market. These guys are the real deal. Not the hot shot equity or forex trader who has 1 or 2 good years, but a poor long-term record.
Tuesday, February 22, 2011
As I mentioned in "5 Steps to Successful Equity Investing" GEICO was a dear of Buffett's (if I remember correctly, it was one of his first investments as an analyst for Benjamin Graham). I also mentioned reinsurance. It's one of the most significant parts of Berkshire Hathaway, and he talks about it here!
Once again, I want to stress that the below are the wise words of Mr. Buffet, NOT mine. He can explain things far better than I could ever dream to.
GEICO’s Strategy: Foot-to-the-Floor
Another way to prosper in a commodity-type business is to be the low-cost operator. Among auto insurers operating on a broad scale, GEICO holds that cherished title. For NICO, as we have seen, an ebb-and-flow business model makes sense. But a company holding a low-cost advantage must pursue an unrelenting foot-to-the-floor strategy. And that’s just what we do at GEICO.
Originally, GEICO mailed its low-cost message to a limited audience of government employees. Later, it widened its horizons and shifted its marketing emphasis to the phone, working inquiries that came from broadcast and print advertising. And today the Internet is coming on strong. Between 1936 and 1975, GEICO grew from a standing start to a 4% market share, becoming the country’s fourth largest auto insurer. During most of this period, the company was superbly managed, achieving both excellent volume gains and high profits. It looked unstoppable. But after my friend and hero Lorimer Davidson retired as CEO in 1970, his successors soon made a huge mistake by underreserving for losses. This produced faulty cost information, which in turn produced inadequate pricing. By 1976, GEICO was on the brink of failure.
Jack Byrne then joined GEICO as CEO and, almost single-handedly, saved the company by heroic efforts that included major price increases. Though GEICO’s survival required these, policyholders fled the company, and by 1980 its market share had fallen to 1.8%. Subsequently, the company embarked on some unwise diversification moves. This shift of emphasis away from its extraordinary core business stunted GEICO’s growth, and by 1993 its market share had grown only fractionally, to 1.9%. Then Tony Nicely took charge. And what a difference that’s made: In 2005 GEICO will probably secure a 6% market share.
* * * * * * * * * * * *
General Reinsurance: Quality not Commodity
Reinsurance – insurance sold to other insurers who wish to lay off part of the risks they have assumed – should not be a commodity product. At bottom, any insurance policy is simply a promise, and as everyone knows, promises vary enormously in their quality.
At the primary insurance level, nevertheless, just who makes the promise is often of minor importance. In personal-lines insurance, for example, states levy assessments on solvent companies to pay the policyholders of companies that go broke. In the business-insurance field, the same arrangement applies to workers’ compensation policies. “Protected” policies of these types account for about 60% of the property-casualty industry’s volume. Prudently-run insurers are irritated by the need to subsidize poor or reckless management elsewhere, but that’s the way it is.
Other forms of business insurance at the primary level involve promises that carry greater risks for the insured. When Reliance Insurance and Home Insurance were run into the ground, for example, their promises proved to be worthless. Consequently, many holders of their business policies (other than those covering workers’ compensation) suffered painful losses.
The solvency risk in primary policies, however, pales in comparison to that lurking in reinsurance policies. When a reinsurer goes broke, staggering losses almost always strike the primary companies it has dealt with. This risk is far from minor: GEICO has suffered tens of millions in losses from its careless selection of reinsurers in the early 1980s.
Were a true mega-catastrophe to occur in the next decade or two – and that’s a real possibility – some reinsurers would not survive. The largest insured loss to date is the World Trade Center disaster, which cost the insurance industry an estimated $35 billion. Hurricane Andrew cost insurers about $15.5 billion in 1992 (though that loss would be far higher in today’s dollars). Both events rocked the insurance and reinsurance world. But a $100 billion event, or even a larger catastrophe, remains a possibility if either a particularly severe earthquake or hurricane hits just the wrong place. Four significant hurricanes struck Florida during 2004, causing an aggregate of $25 billion or so in insured losses. Two of these – Charley and Ivan – could have done at least three times the damage they did had they entered the U.S. not far from their actual landing points.
Many insurers regard a $100 billion industry loss as “unthinkable” and won’t even plan for it. But at Berkshire, we are fully prepared. Our share of the loss would probably be 3% to 5%, and earnings from our investments and other businesses would comfortably exceed that cost. When “the day after” arrives, Berkshire’s checks will clear.
Though the hurricanes hit us with a $1.25 billion loss, our reinsurance operations did well last year. At General Re, Joe Brandon has restored a long-admired culture of underwriting discipline that, for a time, had lost its way. The excellent results he realized in 2004 on current business, however, were offset by adverse developments from the years before he took the helm.
Monday, February 21, 2011
The below is, again, the words of Mr. Buffet, NOT mine. He can explain things far better than I could ever dream to.
Insurance providers have generally earned poor returns for a simple reason: They sell a commodity-like product. Policy forms are standard, and the product is available from many suppliers, some of whom are mutual companies (“owned” by policyholders rather than stockholders) with profit goals that are limited.
Moreover, most insureds don’t care from whom they buy. Customers by the millions say “I need some Gillette blades” or “I’ll have a Coke” but we wait in vain for “I’d like a National Indemnity policy, please.”
Consequently, price competition in insurance is usually fierce. Think airline seats.
NICO’s Strategy: Pricing Discipline
When we purchased the company NICO – a specialist in commercial auto and general liability insurance – it did not appear to have any attributes that would overcome the industry’s chronic troubles. It was not well-known, had no informational advantage (the company has never had an actuary), was not a low-cost operator, and sold through general agents, a method many people thought outdated.
Nevertheless, for almost all of the past 38 years, NICO has been a star performer. Indeed, had we not made this acquisition, Berkshire would be lucky to be worth half of what it is today.
What we’ve had going for us is a managerial mindset that most insurers find impossible to replicate.
Can you imagine any public company embracing a business model that would lead to the decline in revenue that we experienced from 1986 through 1999? That colossal slide, it should be emphasized, did not occur because business was unobtainable. Many billions of premium dollars were readily available to NICO had we only been willing to cut prices. But we instead consistently priced to make a profit, not to match our most optimistic competitor. We never left customers – but they left us.
Most American businesses harbor an “institutional imperative” that rejects extended decreases in volume. What CEO wants to report to his shareholders that not only did business contract last year but that it will continue to drop? In insurance, the urge to keep writing business is also intensified because the consequences of foolishly-priced policies may not become apparent for some time. If an insurer is optimistic in its reserving, reported earnings will be overstated, and years may pass before true loss costs are revealed (a form of self-deception that nearly destroyed GEICO in the early 1970s).
Finally, there is a fear factor at work, in that a shrinking business usually leads to layoffs. To avoid pink slips, employees will rationalize inadequate pricing, telling themselves that poorly-priced business must be tolerated in order to keep the organization intact and the distribution system happy. If this course isn’t followed, these employees will argue, the company will not participate in the recovery that they invariably feel is just around the corner.
To combat employees’ natural tendency to save their own skins, we have always promised NICO’s workforce that no one will be fired because of declining volume, however severe the contraction. (This is not Donald Trump’s sort of place.) NICO is not labor-intensive, and … can live with excess overhead. It can’t live, however, with underpriced business and the breakdown in underwriting discipline that accompanies it. An insurance organization that doesn’t care deeply about underwriting at a profit this year is unlikely to care next year either.
Sunday, February 20, 2011
These snippets are taken from a post on the Insurance Journal, but they actually took the information from one of Berkshire Hathaway's annual shareholder letters.
Insurance has been Berkshire’s core operating business since it purchased National Indemnity, a commercial auto and general liability insurer, in 1967. Insurance has supplied the “fountain of funds” Buffett uses to buy other businesses and securities. Among Berkshire’s other insurance holdings today are GEICO, a direct provider of auto insurance, and General Reinsurance.
The Power of Float
The source of our insurance funds is “float,” which is money that doesn’t belong to us but that we temporarily hold. Most of our float arises because (1) premiums are paid upfront though the service we provide – insurance protection – is delivered over a period that usually covers a year and; (2) loss events that occur today do not always result in our immediately paying claims, because it sometimes takes many years for losses to be reported (asbestos losses would be an example), negotiated and settled. The $20 million of float that came with our 1967 purchase (National Indemnity- NICO) has now increased – both by way of internal growth and acquisitions – to $46.1 billion.
Float is wonderful – if it doesn’t come at a high price. Its cost is determined by underwriting results, meaning how the expenses and losses we will ultimately pay compare with the premiums we have received. When an underwriting profit is achieved – as has been the case at Berkshire in about half of the 38 years we have been in the insurance business – float is better than free. In such years, we are actually paid for holding other people’s money. For most insurers, however, life has been far more difficult: In aggregate, the property-casualty industry almost invariably operates at an underwriting loss. When that loss is large, float becomes expensive, sometimes devastatingly so.
Saturday, February 19, 2011
I'd just like to warn you that it is slightly more complicated and will probably take more interest in the topic to not be bored by it. I'll be back with layman explanations of understanding equity investing, but I think it's very important to expose you all to some of the words from the Oracle of Omaha... the greatest investor of all time.
Big picture first, then details. Remember, in the most basic sense we are trying to by anything something that is worth $1 for $0.66. It can be stocks, corporate debt, etc. This list is mostly directed at stocks (equities), but some tweaking can help with other securities.
Enough blabbing, onto the list:
Step 1: Identify Potential/Create a List of Potentially Undervalued Stocks
- Look at ‘daily/weekly low’ lists in Wall Street Journal, Investor’s Business Daily, Financial Times, other newspapers, internet sources such as Barron’s.
- Financially distressed/bankrupt securities (note, this takes more extensive knowledge)
- Other special situations such as spin-offs (what's a spin-off?)
Step 2: Evaluate the Balance Sheet/Foundation (look for red flags)
- The balance sheet shows the financial position/solvency of a company
- Gives an idea of actual worth, how much it owes, and what resources it has going forward
- Basically the same form filled in for a loan
- Make sure it’s not overburdened with debt
- Make sure has enough capital to stay in business during bad times
Step 3: Evaluating Earnings Power/Prospects (lifeblood of company)
- Use “normal”/adjusted earnings for all these calculations – not simply last years net income
- Adjusted means you remove non cash items (e.g. depreciation), non-recurring/extraordinary items (e.g. large one time write-off), etc
- When we say adjusted earnings, we basically mean free cash flow (money that is available to shareholders basically)
Step 4: Come Up With Questions to Understand Competitive Position & Growth Prospects
- I'm going to do a detailed post on this soon, so for now I'll leave it at that
Step 5: Step 5: Get Info Through the “Scuttlebutt” Method (from Phil Fisher)
- "Scuttlebutt" is basically Fisher's way for saying you need to ask important questions to customers, suppliers, employees (& ex-employees), management, competitors, and anyone else who understands the company/industry and may have insights
- One of Fisher’s favourite questions for top executives: "What do you consider to be the most important long-range problem facing your company?"
"Why Buffett Loves Investing in Insurance Companies" (everything from auto insurance (GEICO was a dear of his) to MASSIVE reinsurance (reinsurance = insurance that is purchased by an insurance company (insurer) from another insurance company (re-insurer)) deals)
"Understanding Student Loans and a Basic Analysis of Various Debt Instruments Available to You" (I see too many students on campus with a student loan of more than $100,000! The worst part is they don't know the details of that debt ... if ignorance is bliss, then bliss is expensive!)
Friday, February 18, 2011
It's based on two basic ideas. You want to invest in:
1. Good companies
2. Cheap companies
How does he measure this? How "good" a company is, is measured by its . A companies return on capital employed measures how good it is, while its price-earnings (PE) ratio (how much you pay per dollar of (adjusted) earnings) measures how cheap it is.
With this basic information he:
1. Takes a list of companies (list size depends on how small of a market cap you are willing to invest in (market cap = share price * # of shares outstanding))
2. Ranks each stock from 1 to n (with 1 being best, 2 being 2nd best, etc) on its return on capital employed and then again on its PE ratio.
3. Combine the two ranks for each company
4. Invest in the top ranking (combined ranks) 20-30 companies
5. Repeat each year
This is the simple method, a more advanced analyst can add some slightly more complicated steps. However, his data shows incredible returns when using this simple strategy.
Check out this video of him talking about his approach:
Thursday, February 17, 2011
Starting in 2009 when the program was launched, every Canadian over the age of 18 is allowed $5000 of contribution room. It doesn’t matter if you make $100 of income during the year or $500,000. However, your unused contribution room accumulates and is carried forward if you do not use it in any given year! Another important point is that you are allowed to contribute to your spouse’s account. So if this is the first you’ve heard of this and you and your spouse haven't put anything into a TFSA yet, then you will each already have $15,000 of unused contribution room (from 2009, 2010 and 2011) that you can begin filling up immediately.
You can withdraw from your TFSA at any time for any purpose (but it takes a couple days to get the money out, so it's not as fast as a normal savings account) — and the full amount of withdrawals can be put back into your TFSA in future years. Re-contributing in the same year, however, may result in an over-contribution amount which would be subject to a penalty tax.
The basic trade-off between contributing to TFSA vs. RRSP is that contributions to an RRSP are deductible and reduce your income for tax purposes. TFSA savings contributions are not deductible, but any income/capital gains in your TFSA are NEVER taxed. Not when earned, not when withdrawn.
Which method you want to contribute into first depends on your unique situation (which you should speak with your financial planner about). If you can, however, you should try to contribute the full amount possible to both accounts each year. If you’re able to do that and make prudent investments with the money you will have no worries when it comes time to retire (you may even be able to retire early if you’re lucky!).
Wednesday, February 16, 2011
First, let’s take a peek at their rankings of the top 10 MBA programs:
Check out this link to see a video of two students discuss their experiences of applying to business school:
Let’s Talk Money:
According to The Economist, the financial services sector is still the biggest employer of recently graduated MBAs with 22% finding their way into finance or accounting last year, compared to the other common sector, consulting (15%). You may want to take note of these facts: “...as many others in the economy see their pay squeezed, the salaries of MBA graduates are increasing. The median base salary for students who graduated in 2010 was $94,500—20% more than their pre-MBA salary. This compares with an average salary of $91,500 in 2009, US$90,000 in 2008 and US$89,000 in 2007. Students could also expect a bonus of $17,565.”
- 93% of last year’s MBAs are in work, including 7% who are self-employed
- The average student submitted 33 CVs, attended six interviews and received two job offers
Find more information about all of the above plus more at their website The Economist
Tuesday, February 15, 2011
He gives some simple but valuable insights in this video. You owe it to your future self and family to watch it!!
As he outlines, their approach to finding value is as simple as 4 steps:
Invest only in businesses:
1. You are capable of understanding
2. With intrinsic characteristics that give it a durable competitive advantage
3. With management in place who have a lot of integrity and talent
4. At a price that makes sense & gives margin of safety
Monday, February 14, 2011
Value investing is a style of investing that uses fundamental analysis, which means basing your investment decisions on what is really happening with the business in question. This is in contrast to a technical analysis approach which looks at the (arbitrary) short term movements in a stocks price and tries to predict/profit from which way it will move next. In the short term, a stocks price movement absolutely does NOT always reflect the true nature of the business .. so why is it useful to us? It isn't. When a stock's price goes from $10 to $5 in a single day, it is almost always the case that the business itself did not have it's value cut in half within a single day. So why does the stock price get cut in half? Because the short-term market price is crazy!
The only way the price of a stock is useful to us is in comparing the true value you are getting in that business (slightly more advanced topic which I will cover later) relative to the price you can buy it for.
There are two principles to value investing:
1. Intrinsic value (this is the "true value of the business" that I alluded to above)
2. Margin of safety (you don't want to pay $1 for $1 worth of value)
You need to assess a companies intrinsic value and then purchase the stock IF you can buy it at a price that is less than or equal to about 2/3's of that intrinsic value. Believe it or not there are plenty of companies that you can purchase like this.. that is, you can buy $1 of value for only $0.66.
My next post will involve a more detailed (and coherent!) explanation of the margin of safety principle. For now I'll leave you with this interesting fact: Seth Klarman wrote a book entitled 'Margin of Safety,' but only published a limited number of copies. Value investors today are paying more than $500 for a copy of the book on eBay, Amazon, etc!! They must see A LOT of value in it to pay $500+ for it.
Sunday, February 13, 2011
The basic math:
$1000 income from working (say 30% tax rate) = $300 tax bill ($1000*30%)
$1000 from capital gains (same 30% tax rate) = $150 tax bill ((1/2)*$1000*30%)
When you're investing for the long term, the majority of your wealth creation comes from capital gains. As a result you get to enjoy the very advantageous capital gains tax. Since it's long term you also don't pay the tax for a few years either. Deferred taxes at an advantageous rate? I'll take 3!
Check out this video showing the legendary Warren Buffett (he's probably my hero with Wolverine or something coming in a close second) talking about how he pays a lower % tax rate than his receptionist:
(I'm sort of technically challenged so I can't quite figure out how to insert a YouTube video here .. if anyone wants to let me know in a comment that would be greatly appreciated!!)
EDIT: You guys rock! Thanks for the help getting this video posted!!
Saturday, February 12, 2011
Some of these differences are permanent while others are temporary. This means that at some point in the future, temporary difference will reverse while permanent differences will never reverse.
I'll outline a common example for each to clear things up a bit.
The amount of depreciation that a company claims in any given year is almost certain to be different under tax and accounting approaches. For tax purposes, a company may use a declining balance method at a prescribed rate depending on the type of asset (e.g. business vehicles are assigned to Class 10 and decline at 30% per year). On the other hand, under the generally accepted accounting principles (GAAP) which are used for accounting purposes, a company is likely to use a straight line amortization schedule (i.e. the depreciation reported on an asset is basically a set amount over its economic useful life).
The result of this is that in early years an asset is going to depreciated faster for tax purposes, which means that it will reverse in later years when the depreciation for accounting purposes will be higher. This leads to future income tax liabilities or assets to be reported on the balance sheet!
Meals & entertainment. Under GAAP, these expenses are fully deducted from income. For tax purposes, only 50% of these expenses can be deducted from income. The idea is that you can deduct the cost of entertaining clients (1/2 the bill), but cannot deduct your own meal (the other 1/2 of the bill)!
Friday, February 11, 2011
1. Creating and delivering value to the world.
2. Communicating the value that you add to sustain maximum long-term profits.
Well then, the next question is: what is value? To your customer, value is what the customer gets in the purchase, use, and ownership of a product relative to the costs and sacrifices incurred. To you, value is whatever it is to your customer!
Great, so all we have to do is make something that is more valuable to customers than it costs to purchase it (including time spent traveling, shopping, etc. for it), right? I wish. Now you need to communicate that value, and you have to do it in a way that makes the customer perceive your product to be more valuable than your competitors’.
Let’s face it, the truth is that many of the big brands are made in the same factories, by the same employees, with the same materials as many of their competitors. In these cases, the brands that people buy are the ones whose companies do a better job communicating with customers the benefits of their product and brand. They cause customers to perceive greater value relative to competitors.
Here’s a great example of a brilliant marketer. An entrepreneur in England offered a 2 week, deluxe 61-step car wash. He was able to line up a solid 9 months worth of customers. What’s so special about this you might be asking? .. well, he charged $10,000 per car. He was able to convince around 19 people that he could add more than $10,000 worth of value with a car wash. That’s roughly $190,000 in revenues.
Stay tuned and as we progress I’ll teach you how you can create this sort of perceived value.
Wednesday, February 9, 2011
Before we get into the thick of finance, it would probably be helpful for me to define a few basic financial terms.
Money markets are financial markets where short-term debt securities (sometimes called money market instruments) are bought and sold. For example, a
Capital markets are financial markets where long-term debt and equity securities are bought and sold.
These can be either primary or secondary markets.
A primary market is where debt and equity securities are FIRST created. So when a corporation first sells it’s stock through an IPO (initial public offering), it is called a transaction within a primary market.
When that equity is then sold to someone else, it is done so in a secondary market. For example, the New York Stock Exchange would be considered a secondary market.
In order for a firms stock to actually be listed (stocks being traded) on an exchange, the firm must meet specific minimum criteria. Different exchanges, of course, have different criteria; some points of concern though are minimums in net tangible assets, pre-tax earnings, outstanding share market value, and more.
Monday, February 7, 2011
The figure shows a simplified organizational chart for a large corporation (missing departments - for illustration purposes.)
As you can see from the figure, shareholders effectively hire management. The problem is that management goals are not necessarily aligned with shareholder goals; shareholders want to maximize their share price, whereas managers want to maximize their salaries and keep their jobs.
It may seem that these goals would basically result from the same business strategies, but they don’t always.
Some examples are that managers may want to:
- Expand the business (bigger business = bigger salary)
- Acquire relevant companies at inflated prices (i.e. pay too much!)
- Buy a corporate jet that isn’t actually needed or cost-effective (i.e. less cashflow to shareholders!)
- Not take risks that shareholders would prefer
- For example a shareholder may be well diversified among the drug industry, so it is favorable for the companies to take financial risks to develop the cure for cancer. Failure means that the shareholder will lose their equity in that single business, where as failure to the CEO means loss of job.
What help to align shareholder and management goals?
Luckily for us shareholders, there are three main weapons that we have to keep managers ‘in line.’
First, managers’ main potential income can come from share options. When they are given share options, there new goal becomes to also maximize the share price. They will have incentive to only execute strategies that the market will value and will therefore increase the share price.
Second, we do essentially have the option to hire/fire management if they are underperforming, or not acting optimally. The problem here is that the more shareholders that a firm has, the harder it is to get them all to vote in the same way. Also, many of the shareholders are funds, average people, or organizations (i.e. charities) who are not necessarily active within the company (evaluating management, voting, etc.) So this is a much more powerful weapon with fewer, more active shareholders.
Finally, there is the threat of an acquisition. If a large player notices that the firm is grossly underperforming, he may decide to acquire the firm and turn it around by replacing management.
Saturday, February 5, 2011
There are basically three types of businesses, each having their own distinct advantages and disadvantages. They are as follows:
- Simple to setup and run
- Income is taxed only once
- UNLIMITED liability - this means that creditors can go after your personal assets for payment of the businesses debts
- Limited growth due to no outside equity funding
- Life of the business may be limited to the life of the owner
- Owned and operated by one person
- Same as sole proprietorship, but with two or more owners (partners)
- Partnership agreement outlines how gains/losses will be divided.
- Same as above, but a limited partner(s) have limited liabilities
CORPORATION - Multiple types of corporations are available, but we will focus on the basics of corporations
- LIMITED liability - unless you sign away your personal assets on a loan, they cannot be sought after by creditors.
- Easy to transfer ownership (stock sales)
- Very regulated
- Corporate income is taxed, and then dividend income is also taxed (the dreaded double taxation)
Different businesses require different business structures. The choice between starting a business as a sole prop or corporation is a tough one – you must carefully consider the pros and cons of each and how they affect your business when making that choice.
Well, I'll start off with my own info. My name is Scott, and I'm currently in my final semester of a business and economics undergraduate degree in Canada. I'm very interested in entrepreneurship and finance, so don't be surprised if the majority of posts fall under those sections! In particular, I will largely be focusing on the art and science of Value Investing. Don't worry though, I'll try to also post about topics such as marketing, human resources, commercial law, and more!
Every now and then I will also throw in an analysis of current events or news(i.e. an analysis of the economy on a macro level and some expectations that we can reasonably expect, OR when a news release is made by a company, I'll comment on some implications, consequences, etc of it.)
So, now for some logistics. My postings will depend on when I get time away from homework and my personal business ventures (planning stages right now for a couple ventures!).
Be aware, sometimes the information that I give will be only relevant for Canada, and sometimes only for USA (taxes, regulations, etc sometimes differ.)
I will get my very basic intro to business post up tonight. Be prepared people, we will be getting deep into some topics - make sure you keep up with my posts!
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