THIS IS MY 181ST BLOG ON UNDERSTANDING MONEY
TOOLS
December, 2019
Time to write another blog. I usually write when someone initiates something material,
or I feel it is important information that will be constructive to your life.
In this blog we will cover current finances, and more. Recently, a friend of mine who went
back to college late in life and this month is graduating with an MBA, talked
to me about the direction he was intending to go and why; teaching with
emphasis on AI. Prior to his
return to college he was “consulting”, the term used by many when unemployed. He, and you, might find out that
consulting is a tough “gig”, and very inconsistent. If you are working for a large accounting or legal firm,
that is a different world, but as an individual it is tough. In that capacity he was very unfulfilled.
Through this conversation, we maneuvered into what makes
success and personality traits. In
my professional life I have gone through several psychological tests for
strengths and weaknesses related to the work environment. When helping build up
an oil company we hired an “in house” psychologist to improve our employees and
their state of well-being both at work and at home. Here are some of the traits I have witnessed for a
successful profession:
- Right
brained individuals are more creative, optimistic and think ahead and in larger
scope. Many times details and
organization are left behind. With
a strong ego this type of person makes a good CEO or President of a
company. If you are into Zodiac
signs Leos make good leaders.
Presidents Clinton, Obama and Trump are all Leos.
- A
left brained person is analytical, hesitant and sees every detail and is
generally organized. They make a
great number two person in a company, and the CEO needs this person to point
out the negatives and brings caution, and balances the two.
- With
both of these types of people they should work well with people and ideally
“goal set” in the corporate world.
It would be nice to see a more social and interactive setting in today’s
world!
In my friend’s case, I agreed, knowing him well, that
teaching was a perfect setting for him.
Let’s move on to stock and market analysis, with more
definition from my last blog. Once
again, another friend reading my last blog could not understand financial
ratios of importance. Finance is
numbers. This made me want to
venture into what we have below.
We have covered ratios.
They are important in comparisons when viewing stocks, mutual funds and
index funds. You want to compare
before making financial decisions.
It also shows trends over time, when comparisons are made. It makes you more knowledgeable when
communicating with your financial advisor.
In the last couple of blogs I used the United States most
conservative index the Dow Jones Industrial average of 30 stocks. Over the past 123 years it has given us
a “mean” or average overall for a price to earnings expressed as price/earnings,
and that figure is 15. (Sometimes
shown as 15:1) When you use a “/”
it means a fraction of something, less than or greater than the whole. Example is 1/2 of 2=1, or 1/3 of
12=4. The top, or first number, is
called the numerator and the bottom number is called the denominator. The numerator or top number is always
the multiplier number, the bottom number the denominator is always the number
you divide by. Let’s assume the
numerator is 5 and the denominator is 3 and you want to find the “quotient” or
result of 5/3 of 3. It would be 5,
yes? Better say “yes”!
Now, relate this to your financial usage. Right now, the Dow average is a
ridiculously high 28,239 with a P/E of 29.9. Recalling the “mean” average for the Dow at 15 using our
above fractions, let’s see where the Dow should be without governmental
interventions of money. Should I
buy into this Index? We take the
15 as the numerator and put it on top, or the multiplier, and we take the 29.9
and place it on the bottom of the fraction as the denominator. This gives us a “fraction” as to
“earnings”. Now take the fraction
times the current price of the Dow of 28,239 and it will give you the number 14,166. (We took 28,239 and multiplied that
number by 15, then we divided that number by 29.9, to give us 14,166.) That is where the Dow to historical
“means” should be trading. If the
28,239 were proper what should the parity ratio of historical earnings to
current earnings be? Answer: 15/15.
Let’s use fractions another way; price to earnings
ratios. In this example, you place
the price of a stock at the top (numerator) and earnings at the bottom
(denominator). Divide the bottom
number into the top number and it gives you the price to earnings ratio. Using this practically, let’s say you
are viewing stocks in an Energy “index” (a grouping of oil/gas stocks that you
buy together called an “Index Fund) and you see one stock with a P/E of 40:1
when the average is about 25:1 for oil and gas (as of December 23, 2019). A red flag should go up and you
question what makes this company so outstanding. You can find good stocks at a
10:1 price to earnings ratio paying dividends.
In today’s questionable “false economy” stick with low P/E
stocks that have a good history of strong earnings. No earnings and losses? Not sure if I would buy!
Now, you may ask, “why use all this math as many companies
do not have any earnings, and show losses”? Good question, and permit me to answer. Many of these companies are tech
companies found on the NASDAQ Exchange; about 3300 stocks. First, we are at the top of our
country’s “growth cycle” only held there this long because the government keeps
pumping cheap and free money into circulation. Immigrants and poor are getting food stamps and free care on
Medicaid, however they are putting this money back into society, thus improving
Gross Domestic Product. The
largest corporations are getting low interest loans and selling bonds; some of
this money goes to improving their companies and manufacturing equipment.
Next, if a company was taking losses, never showing a profit
and was a private company instead of a publicly traded company would you buy
the company? Hopefully, no. Why then should you buy stock in a
losing company on an Exchange?
There are only two reasons I can think of. One of course, is that you think the stock will go up,
company shows a profit, thus you profit.
Secondly, you hope that Wall Street has a sucker bigger than you to buy
this stock and you receive a profit.
Of course, my poster children for this are Uber or Lyft. Uber loses billions of dollars each
quarter, never has shown a profit and may never show a profit. A company like this goes public for two
main reasons, 1) to make the original executives very rich and, 2) to be able
to put up stock to borrow more money.
Last time I looked Uber’s capitalization was $45 billion. (Capitalization is determined by taking
the amount of outstanding stock being traded times the price of a share of
stock.) Crazy, but true!
I used the term “false economy” above. Why? Let’s take a look at only a couple of things. First, the government with “off balance
sheet” borrowing and lending has, and will, place another $2 trillion into the
banks and stock markets to “stabilize and calm” markets. This huge sum of infused money started
on September 22, 2019 and will continue until the end of this year. This has pushed our central bank, the
Federal Reserve, into currently holding $4.2 trillion of our debt. (This was
accomplished legally through a March, 1988 Act permitting such emergency action
without Congress or Senate approvals.)
Big, smart money is sitting on the sidelines with cash and bonds in
countries like Switzerland, Germany and the Netherlands; so much money that
their bonds are in a negative yield position.
In my 20 years of work in the financial area I was a numbers
guy. It bugs me to see what we are
permitting with company financial disclosures to the public and Wall Street. The government’s “General Accounting
Principles” (GAP) or “General Accounting Principles and Practices” (GAPP), have
changed significantly to make companies look stronger than they are. What is
the difference from old? Have you
heard of “EBITDA”? This is
reporting “earnings before interest, taxes, depreciation and amortization”. This number then is the financial
performance before these expensed items.
I recently read how extreme this can be in misleading the public. The
example was a public company reporting earnings of about $600 million, but
without EBITDA and following old practices they would have reported a loss of
about $250 million. Perhaps people
would have sold the company’s stock or not invested.
Again, and as always, I hope this information helps you.
