Financial Frameworks Podcast 36: Value Investing Hard Task 4 - Passing on a Stock that is Close
Financial Frameworks is focused on helping value investors integrate their skills and decision-making styles with solid fundamental financial concepts. This podcast provides a way to determine if an investment is close to meeting a person's criteria for making a solid, possibly exceptional, investment, but must be passed on because, while it is close, something is missing. Dr. Lehan, the author, is mindful of Warren Buffett's and the late Charlie Munger's admonition that "saying no most of the time" is a perquisite for excellent value investing.
The podcast walks through an example, then outlines the steps for listeners to walk through their own "mini-simulation" for applying one Buffett tool and two Philip Fisher tools to a prospective investment to see if it fits or is a near miss.
Financial Frameworks Podcast 35: Value Investing - Committing to Your Decision
Financial Frameworks has been discussing what Dr. Lehan sees as difficult tasks when performing value investing. This podcast outlines his third hardest task, committing to the decision in a way that is self-aware, rational and available for review and future learning. Dr. Lehan points out Daniel Kahneman's research that proves that we don't always remember things correctly. Like other Financial Frameworks podcasts, Dr. Lehan focuses on things to do to make the clearest possible decision and learn for better decisions in the future.
Financial Frameworks Podcast 34: Trusting Your Judgement, Avoiding Overconfidence & Prospect Theory
"How do I know that I am making the right decision?" Financial Frameworks continues its highlights of Dr. Lehan's most difficult tasks by presenting research and suggestions on how to answer that question when making an investment. This podcst focuses on behavioral finance research that has shed light on how a person learns to trust their judgement and avoid overconfidence when information is conflicting, or absent, or, as is often the case, just plain confusing. Financial Frameworks' purpose is to help investors create frameworks that are durable, thorough and solid. This podcast describes common errors in decision-making processes and outlines PROSPECT THEORY research done by Daniel Kahneman and Amos Tversky that illuminates how our brain makes connections that aren't really there and how to avoid making those mistakes. What occurs when we are making decisions about money is not complicated, but is a process that most of us are unaware of - if we didn't know what to look for. Financial Frameworks job is to make the connections from the abstract, conceptual level to the point of action. This podcast does that - or at least begins to - regarding why and how to trust our judgements when investing.
Financial Frameworks Podcast 33: The Hard Parts of Value Investing, and We’ll Start with Determining a Margin of Safety
Berkshire Hathaway – Data from 2023 3rd Quarter Report
Criteria Data Weight
Assets vs. Liab. $590.4 billion curr. assets __70%
$485.2 billion total liabilities
+ $105.2 billion, or an 18% difference
Earnings Safety Operating earn. up 40% __ 25%
Other Factors Diversified = Good ___5%
In this case Berkshire’s current assets exceed their liabilities by so much - $105 billion dollars or 18% - that this factor is most heavily weighted. Operating earnings (excluding investment losses and gains required to be reported) are up significantly, so that increases the size of my margin of safety.
Financial Frameworks is now focusing on two topics: Value investing and how we learn about investing - for the purpose of getting better at it. This podcast outlines Dr. Lehan's "Four Hardest Value Investing Tasks" - for him anyway, and then discusses his first hard task - insuring a margin of safety in an investment. After a brief tribute to Charlie Munger - who definitely believed in margin of safety - Dr. Lehan outlines his three basic criteria, then presents three examples of different techniques that are widely, and successfully, used. This is followed by a problem - the learning portion of the podcast - to apply the concepts to their own investing thinking.
The examples are Benjamin Graham's Net-Net approach, Dr. Bruce Greenwald's three-step valuation approach and a review of the principles applied by The Baupost Group, run by Seth Klarman. Dr. Lehan presents his assessment of Berkshire Hathaway's margin of safety using his three criteria and provides a blank template on his website - https://finframeworks.com .
The podcast alternates between clear, basic, concepts for investors new to value investing and a detailed overview of Dr. Greenwald's thought for more experienced investors interested in refining their thinking.
FinFrameworks Margin of Safety Worksheet
Your Company Example: ___________
Criteria Data Weight
Assets vs. Liabilities _______ ______
Earnings Safety _______ ______
Other Factor _______ ______
Personal and Industry Knowledge:
______________________________________________
______________________________________________
Financial Frameworks Podcast 32: Learning About Learning and Applying it to Value Investing
Financial Frameworks is shifting its focus to cover two important topics - the learning process and, the core of Financial Frameworks content, value investing. Dr. Lehan believes that most of us would be more successful if we were clearer about how best to learn and applied techniques that are emerging from current learning theory. Financial Frameworks will combine applied learning tools with value investing content and problems to both increase our skills and provide practical scenarios to test those tools while developing value investing skill.
Financial Frameworks Podcast 31: Value Investing Using Professor Bruce Greenwald’s Growth Evaluation Methods
Financial Frameworks presents fundamental financial concepts in a practical, applied format and has been focusing on value invest both for its own sake and as a solid way to learn about broader applied and behavioral finance.
This podcast outlines Professor Bruce Greenwald, Directo of Columbia University's Heilbrunn Graham & Dodd Value Investing Center, approach to estimating and calculating the potential growth of an investment/stock. The goal of his method is to find an undervalued stock that will produce long term gains, similar to Warren Buffett's experience with Coca Cola.
Dr. Lehan outlines the central calculations in Greenwald's method and provides key concepts Greenwald uses in making informed judgements about a stock and its industry.
B & N Greenwald/Bellissimo Inteview Link: https://www.youtube.com/watch?v=6rZpBJpETPE&t=706s
Podcast 30: Margin of Safety in Valuing a Company - Using Prof. Bruce Greenwald’s Tools. Plus Savings vs Investing and Loss Aversion Bias
Financial Frameworks continues looking for ways to apply margin of safety when selecting investments by looking at Professor Bruce Greenwald's approach to value investing. Prof. Greenwald divides a company into three parts for valuation. He measures assets first, then current earnings and finally makes future growth estimeates separately. Today's podcast outlines Prof. Greenwald's thinking, the underlying logic and changes in markets that guide his thinking and suggests how you can apply his method. Because his future growth estimates is so interesting, and more detailed than Discounted Cash Flow projections - which we discussed earlier - I will spend the next podcast on the hows, and what I think are the why's of Prof. Greenwald process for estimating future growth a company's future growth. The context for my analysis is to build a margin of safety into investing. I may be being repetitive in reminding you of the context, but I don't think emphasizing margin of safety can be done often enough.
Additionally, in response to listener comments, the podcast considers why most people look at savings accounts and investing as different activities - more like a fork in the road than as different stores on the Main Street of investing - and why we shouldn't. That topic brings me to a review of our loss aversion bias as the podcast's final topic. Financial Frameworks focuses on being clear about our decisions and understanding our values. This discussion is part of that process.
As always, if you find this useful, please mention it to a colleague.
Mike Lehan
Podcast 29: Translating the Margin of Safety from Concept to Tools
Margin of safety is an important concept, but how do I apply it in practical terms. This podcast shows how value investors like Warren Buffett use Owner's Earnings and the Discounted Cash Flow method to invest. Fancy terms but basic math and sensible thinking. I think you'll find the description of both methods clear and helpful.
Financial Frameworks' previous podcast focused on linking your overall investment strategy with two techniques for estimating future stock values or prices. Because Financial Frameworks believes in balancing future growth with safety, I’m following that podcast with one that focuses on translating the concept of margin of safety to a set of calculations that you can pair with the earnings tools to fit your overall investing strategy.
Today we’’ll discuss margin of safety basics, contexts, then, using Berkshire Hathaway as an example, do a margin of safety calculation using Owner’s Earnings and the Discounted Cash Flow model. We’ll also talk about current market issues and, as always, present you with your usual problem for you to apply the tools to your situation.
Podcast 29: Margin of Safety from Concept to Tool
Step 1 - Owner’s Earnings for Berkshire Hathaway. Data taken from 2022 Year End Annual Report
Calculations by Financial Frameworks do not serve as investing advice or recommendations.
Net Income* $35,460,000,000 – see note below.
+ Depreciation & Amortization $10,899,000,000
+ Change in Accts. Receivable ($5,592,000,000)
+ Net change in Accts. Payable $2,033,000,000
+ Income Tax Excluded per note below.
+Maintenance & Cap Expenditures ($14,454,000,000) – 5 year average.
= Owner Earnings $28,464,000,000
*I am removing the distortion in Berkshire’s reported net income for 2022 that was created by the recently imposed requirement to show market adjustments to securities losses or gains – in this case a $67 billion paper loss on securities still held by Berkshire Hathaway in the Income Statement. To be consistent I have not included the $8 billion tax credit caused by $67 billion paper loss.
Step 2 – Discounted Cash Flow Calculations
Initial Cash Flow: $28,464,000,000
Number of Years: 10
Estimated Growth Rate: 10%
Discount Rate: 4.5%
Cash Flows Value @ 10% Growth Rate Discounted by 4.5%
Year 1 $31,310,400,000 $29,962,105,263
Year 2 $34,441,440,000 $31,539,058,172
Year 3 $37,885,584,000 $33,199,008,602
Year 4 $41,674,142,400 $34,946,324,844
Year 5 $45,841,556,640 $36,785,605,099
Year 6 $50,425,712,304 $38,721,689,578
Year 7 $55,468,283,534 $40,759,673,240
Year 8 $61,015,111,888 $42,904,919,200
Year 9 $67,116,623,077 $45,163,072,842
Year 10 $73,828,285,384 $47,540,076,676
Totals $499,007,139,227 $381,521,533,516
Step 3 – Comparing Sum of Cash Flows with Market Capitalization of Berkshire Hathaway (5/10/23) to Determine if there is a Margin of Safety.
The Discounted Cash Flow model has calculated the present value of the future cash flows of Berkshire Hathaway, given our assumptions, at $381+ billion dollars for the next 10 years. Using Mr. Buffett’s preferred way of doing things, he has said that he likes to look at the whole business rather than per share value as he likes to think of himself as a business owner. So, we will compare the $380 billion with the current market capitalization of Berkshire Hathaway to see if there is a margin of safety. If the $380 billion estimated valuation is higher than the current market cap, then Berkshire’s stock could be considered to be underpriced and a margin exists.
Comparing the results – again $380 billion of future earnings or cash flows – with today’s market capitalization of Berkshire Hathaway, which is $713.51 billion (Yahoo Finance, 5/10/23) and find that there is not a margin of safety for buying Berkshire Hathaway, using the DCF method and my calculations, but that Berkshire’s market value exceeds the discounted cash flow value.
Podcast 28: Value Investing Building on What You Know: Estimating Future Value, An Introduction to Margin of Safety and the Value of Strategy
Dr. Lehan suggests that the best starting point, and long-term perspective is by building your investing skills on what you already know. How does a person do that? There have to be right ways and wrong ways. How do I translate my general knowledge of business into focused inquiries that accurately assess the value of a company and its stock? Dr. Lehan outlines the steps for one value investing approach to estimate a company's potential and future value. He also introduces margin of safety - a critical value investing principle - for a more lengthy review in the next podcast. The final topic is why strategy is critical, along with plans. As always, the podcast concludes with practical questions for listeners to answer and compare with Dr. Lehan's subsequent answers to the same questions.
Problems/Questions – Financial Frameworks Homework Posted
Estimating a Stock’s Future Growth:
Problem: I have used two examples of stocks – Delta and Next Era Energy today. I suggest that you find a stock that you are interested in and find the PE and PEG for that stock in the financial resources that you use. If the stock has a PEG under 1, follow it for 2 or 3 weeks to see if the PEG changes. If your first stock pick doesn’t have a PEG below 1, pick another one until you find one that does, then follow it. I will do the same and post my findings on Financial Frameworks.
Financial Frameworks Actions: I decided to stick with the energy sector and did my usual reading – Yahoo Finance, Wall Street Journal, NY Times Business Section, Value Line and two subscriptions that I get and selected Epsilon Energy as a candidate. It has a PEG of .02 and the PE is below the industry average. Additionally, the price per share has dropped by about 10% since I started watching it, so I’m wondering if it is a bargain – market headwinds, or something is wrong. The price drop interests me, so I have done additional research reviewing financial statements and comparing Epsilon with competitors. I will keep you posted regarding Epsilon.
Strategy:
Problem: A big part of my strategy is sticking with things I understand. Based on our PEG research, and general market information, one example today, Delta Airlines, could be a good buy. But it is outside of my stated areas of expertise. What will I do? A famous theologian once said that he “ Can resist everything but temptation..” I have several choices of action. What do you think I will do, and equally importantly, what would you do?
Financial Frameworks Actions: Deciding what to do about Delta Airlines was an emotionally draining process. But it was – and hopefully, continues to be – worth the effort. For the next several days following the posting of the podcast Delta rose from $33.02 (when I looked at it on 4/13/23) to $36.19, closing at $35.93 on 4/19/23. A 9% gain in 5 trading days will get a person’s attention. My internal debate revolved around answering two questions: 1) “Do I stick with my circle of competence or venture beyond it because Delta is such a solid company?” 2) “Is my knowledge of Delta, and the passenger airlines business sufficient to commit my limited investment dollars to it’s future?”
Surprisingly, I answered the second question first because I have been reading works by Daniel Kahneman (Thinking Fast and Slow) in which he analyzes intuitive logic versus, logical, procedural, systemic logic. My conclusion after that review was that I have a general level of knowledge about Delta and how the passenger airlines industry works. And I have the statistics showing post-pandemic traffic increases. But I don’t have the inner workings knowledge of the business required to commit dollars to its future in the form of Delta stock.
Turning to question 1, I concluded that I am sticking to my circle of competence, but in a roundabout way that did not at the time feel logical. Now, several days later, reflecting on the decision-making process is giving me more insight into the way I integrate logic and emotion. It reminded me of a conversation with a friend of mine whom I worked for and admired in the banking industry (He was an executive vice president at the firm we both worked for,) once saying to me: “Do you think I’m smart, Michael?” I said; “Yes.” He said; “Thank you. And I can always be smarter. Now, I have what may seem like a stupid question for you.” Maybe the getting-smarter process is sometimes circuitous and indirect.
Podcast 27: Investing: Building on What You Know, Value Investing, Today’s Market, & ESG Developments
Successful investing is an interdisciplinary process that starts with using what you know and, through solid questions; building a durable framework to hold onto your money. Today’s podcast contains four threads - building on what you know, value investing, mid-March market concerns and ESG in Kentucky.
Podcast 26: Conclusion to ESG Metrics: Selecting An ESG Assessment Method
Environmental, Societal and Governance (ESG) business practices are increasingly part of many investors criteria for buying a stock. Dr. Lehan has examined four alternative ways to assess ESG in previous podcasts and in this episode concludes the analysis with a recommendation that does not require a lot of time while being comprehensive. For simplicity and time sake, this and previous podcasts have focused on the greenhouse gas element of ESG, while the process can be applied to other ESG issues.
Hold Onto Your Money - 4 Approaches to Measuring ESG - Part 4
Financial Frameworks Podcast 25 looks at four ways to measure ESG performance by a company you might want to invest it. Dr. Lehan starts at a high level with the United Nations Principles for Responsible Investing and finishes with the concrete metrics of Key Performance Indicators. The review of these four different approaches will lead to tools to evaluate the ESG information you get in a way that you can use them with individual investments. After all, if you can't use something, what good is it?
Value investors balance safety and growth and now ESG factors come into the equation. How to measure ESG performance? Who is doing the measuring and what do the indices mean? Dr. Lehan reviews four methods so that we understand different approaches before applying them.
Resources:
BlackRock: https://www.blackrock.com/corporate/about-us/investment-stewardship#stewardship-policies
Stern Business School: https://www.stern.nyu.edu/sites/default/files/assets/documents/NYU-RAM_ESG-Paper_2021%20Rev_0.pdf
KPIs: Allvue Systems: https://www.allvuesystems.com/resources/a-complete-list-of-esg-kpis-by-industry/
Morgn Stanley: https://www.morganstanley.com/ideas/sustainable-investing-funds-opportunities
Holding Onto Your Money with ESG Investments - Building Metrics - Part 3
ESG investing is growing and with that growth and interest comes competing concepts of what Environmental, Societal and Governance standards are. Dr. Lehan explores way to commit to ESG with minimal research by an individual investor and examines assumptions and different metrics, and their basis, for investors who want a more detailed understanding. A more detailed understanding is helpful to those building a lifetime investing financial framework for themselves. This podcast is number 3 in a 6 part series as Dr. Lehan applies his framework building tools to assist interested investors in building metrics that mesh with their values while incorporating financial and business standards.
Resources:
Stern Business School & Rockefeller Asset Mgmt Report Link: https://www.stern.nyu.edu/sites/default/files/assets/documents/NYU-RAM_ESG-Paper_2021%20Rev_0.pdf
Harvard Business Review articles (2) links: https://hbr.org/2022/03/an-inconvenient-truth-about-esg-investing
https://hbr.org/2022/08/esg-investing-isnt-designed-to-save-the-planet
United Nations Principles of Responsible Investing Link: https://www.unpri.org/
Black Rock Investment Stewardship Principles Link: https://www.blackrock.com/corporate/about-us/investment-stewardship
Holding Onto Your Money - ESG Investing to Build Your Savings - Part 2
Financial Frameworks Podcast 23 continues last week's discussion of ESG investing as a way to hold onto your money. This podcast examines two companies - one and ESG (Environmental, Societal, Governance) company by virtue of the way it does business - Microsoft and a second company that produces an environmental improvement product and service, renewable energy. That company is Next Era Energy. Dr. Lehan, using a drill down method uses these two companies as models for listeners to develop their own templates. Both companies are making significant efforts, provide investors with a lot of high quality information and also generate opinions about their efforts - more information for investors to put into their mental grist mills when considering alternative ESG investments. In short, in addition to be being solid companies, they are excellent teaching tools.
Dr. Lehan offers his own criteria for investment safety, growth and ESG evaluation in a way that listeners can build on those tools. Finally, questions and tasks are presented to listeners as next steps in their investment and savings education process.
Resources:
ROIC Formula Link: https://www.investopedia.com/terms/r/returnoninvestmentcapital.asp
Microsoft Environmental Sustainability Report Link: https://query.prod.cms.rt.microsoft.com/cms/api/am/binary/RE4RwfV
Next Era Energy Sustainability Report: https://www.nexteraenergy.com/content/dam/nee/us/en/pdf/2022_NEE_ESG_Report_Final.pdf
Holding Onto Your Money & ESG Investing - Part 1
This podcast is part of a series about holding onto your money through savings accounts, CDs and investments. This podcast focuses on ESG investing through definitions, examples and tasks for listeners.
The podcast provides ESG definitions from institutions and from brokerage firms selling ESG investments to then assist listeners in finding and evaluating ESG investments in a neutral and efficient way while using information and screening methods provided by brokerage firms. ESG investment requires integrating ones' values with criteria for safety and growth in investments. Dr. Lehan provides listeners with questions and tools to research and answer those questions.
Resources:
CFA Institute: https://interactive.cfainstitute.org/ESG-guide
Investopedia: https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria.asp
Holding Onto Savings - Savings Accounts and CDs
Saving money is not easy. Holding onto those savings is important work and requires attention. We've looked at issues in using stocks and bonds for savings and this episode considers certificates of deposit and savings account. As always, I look at how we think about matching our values with financial plans and included a question or problem or two for listeners' consideration. References for further exploration are included.
Resources:
Investopedia Link: https://www.investopedia.com/terms/c/certificateofdeposit.asp
Nerdwallet Link: https://www.nerdwallet.com/article/banking/5-best-alternatives-to-traditional-savings-accounts
The Millionaire Next Door:The Surprising Secrets of America’s Wealthy, Thomas Stanley, William Danko, Taylor Trade Publishing, 2010
Holding Onto Your Savings - Where to Put Them - Stocks & Bonds
Setting money aside to create savings is difficult and challenging work. Inflation makes it harder. Let's say that you are doing that, now where are the savings stored so that you hang on to them for the long-term - whether that is 2 years or 20 years? This podcast finishes setting the context - all the information you receive and how you think about saving - and outlines two strategies. One from game theory and one from Peter Lynch. Both balance safety and growth. Both address your thinking and focus on stocks and bonds as the vehicles. The strategies are summary level, and that is ideal for you to explore the aspects of the strategies that are most important to you. The podcast contains questions for you and additional resources. The next podcast will move onto savings accounts and CDs.
Resources:
Podcast Citations.
1. Julia Child: How to Flip a Potato Dish, You Tube
Link: https://www.youtube.com/watch?v=k6s6rVAkFrE
2. Headline: “What are safe investment during volatile market? Experts weigh in” Two experts cite short-term treasury notes, Treasury Inflation bonds, certificates of deposit or longer-term bonds. Yahoo Finance Ines Ferre, 10.17/22
3. Article two from Deep Dive by Phillip van Doorn (10/12/22)headlines “The stock market is in trouble. That’s because the Bond market is ‘ very close to a crash.’ Mr. van Doorn cites other souces who believe that the bond market could see an absence of Treasury bond buyers in the near future.
4. A Bloomberg article dated 6/24/22 by Suzanne Woolley entitled “Where to Invest $1 million right now” starts with the lead sentence; “It’s scary out there.”
5. Last note on bonds,, a three page article in the New York Times dated 9/30/22 by Jeff Sommer headlines “Bonds May be Having their Worst Year Yet” While the headline is an attention grabber, Mr. Sommer states that principal is safe, if bonds are held to maturity, then later states that bonds are having their worst year ever since 1926.
Link: https://www.nytimes.com/2022/09/30/business/bonds-market.html
6. Finally – the icing on the cake – an article with the headline “We Are Seeing Very Attractive Valuations: Billionaire Dan Loeb Likes These Two Stocks in Particular” appeared on TipRanks and Yahoo Finance on October 20, 2022.
Link: https://finance.yahoo.com/news/seeing-very-attractive-valuations-billionaire-153925057.html
S & P 500 Average Return 1928 – 2021, Investopedia
Link: https://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp
Historical Return on Stocks, Bonds, ND Bills, 1928 – 2021, NYU, Stern School
Link: https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
Behavioral Finance
How Customers Think: Essential Insights Into the Mind of the Marketplace, Jerald Zaltman, Harvard Business School Press, 2003
Thinking Fast and Slow, Daniel Kahneman, Farrar, Straus & Giroux, 2011
Small Cues Change Savings Choices, James J. Choi, Emily Haisley, Jennifer Kurkoski, Cade Massey, Journal of Economiic Behavior & Organization, August 24, 2017
Stock & Bond Related Resources
The Intelligent Investor, Benjamin Graham, There are multiple versions in print. I recommend the 1973 revision without commentary – dated material but easier to grasp the concepts – for me at least, Harper & Row, 1973.
One Up on Wall Street, Peter Lynch, Simon & Schuster, 1989
Treasury Direct: Very informative. Somewhat complicated and the source for direct purchase of Treasury bonds.
Link: https://www.treasurydirect.gov
FRED – St. Louis Federal Reserve. I recommend using the link below to access the St. Louis Federal Reserve Economic Data and then typing in a general search query – something you are interested in – prices, rates, behavior for the last 6 months, Treasuries, corporate bonds – and then selecting from the results to further refine your focus and familiarize yourself with terms and issues. I like this method because it informs what I already know and often takes me to topics that I wouldn’t necessarily thought of, but are useful contributions to my framework.
Two Strategies for Holding Savings Value During Inflationary Time
Podcast 20, Financial Frameworks
Strategy 1, Maximin Planning Strategy: Keep Losses to a Minimum
1. What are your Critical Assumptions:
Timing – flexibility or no flexibility with fluctuation
in principal. Savings Funds must be in place
(months or years from now) on this date _______
Savings Amount for this Exercise _______
2. Goal (or Goals) – rank, or percents, usually work,
1 being most important, 4 being least preferable
Preservation of Principal ___
Hybrid of principal preservation/beat inflation ___
Hybrid of principal preservation/12% growth ___
12% growth, poised for post inflation ___
3. Assessment of Environment:
Project your Estimate of the inflation rate at 3 different points in time.
Inflation Factor: 6 months from now inflation will be ___
1 year from now ___
2 years from now ___
4. Recession Factor: Likelihood of recession. Select a percent
likelihood factor. I usually use 10%, 25%, 50%, 75%, or 100%,
because of the emotional resonance of those numbers for me. ____
5. Conclusion: Projected Value of Savings Amount at Time Period Stated in Assumption. The objectives are restated for listing the projected the value because your result should be consistent with your process.
Preservation of Principal Projected Value ________
Hybrid principal preservation/beat inflation ________
Hybrid principal preservation/12% growth ________
12% growth, poised for post inflation ________
Strategy 2: Peter Lynch Stock Selection Alternative
Peter Lynch repeatedly states “Never be out of the market.” He then goes on to articulate how difficult it is to time bottoms and peaks of markets and that a small number of days can contribute significant gains. In addition to outlining elements of his approach to selecting investments, Mr. Lynch spends a lot of time in One Up On Wall Street describing characteristics that a successful investor should have. For our purposes here, I will cite four that he highlights repeatedly as essential. They are:
1. Patience
2. Persistence
3. Detachment
4. Willingness to do independent research.
The second element of the strategy is to consider looking at stocks like Peter Lynch does. He divides his holdings into 6 categories:
· Slow growers
· Stalwarts
· Cyclicals
· Fast growers
· Turnarounds
· Asset plays (buy stock for book value of companies net assets).
During stressful times – this would qualify for that - in One Up on Wall Street Mr. Lynch selects those stocks from his 6 categories that he believes that will do best – keep selling products, maintain reasonable profit margins, etc. during that portion of the business cycle – a business downturn of trough portion of the business cycle.
Strategy 2 tasks:
1. Rank yourself – 5 being high and 1 being low in terms of
these 4 qualities. Please don’t apply the Lake Woebegon classifications developed by Garrison Keilor on Prairie Home Companion “where all the women are strong, all the men are good-looking, and all the children are above average.”
1. Patience _____
2. Persistence _____
3. Detachment _____
4. Willingness to do independent research _____
2. Let’s assume that you ranked well in the four qualities. Your second task is to determine your independent research ranking. Please spend between 1 and 2 hours looking up companies that fit into one, or two of Peter Lynch’s categories and produce a list of 5 to 8 candidates for your investment.
As the final part of your exercise answer two questions.
1) Did I enjoy doing that research? What aspects?
_______________________________________________
_______________________________________________
2) How did I look for negative information about my candidates?
_______________________________________________
_______________________________________________
Keeping Your Savings - Where to Put It - Balancing Safety & Growth
This podcast is the first of three that, reviews stocks and bonds as places for savings in terms of balancing safety and growth. The podcast asks listeners to examine how they handle financial information - especially conflicting and uncomfortable data.
The podcast provides filters and tasks for a listener's self-assessment and sets the stage for the next podcast in which I'll suggest how to make safety and growth measurable - within a person's financial framework - before outlining two strategies to do it. The goal here is for a person to be clear about their decisions, continue to learn and build at the same time, during this savings challenged inflationary time, and to hold onto their savings despite the current market volatility and cost inflation headwinds that we all face.
There will be a third podcast that applies the same framework to other savings vehicles including savings accounts and CDs.
Saving - Why It Is Hard and Some Steps for Success
Resources Mentioned in the Podcast:
The Little Book That Beats the Market, Joel Greenblatt, Wiley, 2010
Treasure Hunt: Inside the Mind of the New Consumer, Michael J. Silverstein, Penguin, 2006
The Fight Over Inequality, Thomas B. Edsall, New York Times, April 22, 2012. Link: https://archive.nytimes.com/campaignstops.blogs.nytimes.com/2012/04/22/the-fight-over-inequality/?searchResultPosition=1
Financial Wellness Meets Behavioral Economics, Shlomo Benartzi, Voya Financial. Link: https://www.voya.com/page/financial-wellness-meets-behavioral-economics
MarketWatch: Two Links to articles re saving
1. Not Getting By on $350,000 Link: https://www.marketwatch.com/picks/im-paycheck-to-paycheck-i-make-350k-a-year-but-have-88k-in-student-loans-170k-in-car-loans-and-a-mortgage-i-pay-4-500-a-month-on-do-i-need-professional-help-01664544530
2. Mark Cuban on savings. Link: https://www.marketwatch.com/picks/mark-cuban-has-repeatedly-given-this-simple-piece-of-money-advice-and-its-more-lucrative-to-do-it-now-than-it-has-been-in-over-a-decade-01664393871
Rich Dad Poor Dad. The website shares budgeting and planning tools. Link: https://www.richdad.com/resources/tools
This podcast outlines some of the reasons - practical realities, what our choices are and overview statistics that provide a framing context both for reflection and for analysis. There are no two ways about it, saving money is not easy - not a walk in the park for most of us. After revieqwing some of the obstacles - to better avoid or overcome them. I talk about steps that a person, or a family can take to cause saving to happen. They are not exhaustive - anybody who can do that in 20 minutes, my hat is off to them - and the points are starting points. The podcast concludes with some questions, or problems to think about, transfer to your own situation and develop strategies for. Good decisions often take time, so the questions are food for thought. Finally, the episode concludes with a list of resources cited that could provide further illumination for the listener. Those resources are listed here as well.
Financial Frameworks’ purpose is to increase your financial decision-making skills, particularly about saving and keeping what you earn, building on what you already know.
The Consumer Price Index - What It Is and Why You Care About It
When we make financial decisions we include personal data - we have 3 children, we have no children - and personal preferences: I want to buy a convertible but what is really needed is a medium-sized SUV. We include hard and fast financial information, like our monthly budget, or annual salary. However, when looking into the future - because all financial decisions bear on the future and are beneficial to, or detrimental to our future, some consideration needs to be given to what that future will look like. Since consumer spending is a big piece of the US economy - about 70% - looking at whether costs are increasing or decreasing is a useful thing to do. Start with the Consumer Price Index because it is comprehensive, clear, reasonably accurate and well thought out. This podcast provides a 20 minute practical way to do that.
In the CPI podcast I asked you what you think the CPI report at the end of September will show regarding gasoline prices and, again, where you think inflation will be in 6 months, or to be more specific, at the beginning of April. In order, where I live gas prices are at about $3.39. I believe, that the CPI will show a 20 - 24% drop in gas prices for the month of September.
Regarding inflation, I, as others do, divide inflation into two categories: Transitory, or short-term due to specific issues, like certain supply chain issues, and Long-term, like meat prices if there are no cattle going to market, or other supply chain issues. I think the segment that is short term will drop significantly by April and that long-term issues, particularly related to food (which is about 13.5% of the CPI) will come down but more slowly, so my estimate is 5.5% for the beginning of April. We will see!
Resource: Link to the Bureau of Labor Statistics CPI Report
released 9/13/22: https://www.bls.gov/news.release/pdf/cpi.pdf
The Language of Finance - A First Pass
Resources:
Merrill Lynch “How to Read A Financial Report” Link: https://homepages.rpi.edu/~guptaa/MGMT2320/Handouts/howtoreadfinreport.pdf
Investopedia: Click Dictionary. Link: https://www.investopedia.com/financial-term-dictionary-4769738
60 Business and Finance Terms You Should Absolutely Know. Fundera, authored by Nerdwallet. Link: https://www.fundera.com/blog/business-finance-terms-and-definitions
Berkshire Hathaway 2nd Quarter Report, 2022. Link: https://www.berkshirehathaway.com/qtrly/2ndqtr22.pdf
Federal Reserve Economic Informational Resources: Link: https://www.federalreserve.gov/econres.htm
This podcast presents financial terms and their application - including Return on Investment, Direct vs. Indirect Costs, Prime Rate and Real Dollars vs. Accounting Dollars - along with examples and questions for the listener. While the concepts and definitions are have solid theoretical grounding, applications and their usage usually help things stick better.
Part 3 with Dr. Philip Giles: Fed’s Actions - Inflation, Interest Rates & Quantitative Tightening
This podcast continues Financial Frameworks' discussion with Dr. Philip Giles about the Federal Reserve, quantitative easing, inflation, interest rate hikes and quantitative tightening. Both Dr. Lehan and Dr. Giles believe that individuals need to understand how interest rates have immediate and long-term effects on individuals and families. This 3rd segment of the conversation focuses on what is happening right now - interest rate increases and quantitative tightening by the Federal Reserve. As we often do, questions and problems are posed at the end of the episode.
Part 2 with Dr. Philip Giles Re. the Fed, Interest Rates, Inflation and Quantitative Easing Since 2020
This podcast continues our conversation with Dr. Philip Giles regarding the recent (last 20 years) actions by the Federal Reserve in dealing with financial crises and the current rise in inflation. This podcast focuses on quantitative easing and the tools, including Federal Funds interest rates, the Fed has been using between 2020 and early 2022 to avoid the economic pain created by the COVID pandemic. This podcast links the esoteric and often seemingly obscure actions by the Fed with listeners everyday thinking about interest rates and financial decisions. We work to link key concepts to routine financial decisions to build stronger, better financial habits.
Conversation with Dr. Philip Giles - Part 1, the Fed, Inflation & Interest Rates
This podcast is the first of three conversations with Dr. Philip Giles, formerly of Columbia University, regarding the Federal Reserve, recent economic events, quantitative easing and tightening and recessions. Dr. Giles has advised financial institutions and taught money and banking, fixed income securities and interest rate theory to bank lenders and senior executives in the US and internationally.
The Federal Reserve manages interest rates, which, in turn, directly influence financial decision making, business cycles, corporate investment and jobs. This podcast provides background for discussing the "free money" we've just experienced and the "free money is over" period we are now experiencing. As is the case for all Financial Frameworks podcasts, the emphasis is practical and on providing information you can use in your own financial framework.
Budgeting During Inflation Using Cash Flow & Risk Metrics
Many individuals and families have not experienced an inflationary period similar to what we are experiencing right now. The last time the economics and business cycle looked like this was in the early 1980’s. How does an individual or family decide about purchases, or deferring them when prices are rising rapidly, interest rates are increasing, there is doubt about what the economy will look like 6 months from now and other forces - climate, a war in Europe, political issues - abound. Financial Frameworks takes its core framework - cost vs. worth - and applies it to budgeting and expense questions. This podcast provides examples and problems as well.
A Practical Recession Primer for Individuals
This podcast is intended to be useful to you in determining how and whether the recession will have an impact on your life and assist you in making upcoming financial decisions. We’ll cover five things in this podcast;
Questions that you need to be asking yourself because if you are asking really good, focused questions, you will get better data and answers.
A summary snapshot that defines a recession (so that, when you are listening to a commentator, you are on the same page), outlines immediate effects, then long-term effects, then compares today to previous recessions.
Three examples of behavior in an economic downturn – actions to avoid and actions to embrace.
As in previous podcasts, some questions and problems to consider, then conclude with some additional resources for your use.
Here are this podcasts’ questions and problems for your consideration. I’ve also included my suggested responses to the questions
a. Most financial planners, and retirement advisers, and security firms advise individuals to have X months worth of savings available for surprises? What is the number of months that your research uncovered?
My research turned up 7 out of 8 responses suggesting 3 to 6 months. My recommendation is more conservative and also includes spending only on the basic necessities and is 6 months. Part of my thinking in suggesting that is due to, what seems to me, to be so many employment variables and changes occurring in the workforce today.
b. You are seriously considering making a major expenditure in the next 3 months. Do you do it or hold? More importantly list the top 4 criteria for your decision.
I would initiate the expenditure if I was 100% certain, with data to back it up, that the expenditure would pay for itself within a reasonable amount of time (which definition varies from person to person - in my case, 4 years) and produce additional income. If it did not meet those criteria, I would not go forward with the expenditure.
c. Take 20 minutes and write down what your assessment is of how an economic downturn lasting 8 months and reducing your income by 15% would personally affect your situation. If you find the exercise interesting, write down any actions you would take to ameliorate the situation.
First of all, we’re making the assumption - as part of the problem - that I know that the downturn will last 8 months - when, of course, I d don’t know that ahead of time. Putting that objection aside, i will do 2 things. I’ll start looking for areas of savings, such as newspapers and books that would normally be purchased, and then I would start at the other end and add up monthly medical bills - including insurance, rent or mortgage and/or property tax bills, utilities and finally transportation and food costs. With those 2 sets of information in hand, I would start reviewing the second list to see if there were any items that could be whittled down. The last thing that I would do is start thinking about ways to increase income - get back the 15%. I am fully aware of how complicated and strenuous an undertaking that can be, so that is why it comes after expense control.
2. Resources
Solid financial thinking requires a framework for seeking and analyzing data. Because details are so important in applying the concepts, when talking about a recession, the context is very important. Three resources are recommended below. Each resource presents a piece of the puzzle for you to consider as you determine how you want to go forward in this challenging economic environment.
1) Business Insider is a reliable source for overview perspectives, delivered succinctly, while being comprehensive and accurate. The article is at the link below:
https://www.businessinsider.com/personal-finance/what-is-a-recession
The article provides an overview of recessions from the context of a business cycle, then describes what differentiated two recent recessions. I use articles like these to guide me in looking for data that is right in front of me and which I often miss.
2) MoneyCrashers is an excellent source of information that focuses on the practical implications of large scale economic activity in a personal way. This post, entitled “9 Effects of the Recession on Families and How to Cope” looks at the effects of having limited resources or experiencing sudden economic changes from several areas that would be affected, such as, education costs, investing, real estate and property maintenanceand brings it back to how a moderately well-off family can work to meet the challenges. The link is:
https://www.moneycrashers.com/effects-recession-families/
3) The final recommended resource is more to provide as much context as possible, plus it contains an excellent , with a few charts. I always recommend looking at charts because they pack so much information into a visually understandable frame. The article, from Investopedia, is entitled “A Review of Past Recessions” and begins in 1937, continuing through April, 2020. An accompanying chart showing length and using unemployment indices as the benchmark is included. The piece has a ton of information for such a short read. The link is:
https://www.investopedia.com/articles/economics/08/past-recessions.asp
A Starter Kit for Interpreting Financial Reports
This podcast is a starter kit for reading financial reports, and for building your own core financial statements – an income statement and balance sheet. It is important to be able to at least look at financial statements and a) discern whether you think a company is going in the right direction, or not, b) be able to ask questions to learn more and gain more knowledge, and c) understand your own financial position in standard financial terms – again an accurate income statement and balance sheet without having to spend 2 weeks doing so or paying a CPA to do it for you.
Reading materials that support learning how financial reports are structured:
Purely descriptive and from the point of view of corporate reporting, but categories are applicable to personal financial reports. The first is a Merrill Lynch publication, “How to Read A Financial Report” – downloadable at: https://homepages.rpi.edu/~guptaa/MGMT2320/Handouts/howtoreadfinreport.pdf
2. A second source of information that focuses more on personal financial learning, but includes some business material from an entrepreneurial perspective is the book Rich Dad, Poor Dad. The website associated with the book is linked below and contains related materials for your review.
Link: https://www.richdad.com/
Because financial reports contain so much information and are pretty densely packed with data, one needs robust reading skills to be able to consume, effectively, large volumes of data. I found, in talking with my students, that many of them had not received much training in how to read. A link is presented below that summarizes the main points from Mortimer Adler’s very thorough book, How to Read a Book. I particularly recommend the section on Inspectional Reading.
Volatility, Mr. Market & Using Your Framework
Podcast 9 reviews a 7 part financial framework introduced earlier and asks questions that focus on market volatility and conflicting information. Examples, including the famous Mr. Market story from Benjamin Graham, a review of Peter Lynch’s - a fromer manager of Fidelity’s Magellan Fund - approach to volatility and concludes with questions and problems for the listener’s consideration.
A Detailed Framework & Values
In the first Financial Frameworks podcast we talked about two frameworks, or models, for you to consider using when analyzing financial issues. The first model was simply to compare cost and resulting worth: that is look at what something cost – including all costs, and comparing the costs with the value or benefits, or profit, that you would be receiving to determine if the expense was worthwhile. That is a very simple, sort of a root type of framework. The second framework expanded cost and worth into greater details and organized them into 7 areas. This podcast will describe that 7 part framework in further detail and will focus on the importance of integrating these tools with your values. Your decisions need to be consistent with your values in order to be the best possible decisions. Again, incorporating values in financial decisions is not difficult, but does demand clarity and discipline. When analyzing a financial choice, I find that this 7 part framework is useful whether the analysis is simple, and it is used as a checklist, or more detailed, requiring notes, calculations and a written explanation. In the latter case, the first step is to fill in the blanks, secondly, determine which elements are most important for the problem under consideration, then begin assembling the specific numbers.
Interest Rates - Understanding & Anticipating
This podcast looks at the practical hows, whys and what’s f interest rates. Most of us are taught the what’s - on things like credit cards, car loans and mortgages. However, planning, being in charge and having a framework for making good decisions means understanding the hows and whys of interest rates before making choices. In addition to going over the hows and whys of interest rates, we will provide some context for the near future, framing why interest rates will be rising. Finally, the podcast will tackle the question of how to make rising interest rates work for you?
Core Concept - Return on Investment
Podcast 6: Return on Investment Question: An initial investment of $1,500, left untouched, compounding at an average rate of 23% per year, for 25 years, looks like this.
Period Initial Value Value After Compounding
$1,500.00 $1,845.00
$1,845.00 $2,269.35
$2,269.35 $2,791.30
$2,791.30 $3,433.30
$3,433.30 $4,222.96
$4,222.96 $5,194.24
$5,194.24 $6,388.91
$6,388.91 $7,858.36
$7,858.36 $9,665.79
$9,665.79 $11,888.92
$11,888.92 $14,623.37
$14,623.37 $17,986.75
$17,986.75 $22,123.70
$22,123.70 $27,212.15
$27,212.15 $33,470.94
$33,470.94 $41,169.26
$41,169.26 $50,638.19
$50,638.19 $62,284.97
$62,284.97 $76,610.51
$76,610.51 $94,230.93
$94,230.93 $115,904.05
$115,904.05 $142,561.98
$142,561.98 $175,351.23
$175,351.23 $215,682.02
$215,682.02 $265,288.88
This podcast continues working through the four applied concepts for analyzing financial decisions that I think are great cut to the chase tools - namely looking at decisions through the four lenses of cash flow, profitability, return on investment and risk clarification. Today we will look at return on investment. Return on investment measures the results of an investment in a specific time period. For example, I put $1,000 in a 401K today. One year from today the balance is $1,100 – the result is $100. $100 divided by $1,000 is a 10% increase or return. That is the arithmetic. However, thinking about future benefits, or profits, in broader terms than just the math; to include all of the elements that go into a return on investment decision is a valuable financial framework tool. And that is what we will be talking about today. In addition I will outline some practical personal and work-related situations, look at some examples of why thinking about return on investment as clearly as possible in all sorts of financial decisions is of benefit to you.
Core Concept - Applied Risk
This podcast will look at risk and how one makes risk issues as clear as possible in different types of decisions.
Understanding the risks involved in making a financial choice is essential for the decision to be successful. For our conversation today we will provide working definitions of risk and the podcast looks at risk from three perspectives, first an individual perspective – how a person incorporates risk into their thinking, secondly organizational, focusing on Highly Resilient Organizations. Finally, the podcast describes risk from an investment perspective and presents questions for listeners to consider.
Podcast 5 Problem: Summary of Analysis of Risks per the Four Categories Outlined in Podcast 5.
Tesla Inc.
1. What don’t I know:
I do not have the knowledge to confirm Tesla’s claim of 200,000 per car. The car is more than a battery. Will the vehicle last? More research is required.
2. Industry Risk:
Every piece of market research I found predicted industry growth of 5 to 10 times. Even if they are off by 50%, that provides a sufficient margin of error to support investing.
3. Market Risk:
Several analysts predict a significant correction. However, my approach follows Peter Lynch - stay in the market. There is risk, but Tesla’s financials support long-term value.
4. Company Risk:
Tesla’s financials and 1st quarter production support long-term growth. The primary question that I will research is; “When Tesla’s prime mover advantage begins to shrink will their margins hold?” My second question will be to observe whether production costs diminish per unit as production grows. That would be a significant moat.
Four Core Concepts, Profitability & Retained Earnings
This podcast outlines four core concepts for analyzing financial decisions that I believe are great for someone not trained in finance to quickly decide what aspects of the analysis or problem are most important and need to be focused on. I use these concepts as lenses to focus on investments, significant purchases, planninng and for building day-to-day habits. After the overview we will look more closely at one of the four concepts, profitability, and finally, we will answer the question I asked in Podcast 3: How does one evaluate whether profits, or surplus funds, are being used well?
The Four Core Concepts are: Cash flow, Return on Investment, Profitability and Risk Quantification.
Personal Retained Earnings:
Was the surplus money, the retained earnings, used the way I intended to use it? Yes. The funds are still in place for use in a capital project that will occur on my property later in 2022. Opportunities for growing the funds - investments were looked at and declined because, if principal declined, there is currently now way to replace these funds.
Investment Evaluation Retained Earnings
Berkshire Hathaway: The short answer to this question is to note that Berkshire had net earnings (after taxes) in 2020 of $43 billion and during 2021 the company had net earnings of $90 billion. Even taking into account the pandemic, a doubling of net earnings indicates that the retained earnings from 2020 did not sit idle.
Rivian: The answer to this question will be in Rivian’s 10 Q for the next quarter. Right now - at least as far as I can tell from my reading - and please feel free to inform me as I miss things - i don’t know exactly how the funds are being used.
Four Key Concepts, Inflation & Budgeting
Podcast 3: Inflation Gasoline Example.
Let’s go over my criteria for evaluating the impact of increased gasoline prices, then you will place them in your “Keep the Ship Steady Inflation Framework”, fill in the blanks as an example and see if that produces an intelligent strategy.
Criteria for Evaluating Impact of Inflation:
Annual gas expenditures 2021 8,500 miles @ 20 mpg @ $3.01 per gallon = $1,279.25
Projected for 2022 8,500 miles @ 20 mpg @ $4.31 per gallon = $1,827.50
Net potential increased cost for 2022 = $548.25, or 42% more - for that expense category - gas.
% of disposable income (estimate is OK) 4.5% for avg household @ $3,000 and 12.4% for bottom 20% of households
Wiggle room in your disposable income I try to save 4% of my gross income or $2,400, so increased gas takes a bite.
Possible offsetting savings/non-expense ????????
Source of additional gas funds Savings, no movies, fewer books, fewer trips?
Value of fewer trips + + +
Value of continuing to spend same amount - - -
Value of alternative solution What is cost of less socialization. Decided to hold additional cost to + 10%, give up buying books, plan driving.
Podcast 3 provides four key concepts, or lenses, that can be used to categorize financial questions in terms of the end, or what is most important - cash flow, profitability, return on investment or risk analysis. These are priority points from which to start when examining complicated, or difficult, choices you may have. The podcast also provides insights into current inflation issues and budgeting techniques.
Time Value of Money, Biases, A Decision Matrix & Inflation
A Financial Framework: Build on What You Know With Sound Fundamental Concepts.
This podcast introduces financial frameworks as an essential tool in making better financial decisions and becoming more skilled in the process at the same time. The podcast introduces concepts, tools and problems as the emphasis here is on learning by doing. The frameworks and tools are presented to fit listeners' situations rather than asking them to fit their concerns to standard formulas and concepts.
Supporting Materials for Podcast 1
Link to Uncomplicated Compounding Example: https://www.calculator.net/compound-interest-calculator.html
Link to sophisticated Compounding Example: https://www.5minutefinance.org/concepts/time-value-of-money-multiple-cash-flows