The ability to distinguish between the noise and the signal is a rare skill within the confines of the financial markets and investment world. In our modern times, there is too much emphasis on the stock market while this particular market may tend to disguise macroeconomic realities, especially when isolated in the broader context of indices. Especially for a retail investor, there are many other investment vehicles ranging from physical assets such as real estate and precious metals to commodities and other diversified portfolios the underlying assets of which may still be the physical assets. In this article, I will introduce other important financial markets that will be utilized as reliable proxies to understand current market conditions and are generally ignored by retail investors. In these perilous times, ignoring these fundamental markets and solely focusing on stocks may ruin your wealth and derail your plans to financial freedom. The content can also be used as a blueprint for understanding different set of investment vehicles and comprehending the fundamental differences between markets, as well as increasing your financial acumen with respect to removing the noise from the signal.
Tag Archives: Financialliteracy
On economics you have been taught wrong 🧭
Unfortunately, the dismal science taught in our schools and universities rests on many blatantly wrong assumptions.
From the definition and calculation of inflation to investment management and worshipping only a small subset of assets while ignoring those that would lead to greater financial freedom, the economics, as a subject, is losing ground while being mired in farfetched quant analyses and losing its connection with the realities of daily life and our changing world.
In this article, I elaborated on the most common misconceptions that are being perpetuated through the teaching of economics. The reality appears to be quite different from what you are being told every day.
Which company is this?
Which company is this?
Hints:
-It operates in a traditionally analog business that is tested by digital challengers.
-However, it continues to beat every one of them in terms of profitability.
-Operational excellence, efficient cash flow management, customer loyalty, and customer service are their hallmarks.
-It also started its digitization initiative, currently comprising 16% of its total net sales at maximum (does not disclose exact number)
-It has a positive book value, so do not mistake it for other companies that are technically accounting insolvent.
-Its stock is currently traded at a P/E of 45-50.
-Its stock is currently traded at a P/B of 15.
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Note: This article is based on a social media post I wrote almost 4 years ago. In the article, I will unveil the company and dissect its operations and its stock. Moreover, we will try to look into whether much has changed since the first time I published my post.
Retirement, Financial Independence, and Withdrawal Rates 💸
Can a portfolio containing bonds increase the success rate of an orderly retirement?
What is the required withdrawal rate for such a portfolio to succeed?
As riskier securities, stocks may provide more returns and higher sustainable withdrawal rates, however at what cost, i.e. risk?
What may be the composition of a portfolio that would allow you to withdraw at 4% annually, $3500 each month for the next 20 years?
As assets that are more dependent on the current fiat currency rules continue to struggle, the success rate of such portfolios will dwindle.
In this article, I expand on how retirement funds are constructed and why many of them will fail eventually given today’s gloomy conditions while also answering each question mentioned above. In addition, I will also share my thoughts on what I myself do to survive and explain the illusion of measuring your returns in terms of just percentages and fiat currencies.
Historical Returns: Commodity Futures vs Equities. Revisiting the work of Gorton and Rouwenhorst
They did not teach you this in your finance classes 💡
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When using Treasury bills as the margin collateral for the futures position without leverage, fully collateralized commodity futures have essentially the same returns and Sharpe ratio as equities.
Agree or disagree?
In this article, I will investigate how the returns on commodity futures compare with those on Equities.
Solution to Management Science Series #197: Financial accounting as a forensic tool: Selling Receivables, aka pure factoring, Before the Collection Date
Financial accounting as a forensic tool: Selling Receivables, aka pure factoring, Before the Collection Date
Company A sold its receivables to a competitor and was paid in cash. You do not know whether the sale was made on nonrecourse basis or not. How would you label this transaction, financing or operating?
Company B sold its receivables to a bank and agreed to assume the risk of collection while also being granted a loan against the receivables sold. How would you label this transaction, financing or operating?
Company C, a manufacturer of trucks, sold its receivables to a bank on a nonrecourse basis. Nonetheless, if the bank were not able to collect the receivables, Company C should sell trucks in equivalent value to the bank and even repurchase the trucks if the bank were not able to sell them. How would you label this transaction, financing and operating?
As I’ve always been doing, in this article, I will solve this question and demystify the tricky accounts receivable account and what you need to look for lest you not get tricked by financial shenanigans related to receivables.
Solution to Management Science Series #196: Financial accounting as a forensic tool: This time, investigating restructuring projects
Financial accounting as a forensic tool: This time, investigating restructuring projects
Many analysts and investors have a hard time, grasping the reasons behind why companies, especially those that are publicly traded, announce bigger layoff plans than is financially warranted.
Laying off employees is almost always one of the first acts companies undertake in their restructuring efforts. Nonetheless, these restructuring projects may be utilized to smooth earnings. Do you know how? Try to solve the following example:
Assume that the automaker Alliance planned to lay off 200 people and published the developments accordingly. The company offers $60,000 severance package for each person who is going to be laid off.
In fact, laying off only 100 people would have sufficed; however, the company chose to announce a bigger number, i.e. 200 people, and stated the relevant accounts as if it had laid off 200 people.
Why would it do so? How will this restructuring charge affect current period’s operating profit?
How would the operating profit change if the company were to restate the relevant accounts and release the related reserve accounts to reflect the real number associated with these layoffs, i.e. 100 people rather than initially stated 200 people, in the following quarters?
Solution to Management Science Series #195: Valuing Options to Expand
Casca is a video games company based in Midland. It has created many of the most well-known IPs in the video game industry.
Financial analysts of Casca estimate that Casca has a total value of $2.3B according to their DCF models. These IPs and franchises are highly valuable and Casca aims to create new video game franchises for the foreseeable future.
Developing these video game franchises also allows Casca to enter toy and merchandising industry, establishing a new adjacent business activity. Casca could initiate and expand this business activity over the next 4 years.
Current cost of this business activity is estimated to be $1B. Expected cash flows are after-tax $120M per year for 18 years. Cost of capital for toy companies is estimated to be 17%. Casca analysts investigated annualized standard deviations in firm value for publicly-traded toy companies.
With appropriate risk and company-specific adjustments, Casca thinks that the appropriate volatility value for this project is around 27%. Should Casca expand into toy business?
Solution to Management Science Series #194: Valuing Oil Reserves
Ace Chemicals has claims on oil reserves amounting to 5 billion barrels in the South Arkham Sea. Ace’s rights to develop these reserves will expire in 30 years.
Currently, developing these reserves will cost Ace $20 per barrel. Use Crude Oil WTI Futures as a proxy for the current market price of oil. Production costs per barrel is estimated to be $40 per barrel.
Use appropriate risk-free rate for this project. Also, how would your model consider the volatility of this project?
Factor in the cost of delay of the project in your model and decide whether Ace should start developing reserves now or rather wait.
Solution to Management Science Series #192: Accounting for Investments in Other Companies and Financial Forensics 🕵️
A publicly traded company, Museum Enterprises (ME) has had rough years lately not living up to the expectations of financial markets and equity investors, missing all of its target earnings.
ME, which stores and sells art collectibles, believes that organic growth is not viable given the current market conditions.
So, at the end of the last fiscal year, it purchased 65% of equity in Castle Entertainment. At the end of this fiscal year, Castle recorded $500M in revenues and incurred total expenses amounting to $230M.
-How will this investment affect ME’s revenues and operating income? Give a quantitatively concrete answer.
-How will this investment help ME’s income before income taxes? Give a quantitatively concrete answer.
-Assume that ME has 40 million shares of stock issued and outstanding and the corporate tax rate for ME is 21%. How will ME’s investment in Castle affect its EPS this year; calculate it!