First of all Happy Thanksgiving to everyone, if you're reading this I congratulate you on a) not being in a carb induced coma and b) reading on a day of rest.
Thanksgiving is a day when people hang back and relax with family and friends, eat a lot, watch football, and fall asleep. All these things have their place at some point during the day and should be enjoyed thoroughly, but I'd also like to suggest something wholesome and developmental.
I've been looking at the day like this: today we unwind and maybe throw the diet out the window for a day, but its also a great opportunity to reflect and map some stuff out. All the everyday garbage is out of our heads and we can now see the road ahead objectively, and that's a huge advantage that shouldn't go to waste!
To use a crude metaphor, we're both the cast-iron and the metalworker working on it...today's the day to remove yourself from the flame and allow yourself to cool to see what shape has taken form. Make some decisions as to what you want to become and then thrust yourself back into the fire.
Use today to look at how far you've come and what you've done great these last few months. Similarly, look at what you've done not so great. Start to see how both the good and the bad have contributed to your current quality of life. Are you where you want to be? If not, are you on the right path? How do you know? What indicators have you chosen to let you know at this point?
If these are things you haven't considered in the past, its never to late to start! What to you want to do by, let's say, January? Why do you want to do it? What will you have gained from it? How do you think that will make you feel? What are you willing to do (or not do!) everyday to succeed? How do you know you've achieved it? And most importantly...how will this enhance the quality of life for you forever once you've got it? After all, nothing is worth accomplishing if the effects are only temporary or unsustainable.
These types of questions really help to strip back the layers of bologna when we are trying to make a change, but really aren't committing to it. If anything these types of questions can help realize just how unimportant something is to us! A lot of people have weight loss goals but find their only motivation is to look better. That's just the surface! They never considered how they'd feel about themselves, what they'd learn from it, why its important and how their success will enhance their lives beyond the goal itself.
These types of layer-penetrating questions can help us reach deeper levels of desire for success so that we are completely aligned with our goals for transformation. Wishing the best of holiday weekends to you, your families, and your friends!
Thursday, November 25, 2010
Wednesday, November 24, 2010
Why Small and Micro-Cap Companies Are Better For Your Portfolio
I have MSNBC on in the background and they just mentioned that Cisco (CSCO) may now be undervalued due to its recent drop. A quick earnings power calculation using an 8% cost of capital due to their financing mix shows actually that they're pretty fairly valued in my opinion (plus or minus a dollar) which got me thinking about market prices in general.
A lot of investors, especially value investors, like to purchase companies selling for less than what they think they would be sold for. However, the inherent error in this thinking is that it leads one to believe that the market is pricing companies at how much they are truly worth, when its clear that it is pricing companies as a going concern. What does this mean? It means that the market price is only reflective of the expected future earnings power of the companies assets, not its buyout value.
In other words, let's say I have a unique lemonade machine that makes the greatest lemonade ever and I can make $10 a year with it by opening a lemonade stand. Assuming I have a 10% cost of capital (for a lemonade stand, I know this is ridiculous but just to prove a point!), the earnings power of that lemonade stand would be $100 ($10/.10). This $100 would be the reflected market capitalization if my stand was publicly traded. If however, you came along and offered to buy me out, it really wouldn't make sense for me to sell it to you only for a $100.
But that's what it's worth right? Well yes, but its worth that much assuming nothing changes (as a going concern!). However, if you come in and offer to buy, suddenly the perceived value of my stand increases. As the owner I start to think "this is greatest lemonade stand in the world, they'll make a killing...and what about me? The only thing I know how to do is sell lemonade. Where can I find a stand of equal value once I sell? Nowhere! They better pay up then." So we have a small element of reflexivity coming into play here.
In a way, this happens in all acquisitions, that the very premise of an acquisition being proposed ups the perceived value of the entity from a going concern to a total buyout value. This is why when a potential acquisition is announced, the stock price jumps.When a possible acquisition manifests, suddenly book value and intangible asset value get factored in along with earnings power, which puts a premium on the original market price.
The positive outlook one could take from this then is that technically all public companies are undervalued to what they are really worth. The bad side about this is that "buyout" value will not justifiably manifest unless someone comes along to buy the company (it could manifest from market gyrations, but there's no fundamental basis to support this). With this in mind, what do you think the odds are of someone coming along and buying, say, Exxon-Mobil? ZERO!! Its one of the biggest companies in the world, who would even have the money to do so?
Which leads me to my premise that the individual investor has a better shot at having value realized by investing in smaller companies. Not only because smaller companies have a better chance at being acquired (that's a crapshoot, don't start trying to predict that stuff), but because less market participants are paying attention to them. If 10,000 CFA's are watching CSCO and valuing it accordingly so that the market prices it at around $19, what are the odds that all 10,000 CFA's and all the other market participants are wrong?
In the book The Wisdom of Crowds by James Surowiecki, he makes a point about this using the popular game show "Who Wants To Be A Millionaire." He noted that when someone Phoned a Friend, on average they received a correct answer about 65% of the time (actually seems pretty high to me!). Compare that to the Ask The Audience lifeline, which yielded a correct answer about 91% of the time. What does this tell you about market prices? They are usually right when lots of people are looking at them.
However, the less people looking at a company, the more of chance it could be unfairly valued. Perhaps only 100 CFA's looked at a particular small company, and because their priorities lie in getting through a ton of small caps and micro caps to move onto bigger and better projects, they might have overlooked crucial information. And that is where the individual investor's edge comes in. Those who are willing to do their homework and find value where a small amount of people were too rushed or lazy to look will get the payoff when the fundamentally supported value manifests in the price.
Something to think about...
A lot of investors, especially value investors, like to purchase companies selling for less than what they think they would be sold for. However, the inherent error in this thinking is that it leads one to believe that the market is pricing companies at how much they are truly worth, when its clear that it is pricing companies as a going concern. What does this mean? It means that the market price is only reflective of the expected future earnings power of the companies assets, not its buyout value.
In other words, let's say I have a unique lemonade machine that makes the greatest lemonade ever and I can make $10 a year with it by opening a lemonade stand. Assuming I have a 10% cost of capital (for a lemonade stand, I know this is ridiculous but just to prove a point!), the earnings power of that lemonade stand would be $100 ($10/.10). This $100 would be the reflected market capitalization if my stand was publicly traded. If however, you came along and offered to buy me out, it really wouldn't make sense for me to sell it to you only for a $100.
But that's what it's worth right? Well yes, but its worth that much assuming nothing changes (as a going concern!). However, if you come in and offer to buy, suddenly the perceived value of my stand increases. As the owner I start to think "this is greatest lemonade stand in the world, they'll make a killing...and what about me? The only thing I know how to do is sell lemonade. Where can I find a stand of equal value once I sell? Nowhere! They better pay up then." So we have a small element of reflexivity coming into play here.
In a way, this happens in all acquisitions, that the very premise of an acquisition being proposed ups the perceived value of the entity from a going concern to a total buyout value. This is why when a potential acquisition is announced, the stock price jumps.When a possible acquisition manifests, suddenly book value and intangible asset value get factored in along with earnings power, which puts a premium on the original market price.
The positive outlook one could take from this then is that technically all public companies are undervalued to what they are really worth. The bad side about this is that "buyout" value will not justifiably manifest unless someone comes along to buy the company (it could manifest from market gyrations, but there's no fundamental basis to support this). With this in mind, what do you think the odds are of someone coming along and buying, say, Exxon-Mobil? ZERO!! Its one of the biggest companies in the world, who would even have the money to do so?
Which leads me to my premise that the individual investor has a better shot at having value realized by investing in smaller companies. Not only because smaller companies have a better chance at being acquired (that's a crapshoot, don't start trying to predict that stuff), but because less market participants are paying attention to them. If 10,000 CFA's are watching CSCO and valuing it accordingly so that the market prices it at around $19, what are the odds that all 10,000 CFA's and all the other market participants are wrong?
In the book The Wisdom of Crowds by James Surowiecki, he makes a point about this using the popular game show "Who Wants To Be A Millionaire." He noted that when someone Phoned a Friend, on average they received a correct answer about 65% of the time (actually seems pretty high to me!). Compare that to the Ask The Audience lifeline, which yielded a correct answer about 91% of the time. What does this tell you about market prices? They are usually right when lots of people are looking at them.
However, the less people looking at a company, the more of chance it could be unfairly valued. Perhaps only 100 CFA's looked at a particular small company, and because their priorities lie in getting through a ton of small caps and micro caps to move onto bigger and better projects, they might have overlooked crucial information. And that is where the individual investor's edge comes in. Those who are willing to do their homework and find value where a small amount of people were too rushed or lazy to look will get the payoff when the fundamentally supported value manifests in the price.
Something to think about...
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