Business for sale?

As you know, I’m a member of Networth IQ – and quite an active member, at that! I love reading and answering questions … 

[AJC: you’ve probably already seen that from the detailed responses that I try and give commenters on my posts on this blog … try me, if you have a question … I just won’t give direct personal advice, because I am not a qualified professional, but I will give general advice if I think it will benefit all of our readers]

… and this unique site provides a great platform (as does Tickerhound, which provides a great Q&A forum on everything from stocks to real-estate).

For those of you who aren’t members of Networth IQ, here is an exerpt of a great question:

I found a business for sale that has generated the following free cash flows since 1998.

1998 – $3,426.0 Mil
1999 – $3,949.0 Mil
2000 – $4,917.0 Mil
2001 – $7,133.0 Mil
2002 – $6,077.0 Mil
2003 – $8,333.0 Mil
2004 – $8,956.0 Mil
2005 – $9,245.0 Mil
2006 – $11,582.0 Mil
2007 – $12,307.0 Mil

The current owners are asking $183.49 Bil, …. I don’t have $183.49 Bil, but they said that they would sell me a smaller portion of the business if I wanted … Should I buy?

I like this question on two levels:

1. It’s a neat reminder that when we buy stocks, we’re not just buying ‘bits of paper’ … we’re buying a small piece of a real, live business!

And,

2. It gives me an opportunity to show you the sorts of questions that I would ask – and the types of information that I would be looking at before buying into this – or any – business.

According to Warren Buffet (or sources who purport to know how he works) the intrinsic value of a business is in its discounted cashflow.

That is, a business is – or should be – a cash machine … what’s the reason for owning it, if not to get some cash out?

So, in the above example, we should be able to decide if the business is worth $183.49 Billion (not knowing the company in the above excerpt, I am assuming that this number represents the entire current market capitalization of the business) by discounting the cash-flows shown above …

… a quick look at the most recent cash-flow figure shows that it is currently producing $12 Bill. cash per year (probably growing, if history is any guide); that would mean about 15 years to get our money back … yuk.

Now you know why the stock market is generally a fool’s game … I would by far prefer to invest in my own business, or buy a private one at ‘only’ 3 to 5 years free cash-flow (better yet, Net Income), and grow it … then float it myself!

Or, at least sell it to a public company who can immediately ‘claim’ 15 times my Net Profit (hence, give me 7 to 12 times my Net Profit).

But, if we are going to play ‘the stock market’ game, what would we need to know before we can make an informed decision about ‘investing’ in this stock?

Hmmm …
As I pointed out, the free cash-flows on their own say nothing …
For example, I recently sold two similar businesses: one had been going for many years and generated ‘free cash flows’ [now that’s an oxymoron!] of $1 mill. and the other was less than 2 years old and had yet to make a dime.
Yet, I sold them both (separately) for about the same price! So, there must be more to the valuation of a business than Free Cash-flows, right? Absolutely!Let’s start with Return on Invested Capital:
I’d like to know what it has been for this company (and, the industry) over the past 5 years? I’d like to see an improving trend in excess of 15%, please.
Then, is the company growing?
Cash Flow is just one measure (but, what about operating cash-flow … have they made any strategic purchases / major capital expenditures /etc.), so what about the 10 years trends in: Earnings? Book Value? And, what about plain, old Sales?
I’d like to see a history of growth (min. 10%) in all of these …Now, how is there debt situation?
How long will it take them to cover their long-term liabilities from ‘Free Cash Flow’?
I’d like to see no more than 2 to 3 years.
Do the people who run the company own stock? Are they buying or selling?
Tell me about the company: do they have a ‘sustainable competitive advantage’ (what Warren Buffet calls a ‘Moat’ … but, that’s too much water for me!).

Do I believe this company will be around for the next 100 years … do I really want to buy THIS business in THIS industry?

Lastly, if I like the answers to all of the above (unlikely … so far I’ve only liked the answers to similar questions for 7 companies out of the 5,000+ that I can currently buy a ‘piece’ of) …

…. then how CHEAP can I get this thing!?
PS I made the ‘other’ category … waaaayyyyyy down at the bottom of the 150th Carnival of Personal Finance … whoo hoo!

How much interest do you earn on one million dollars?

Welcome new readers!

Here are three of my favorite posts to get you started; if you want to find out:

1. If $1 million will be enough to retire with, then click here, or

2. How much house you can afford, then click here, or

3. Why buying a new car is such a losing proposition, then click here.

Otherwise, please enjoy this article, then bookmark my home page (click here) and come back often …

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How much interest do you earn on one million dollars?

This was the question that Clint at Accumulating Money asked in a ‘classic’ post – I commented on it earlier this year and still receive click-through’s two or three months later. It must be a very popular question!

I’m not sure why, because it implies that people are happy to just have their life savings ‘sit’ in CD’s …

… but, here’s the answer to the “million dollar” question courtesty of Accumulating Money anyway:

So, to answer the question, how much interest do you earn on One Million Dollars (assuming a 4% interest rate, compounded monthly)?

One Day – $109.59

One Month – $3,333.33

One Year – $40,741.54

Five Years – $220,996.59

Ten Years – $490,832.68

Twenty Years – $1,222,582.09

I think this related question asked by Afroblanco at Ask Metafilter – repeated on Get Rich Slowly (which is where I picked it up) – really goes to show how The Savers (as opposed to The Investors) think:

What’s the safest possible thing that I can do with my money?” :

I take bearishness to an extreme. Having witnessed the 2000 tech crash, I have no faith in the stock market or the US economy. I keep all of my money (USD) in a savings account. However, with the recent financial turmoil, I have a few questions:

  1. Is it conceivable for the FDIC to fail?
  2. If so, is there a place where I can put my money that will be safer than a savings account?
  3. What’s the safest, most risk-free way for me to save money and not get killed by inflation and the tanking US dollar?
  4. If there is a safe way for me to save money and not be punished by inflation and the depreciating dollar, is there a way that I can do this without having to stress out and micromanage my finances? I don’t want to be checking the finance page and making adjustments every day.

Even though I follow finance news, I’ve never done any investing or money management other than socking money away in my savings account. I’m a n00b, I admit it.

OK … I confess …. I am like our friend, Afroblanco … very risk-averse; yet I have become rich by understanding that it is actually safer to invest than not.

The GREATEST RISK that our friend can take is NOT TO INVEST … inflation will just eat up any bank deposit/CD strategy.

Take Accumulating Money’s example above:

One million dollars approximately doubles in 20 years … but, inflation will halve its buying power!

Think about it, if the average bank interest rate is 4% (pushing the value of your savings UP) and inflation averages 4% (pushing the buying power or value of your savings DOWN), what have you gained in 20 years?

Nothing …

Now, if you just push your savings into a low cost Index Fund that averages, say, an 8% return over the 20 years, then the same 4% inflation means that you should effectively DOUBLE the value (or ‘buying power’) of your million dollars over 20 years.

But, Afroblanco is even better off BUYING The Bank [i.e. investing in the Bank’s stock] than putting his money in The Bank. The risk of failure is about the same (if the bank fails you will lose the money that you have IN the bank’s vault as well as the money IN the bank’s stock), yet, as long as he has a long-term view (minimum 20 to 30 years), the former strategy will make him rich and the latter broke.

If the bank stock averages just 12% average growth over 20 years – as any well-picked Value Stock, can easily do – then Afroblanco won’t just double the buying power of his money ONCE, he will get to double it TWICE … that’s $4 million AFTER the effect of inflation (or, the $1 million grows to $10 million in ‘raw’ dollars).

What about risk? Aren’t bank deposits FDIC Insured?

[AJC: Well, yeah … up to a paltry $100kof course, you could open up 4 bank accounts at 4 different banks  … but, $400k is hardly what I hope my readers are aiming at!]

But, inflation is a much bigger risk: 100% certain to eat up your money … and, would the Federal Government (the same entity backing the FDIC) allow a Major US Retail Bank to fail?

I guess we’ll find out in the next few months!

If you don’t believe that’s likely, then isn’t your money just as safe in The Bank as it is in the bank?

[AJC: think about it 😉 ]

And, doesn’t The Bank’s stock at least meet the overall market returns which averaged 8% p.a. for the past 100 years … what have bank deposits averaged in that time? 3%? 5%?

The point here is not necessarily to buy stock in The Bank … rather it’s to think about Investing rather than Saving …

Before suggesting WHAT to invest in, we need to know HOW long is our friend is expecting his money to last? Assuming that our friend is a hands-off investor, here’s what I suggest as the lowest-risk strategies possible:

If less than 30 years, then TIPS are a an option – PROVIDED that he can live off the inflation-adjusted interest (unfortunately, very unlikely in the current low interest environment – but, in 5/10 years, who knows?).

If 30 years or more, then a low-cost Index Fund is ideal for a hands-off investor. There has been NO 30 year period since the recording of the stock market indices where the market has not produced a positive return well above inflation.

If he is more hands on and/or more knowledgeable, then I would recommend no more than 4 or 5 well-selected individual stocks and direct investment in real-estate, for any time period 10 years or greater.

Inflation forces us to invest … because of this, inflation is our friend!