Saturday, March 13, 2010

Is Intrinsic Value the Most Important Thing in Investing?

Many people may be familiar with investing in common stocks as growth vehicles in their financial portfolio. With information a click away on the internet and various books just as available on investing, it seems that everyone has the power to manage their own portfolio like they were a professional investment manager.

Many of these sources point toward Warren Buffet's style of investing, commonly known as value investing. The premise behind the strategy cites that investors own a small piece of a company. The basic philosophy is that a good investment is made in good companies selling at a discount to their intrinsic value.

However, caution and an analytical approach should be taken when defining intrinsic value, which is loosely defined as the price at which a person would be willing to pay for the whole business. This assumption is vague and not useful in practicum at all.

The truth about intrinsic value is that it is subject to the participants involved, meaning that, depending on the buyers and sellers own reasoning, intrinsic value will differ. If you were a small bank up for sale, you would most likely charge a far lower price to a private buyer than you would, say to Bank of America. This is mostly because variables such as the size of the buyer and synergy value come into play.

Furthermore, intrinsic value differs between how the buyer or the seller are evaluating it. While things such as future earnings are factored into both perspective values, there are variables that will discount the value of the business on the side of the buyer that would not affect the value to the seller. These are things such as lack of liquidity and non-diversifiable risk.

Likewise, the value of the business to the seller will factor in the size of the buyer that would not affect the value calculation on the part of the buyer. As a buyer, how big the company is should not make me change my estimate of what another prospective company is worth to me, but it will to the seller.

Tuesday, March 9, 2010

How Much Is That Business In The Window?

Let's pretend for a second, you are the owner of a dry cleaners business. Business has been good the past few years, you've managed to grow your business at about 20% per year by opening a few new locations. You've even managed to sock away about $50k per year in cash after all expenses and re-investments. You remember back only four years ago that with only a $15,000 investment, you've come a long way.

One day, a representative from a larger chain of dry cleaners, comes in and offers you $250,000 to buy you out. Do you take the money?

Knowing the value of your business is a crucial part of being a business owner. Unfortunately, the price of a business is not as clearly defined as say, the value of your house, which has comparables and mortgage value assigned to it by a bank. Unlike a single asset such as a house, anything that produces a profit takes a significant amount of financial analysis, future projections, and discounting to determine what the true value is.

In this example above, you'd be foolish to accept such a low price since a worst case scenario, valuation would still put your worth at well over $200,000. Ironically, about five years ago, insurance agents found themselves in the same scenario when a large insurance corporation came around offering independent agents a buyout price. Most of them had no idea what they were worth and were ill-prepared for the situation.

The truth of the matter is, a buyout proposition can happen at any time to any business, especially in highly fragmented industries that are cost competitive. It is the responsibility of the business owner to know what they're worth in multiple income scenarios so they can make sure the price offered is fair.

Hiring a skilled business appraiser is an investment in your business that will pay for itself many times over in the future.

I would suggest this to anyone who in the future plans to sell their business or pass it on to their children through their estate. You can do an online search for one in your area. Just make sure they have credible experience or are certified by one of the accredited valuation bureaus (IBA, ASA, NACVA, CFA Institute, or a CPA with a ABV distinction).

Having the financial transparency of a proper business appraisal will give you and anyone else the proper assurance that your business is worth the time and effort you put into it.

Saturday, March 6, 2010

The Inevitable Bankruptcy of Domino's Pizza

I happened to get a stock tip that Domino's Pizza (DPZ) was undervalued and was both shocked and appalled at what I saw after further analysis. Over the past 10 years, Domino's Pizza has had increasing negative stockholder's equity, a situation which I thought was only theoretical and seen in business books. Alas, here it is in the flesh.

For those of you with limited accounting background, stockholder's equity appears on the balance sheet. Every company has assets with a certain total worth and the money that the company used to obtain those assets can come from three main sources: borrowing, purchase of stock from investors, or retained earnings (from business operations).

So what we have here on the balance sheet is that domino's assets in total are worth $453 million. But it has borrowed over $1.7 billion dollars! This results that should the company default, the stockholders will owe the creditors an extra $1.2 billion dollars* (and that's excluding the interest on those loans!)! I have never seen this in practice before, never mind in a company with such huge brand equity such as Domino's.

But wait! There's more! In 2008, Domino's Pizza recapitalized its debt by issuing long term notes at about 6%, due in 2037, in order to pay off its current loans. This is the equivalent of paying off your student loans with credit cards. Smart move...

So as Domino's reaches terminal velocity falling down the black hole of debt, it looks like its just a matter of time until it splatters on the bottom. My question is, who the heck are these analysts issuing "buy" ratings for Domino's (here)?! These people need to be reevaluated by their respective firms for not being able to read an annual report. Shame on you Wall Street...

*Of course, due to the laws of incorporation, shareholder's would not be personally liable for these liabilities. See the value of being incorporated? ;o)

Thursday, March 4, 2010

Maximizing Your Chances of Getting Rich

Per my last post, I want to talk about how "The Ways to Get Rich" list can be used as an effective tool in maximizing your chances of getting rich.

Take a look at the list (see it here) and start to mull the categories over in your mind. Which jump out at you? Which categories do you feel you may have an advantage in? Which categories seem too risky for you? Which do you have the patience for? Which ones do you not even have a chance in? If you come don't come from a rich family, you can cross Inheritance off right away.

The fact of the matter is that everyone is different and some categories may carry more risk depending on your knowledge base in that particular category. Gambling may seem risky to you, but to the MIT Black Jack team, its risk-adjusted. Likewise, stock market speculation may seem too risky if you an unfamiliar with how to analyze a business.

Also, some categories may require significantly more start-up investment. You may know a lot about real estate speculation, but if you can't afford a down payment and monthly mortgage payments, that isn't feasible for you right now.

Also be aware that some seemingly low initial start-up cost categories may contain hidden costs. For example, inventing something costs nothing in the early stage if you can make the product yourself. However, chances are that makeshift MacGyver-like doohickey you just made won't be sold with all that duct tape wrapped around it...or with those exact materials. At some point you're going to need to have either some engineering involved, as well as some production costs.

I had an idea for a beverage that I made in my own home, but after about a month's worth of research, it turned out creating a beverage from creation to distribution will cost about $60,000-$80,000 (that's including formula creation, product design, co-packing, warehousing, and distribution methods).

It goes without saying that the more categories you choose to pursue on the list, the better your chances are of getting rich. However, doing all categories half-assed will get you nowhere. Wealth and fortune are created because it takes skill, work, and determination. My advice to you would be to fully master one category, that will be challenging enough for most people.

For the people who really have the commitment, choose two or three categories to master. If you find yourself doing more than that, you have to ask yourself "have I really gone as far as I can in my first categories?" Unless you've been working at them for years, I can say with certainty that you have not.

Also, be careful with the Frugality category. Tendency here would be to say "yeah I'm already cheap" and move on. However, there's an art and science to everything. The Cheapest Woman in the World appeared on Opera and said she was able to purchase two homes and 20ft boat just from her frugal ways. Still think you're cheap enough?

Good luck and I'd love to hear your success stories. You can send them to If your story is interesting, I'll write a post on it as inspiration for others.

The Ways To Get Rich

I made a list of all the possible ways to get rich. For my own personal morality, I did not include anything unethical (drug dealing, stealing, etc.). My goal is to have this list be the most exhaustive category based reference tool of ways to get rich, meaning that every way to get rich somehow falls into one of these categories.

To clear up any ambiguities, "rich" can have many different values depending on the person. But for the article's sake, we will define "rich" as $1,000,000 in net worth. And for those of you who don't know what net worth is, everything you own minus everything you owe.

The Ways to Get Rich:

-Grow a Business (Hold it)
-Grow a Business (Sell it)
-Real Estate Speculation
-Income Property Investment
-Flipping Real Estate
-Stock Market Speculation
-High Salary
-Collecting (art, antiques, treasure, etc.)
-Publishing (book, blog, article, music, etc.)
-Professional Practice (doctor, lawyer, etc.)
-Oil Well Investment
-Currency Trading

To clarify, growing a business and holding it is separate from growing a business and selling it because there are people in the world who have sold their businesses and gotten rich, but wouldn't have done so if they held it (think of the unprofitable companies in the .com bubble).

Also, professional practice is separate from growing a business because it requires an educational variable not inherent in growing a business. Also, a lot of professional practitioners have never grown their practice and have still gotten rich.

If you have any additions to this list that you feel do not fit into these categories, email me at with your suggestion along with ample evidence why. I'll give you a shout out if its well supported!