Category Archives: Value

Price is what you pay; Value is what you receive

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A rumpled man walks into a bank in New York City and asks for the loan officer. He says he is going to Europe on business for two weeks and needs to borrow $5,000.

The bank officer says the bank will need some kind of security for such a loan. So, the man, clearly eccentric, hands over the keys to a new Rolls Royce parked on the street in front of the bank. Everything checks out, and the bank agrees to accept the car as collateral for the loan. An employee drives the Rolls into the bank’s underground garage and parks it there.

Two weeks later, the man returns, repays the $5,000 and the interest of $15.41.

The loan officer says, “We are very happy to have had your business, and this transaction has worked out very nicely, but we are a little puzzled. While you were away, we checked you out and found that you are a multi-millionaire. What puzzles us is why would you bother to borrow $5,000?”

The man replied, “Where else in New York could I park my car for two weeks for $15.41?

Price to Earnings (P/E) Ratio

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Price is what you pay. Value is what you get.

The price-to-earnings ratio, or P/E ratio, helps investors compare the price of a company’s stock to the earnings the company generates. The P/E ratio helps investors determine whether a stock is overvalued or undervalued.

By comparing the P/E ratios companies in the same industry, investors can determine which companies are relatively under or over valued in comparison to their industrial peers.

The P/E ratio is derived by dividing the market price of a stock by the stock’s earnings.

The market price of a stock tells you how much people are willing to pay to own the shares, but the P/E ratio tells you whether the price accurately reflects the company’s earnings potential, or it’s value over time.

If the P/E ratio is much higher than comparable companies, investors may end up paying more for every dollar of earnings.

The typical value investor search for companies with lower than average P/E ratios with the expectation that either the earnings will increase or the valuation will increase, which will cause the stock price to rise.

On occasion, a high P/E ratio can indicate the market is pricing in greater growth that’s expected in the future years.

A negative P/E ratio shows that a company has not reported profits, something that is not uncommon for new, early stage companies or companies undergoing financial perturbations.

Current stock price may be important in choosing a stock, but it shouldn’t be the only factor. A low market stock price does not necessarily correlate to a undervalued or cheap stock.

The P/E ratio is a key tool to help you compare the valuations of individual stocks or entire stock indexes, such as the S&P 500.

References:

  1. Rajcevic, Eddie, Greenbacks & Green Energy, Luckbox, May 2022, pg. 58.
  2. https://www.forbes.com/advisor/investing/what-is-pe-price-earnings-ratio/

The Greater Fool Theory

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“The greater fool theory states that the price of an object is determined not by its intrinsic value, but rather by irrational beliefs and expectations of market participants. As long as there is a greater fool around the corner willing to pay a higher price, the value will continue to rise,” — Ashwin Sanghi

The “greater fool theory” refers to the principle that one can make money by investing into overvalued assets and selling them for a profit later, because there will always be someone else, “the greater fool”, who will come along and pay a higher price for the assets.

Billionaire Microsoft co-founder and investor Bill Gates has dismissed investments in cryptocurrencies, such as Bitcoin, and non-fungible tokens (NTFS). He opined that the digital assets market is largely driven by rampant speculation, greed and the greater fool theory.

Gates stated that the phenomenon of cryptocurrencies and non-fungible tokens as something that’s “100% based on greater fool theory,” since there will always be other speculators willing to pay more for assets.

Gates said he doesn’t own any crypto because he prefers investing in assets with determinable intrinsic value (value that is justified by facts) or “things that have valuable output.”

Thus without having a determinable intrinsic value, — a value that is justified by “facts”; such as assets, liabilities, earnings, dividends and other definite values — investing in cryptocurrency and NTFs is purely speculative by investors.

In the past, intrinsic value was equated to a company’s “book value”. Subsequently, a new concept was developed; the intrinsic value was determined by the earning power or the present value of the discounted future cash flow of a company.

Regarding intrinsic value: “To use a homely simile, it is quite possible to decide by inspection that a woman is old enough to vote without knowing her age or that a man is heavier than he should be without knowing his exact weight..” — Security Analysis by Benjamin Graham, David Dodd, Warren Buffet.

According to Corporate Finance Institute, the best way to avoid being a “Greater Fool” is to:

  • Do not blindly follow the herd, paying higher and higher prices for something without any good reason.
  • Do your research and follow a plan.
  • Adopt a long-term strategy for investments to avoid bubbles.
  • Diversify your portfolio.
  • Control your emotion of greed and resist the temptation to try to make big money within a short period of time.
  • Understand that there is no sure thing in the market, not even continual price inflation.

References:

  1. https://decrypt.co/102973/bill-gates-crypto-and-nfts-100-based-on-greater-fool-theory
  2. https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/greater-fool-theory/
  3. https://medium.com/the-peanut/the-concept-of-intrinsic-value-in-security-analysis-baa26ed1d42a

Purpose in Life: Standing for Something

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“We have the vision, which is the what. We have the mission, which is the how. We have the purpose, which is the why.”

There is a well worn aphorism that goes, “If you don’t stand for something you will fall for anything.” In other words, you must have a purpose for your life, or you’re likely to live aimlessly and to live a life without meaning.

To psychologists, purpose is “an abiding intention to achieve a long-term goals that is both personally meaningful and makes a positive mark on the world.” The goals and dreams that foster a sense of purpose are ones that can potentially change the lives of other people, like launching an organization, researching a disease, or teaching kids to read.

Your purpose will change over the course of your lifetime as your identity and responsibilities changes when going from teen into adulthood, and make the shift to retirement.

Like happiness, purpose is a journey and a practice. That means it’s accessible at any age, if you’re willing to explore what matters to you and what kind of person you want to be—and act to become that person.

If we’re able to revisit and renew our sense of purpose as we navigate milestones and transitions, suggests this research, then we can look forward to more satisfying, meaningful lives.

It’s imperative for young and old alike to know and embrace their purpose in life. By doing so, it gives life meaning and a mission. It gets you up out of bed in the morning and make your day joyful and rewarding when done with purpose.

Vision Mission Purpose

A vision (What) is where you are going or what you will become. It’s what the future looks like if goals and intentions are accomplished and laid out to be the driving force of how you define success. It is your destination at a point in the near or distant future. Vision defines your goal and sets the expectation of what you’ll experience when you arrive at the destination.

A mission (How) is an actionable vision statement — something that will give the vision legs and traction. It’s the what, who and why. It helps you define the immediate goals and helps you stay focused on the plan. It is the path you follow to arrive at your destination: When someone asks you where you are going, they ask you how you are going to get there. Your mission is the how: the unique way you do what you do, the path you choose to follow, the decisions you make to get to your destination.

Purpose (Why) is your sense and feeling of resolve or determination. It’s your why for you are doing the work you are doing. What great problem are you solving, or what movement are you championing? It’s your why do you show up. It is the reason you began the journey, guided by the deeply-held values and beliefs that inspire it to make a difference.

Your purpose is the reason you exists beyond making money. And, once you know your purpose, you know what fulfills and completes you.

Purpose focuses on three elements:

  • Why do you believe you can make a difference? — Purpose needs a reason.
  • How do you achieve? — Purpose needs a plan.
  • What will it look like when you achieve it? — Purpose needs vision.

If you’re creating or evaluating your mission statement, substitute the words Why, How, and What for Purpose, Mission, and Vision. These substitutions will help you minimize any confusion between the terms and what they mean.

  • Purpose guides you. Your purpose articulates the why you do what you do, why you exists beyond making money.
  • Mission drives you. Your mission statement is how you accomplish your purpose. Your mission is what drives you every day to fulfill your purpose. It’s a direct path between your purpose and vision. Mission is doing what matters and eliminating the distractions; it activates the strategy that delivers results and impact.
  • Vision is where you aspire to be. Your vision statement is what you will experience and achieve in the future, the results you are reaching for, the measurable impact you want to make. Your vision reminds you what the difference you make will look like and what change will happen. Vision aligns leaders and followers. Vision keeps you on course, to fulfill your purpose.

Vision is the picture. Mission is the road map to get there. Purpose is the feeling that you have when you accomplish what you set out to do. For example, here is a life purpose that might resonate:

“My life purpose, to love and honor God, is foundational. My professional purpose is to be a ‘Builder’ of a future that transcends ways of working for the wellbeing of people and businesses throughout the world.” –Miles Everson, Former Vice Chairman, PwC US

Your mission is your vision in action, connecting your purpose. Here are a few additional examples of purpose statements:

  1. I want to instill in others the self-love and confidence that gives them the self-efficacy to excel and make their dreams come true.
  2. To live each day to the fullest and appreciate, as well as learn and grow from every experience.
  3. To achieve the education required to serve the purpose God intended for me. With that education, I will give back to society generously, and remarkably leave the world in some concrete way better than it was before my contribution.
  4. To be a father who raises sons to be caring, loving, respectful, responsible men, protective of their loved ones, and daughters to be caring, loving, respectful, responsible women who know their value and will not compromise it.

Billionaire investor Warren Buffett says, “The difference between successful people and really successful people is that really successful people say no to almost everything.” Once you have clear and meaningful purpose, vision and mission, you’re better able to focus your attention on what’s most important and what you value the most in life. And, you learn to say “no” to everything else.

References:

  1. https://greatergood.berkeley.edu/topic/purpose/definition
  2. https://www.forbes.com/sites/forbescoachescouncil/2020/03/04/vision-mission-and-purpose-the-difference/?sh=113e4e70280e
  3. https://www.aespire.com/blog/communications/the-difference-between-your-purpose-and-mission
  4. https://zety.com/blog/personal-mission-statement
  5. https://www.lifehack.org/articles/lifestyle/10-wise-lessons-what-i-wish-i-knew-when-i-was-younger.html

Believe in yourself.

You are often your own worst critic, and so can you be your own best supporter. If you do not have confidence in your own value, abilities and contribution, then nobody else will either. You must have faith in your intrinsic worth. We each have something to offer that is necessary and valuable, though we may not know what that something is.

You do not have to be able to see the end zone. Just because you aren’t able to visualize where you might go and how you might succeed, that doesn’t mean it will not happen. And just because you may have made mistakes does not mean that you can’t achieve your goals in the future. You can do far more than you can imagine if only you believe you can.

What is Return on Invested Capital (ROIC)

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Return on Invested Capital (ROIC) is a performance ratio that aims to measure the percentage return that a company earns on invested capital.

The Return on Invested Capital (ROIC) ratio shows how efficiently a company is using the investors’ funds to generate net income. Investors use the ROIC ratio to compute and to understand the value of a company. It represents for investors how well a company has put its capital to work in order to generate profitable returns on behalf of its shareholders and debt lenders.

Fundamentally, ROIC answers the question:

  • “How much in returns is the company earning for each dollar invested?”

Return on Invested Capital is calculated by taking into account the cost of the investment and the returns generated.

  • Returns are all the earnings acquired after taxes but before interest is paid.
  • The value of an investment is calculated by subtracting all current long-term liabilities, those due within the year, from the company’s assets.

The cost of investment can either be the total amount of assets a company requires to run its business or the amount of financing from creditors or shareholders. The return is then divided by the cost of investment.

Net operating profit after tax (NOPAT) is typically used in the numerator because it captures the recurring core operating profits and is an unlevered measure (i.e. unaffected by the capital structure).

Unlike net income, NOPAT is the operating profits post-taxes and thus represents what is available for all equity and debt providers.

  • Return on Invested Capital (ROIC): The numerator is net operating profit after tax (NOPAT), which measures the earnings of a company prior to financing costs.
  • Invested Capital: As for the denominator, the invested capital represents the sources of funding raised to grow the company and run the day-to-day operations.

Capital refers to debt and equity financing, which are the two common sources of funds for companies that are used to invest in cash flow generative assets and derive economic benefits.

A company can evaluate its growth by looking at its return on invested capital ratio. Any firm earning excess returns on investments totaling more than the cost of acquiring the capital is a value creator. Excess returns may be reinvested, thus securing future growth for the company. An investment whose returns are equal to or less than the cost of capital is a value destroyer. Generally speaking,

  • A company is considered to be a value creator if its ROIC is at least two percent more than the cost of capital;
  • A company is considered to be a value destroyer is if its ROIC is two percent less than its cost of capital.

There are some companies that run at zero returns, whose return percentage on the value of capital lies within the set estimation error, which in this case is 2%.

A higher return on invested capital can be considered an indication that a company is required to spend less to generate more profit.

  • Profitable Returns on Invested Capital (ROIC) → Positive Value Creation and Shareholder Returns

The higher the profit margins of the company, the higher the return on invested capital, as the company can convert more revenue (or NOPAT) into profits.

Companies that generate an ROIC above their cost of capital implies the management team can allocate capital efficiently and invest in profitable projects, which is a competitive advantage in itself.

When investors screen for potential investments, the minimum ROIC tends to be set between 10% and 15%, but this will be firm-specific and depend on the type of strategy employed.

ROIC is one method to determine whether or not a company has a defensible “economic moat”, which is the ability of a company to protect its profit margins and market share from new market entrants over the long run.

Warren Buffett

The overall objective of calculating ROIC is to better understand how efficiently a company has been utilizing its operating capital (i.e. deployment of capital).

Generally, the higher the return on invested capital (ROIC), the more likely the company is to achieve sustainable long-term value creation.

References:

  1. https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-roic/
  2. https://www.wallstreetprep.com/knowledge/roic-return-on-invested-capital/

Know the Value of Stuff; Not Just the Price

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“Price is what you pay. Value is what you get.” Warren Buffett

A father said to his daughter “You have graduated with honors, here is a car I bought many years ago. It is a bit older now. But before I give it to you, take it to the used car lot downtown and tell them I want to sell it and see how much they offer you for it.

The daughter went to the used car lot, returned to her father and said, “They offered me $1,000 because the said it looks pretty worn out.”

The father said, now “Take it to the pawn shop.” The daughter went to the pawn shop, returned to her father and said,”The pawn shop offered only $100 because it is an old car.”

The father asked his daughter to go to a car club now and show them the car. The daughter then took the car to the club, returned and told her father,” Some people in the club offered $100,000 for it because it’s a Nissan Skyline R34, it’s an iconic car and sought by many collectors”

Now the father said this to his daughter, “The right place values you the right way,” If you are not valued, do not be angry, it means you are in the wrong place. Those who know your value are those who appreciate you……Never stay in a place where no one sees your value.”

Don’t force yourself to stay where you are not regarded….

Stay where you are appreciated.

Source: https://www.facebook.com/743724219/posts/10159846889864220/