Warren Buffett On Debt

Good Debt Versus Bad Debt

Another reason why excessive debt can lead to bad results is the confusion between good debt and bad debt. As a rule of thumb, good debt is used to buy assets that generally appreciate in value and bad debt is used to purchase wasting assets that potentially require maintenance and upkeep: jet skis, plasma tvs. More specifically, Robert Kiyosaki, author of Rich Dad, Poor Dad states that good debt is used to purchase assets that put money in your pocket; rental property, dividend paying stocks, franchise businesses, and that bad debt is used to purchase toys or “doodads” that take money out of your pocket each month; jet skis, plasma tvs, cars, etc..

He goes so far as to say that a mortgage on your personal residence is bad debt since, alt

hough the house is appreciating in value, the house is taking money out of your pocket on a monthly basis through upkeep and maintenance, taxes and insurance.

In my opinion, this is a very conservative definition of bad debt. A mortgage on a house is relatively neutral and neither good debt nor bad debt. Although a personal residence creates monthly expenses, a) the house value is appreciating making it a wash on the monthly expenses and b) it is not financially prudent to rent over a lifetime.

An individual who rents for 50 years from the age of 25, paying an average monthly rent of $700 will end up paying $420,000 over a lifetime. If the rents increase at 4% a year, the renter will end up paying well over one million dollars in rent, $1,282,409 to be exact.

I don’t know about you but I can find “bearable” accommodations for half a million dollars.

Bad Debt Examples

• Automobiles
• Credit Cards
• School Loans

Good Debt Examples

• Rental Property
• Business

Neutral Debt

• Home Mortgage

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For more information, check out my first book, My Happy Assets athttp://www.myhappyassets.com/ and the complete second book, Small Business Coffee Hour, Three Essential Ingredients for a

SuccessfulBusinessathttp://www.smallbizcoffee.com/. Both are also available at lulu.com. Happy Reading!

Also be on the lookout for my fourth book due out in February 2012 by Wiley. To stay tuned in go tohttp://www.facebook.com/myhappyasset and "like" away.

Wrapping Your Brain Around Debt Versus No-Debt

1. Debt is a good thing and should be used in buckets for leverage, especially in the realm of real estate.

Two primary reasons exist for the advocacy of investment debt:

a) The use of Other People's Money or OPM and ...

b) The benefits of leverage.

As an investor, it is not necessary to start with a million dollars if you use other people's money which in most cases, is the bank's money. The bank of course does not freely hand out money. They want to see that you can in fact repay the loan through the cash flow of the investment and other sources of income.

The second, important factor is leverage:

If you put $20,000 down on a $100,000 property and it generates $3,000 a year in cash flow, what is your rate of return? It is $3,000/$20,000 or 15%.

If the property increases in value by 6%, how much have you gained?

Answer: $100,000 x 6% = $6,000.

How much of a rate of return is this over your initial investment?

Answer: $6,000/$20,000 = 30%

When you add this to your $3,000 of cash flow, your true rate of return is $9,000/$20,000 or 45%.

If you took that money instead and invested it in a stock mutual fund, how much rate of return would you expect? Answer: 10% over the long haul.

Stocks 10%

Real Estate 45%

‘Nuff said.

A major principle of leverage is that you are doing more with less and less creating the potential for a high return on equity. If instead of $20,000, the investor puts down the full $100,000, the return on equity in the property will be 9%, ($9,000/$100,000) versus 45%. Of course the individual in scenario one is saddled with $80,000 worth of debt. So why is this so bad ...

2. The presence of any amount of personal debt is equivalent to standing next to the gates of hell.

Two reasons to hate debt:

a) The reverse effects of leverage.

b) The confusion between bad debt and good debt.

This is a Two-Way Street - The Reverse Effect of Leverage

Just as leverage can magnify returns as values increase, it can also magnify losses as values drop. In our cash flowing rental property example, let us pretend that instead of increasing in value, the property decreases by 10%. Real estate is seen as a "steady," non-volatile asset class, unlike the stock market, that over the long term, consistently increases in value by 4% to 6% a year. But, there are occasions, (think 2007) when real estate values drop.

Instead of increasing in value by 6%, let us analyze the investment with a 10% drop in value.

If the property drops in value by 10%, how much have you lost?

Answer: $100,000 x 10% = -$10,000.

Based on the initial investment, what is the percentage loss?

Answer: $10,000/$20,000 = 50%

In the world of stocks however, a 10% loss will only equate to a $2,000 loss. (10% x $20,000).

Additionally, if your rental property asset has dropped in value, it is safe to assume that not all is well with the economy and rents will suffer. Let us assume that rents drop from $3,000 to $2,000 in the rental scenario. The total return during the downturn will be -40%, (-$8,000/$20,000).

Most real estate investors only pay attention to the cash flow. In the long haul, is it safe to

say that real estate will continue to increase in value. I believe the answer is yes .... as long as inflation exists, real estate values will increase. In the real estate world, economic downturns are truly detrimental when cash flow turns negative and the investor is unable to pay the bills. As long as the upfront cash flow analysis is through, the financing terms are favorable and quality property management is in place, the risk should be mitigated.

My Poor, Poor Income Statement. Damn You Debt!

Debt becomes a huge anchor weight when an investment or business can no longer cash flow through the debt payment. For example: Let us say in the rental property scenario that cash flow is slim due to the amount of debt taken on to finance the property. What happens during a rental downturn ...

You can see that before the downturn, cash flow is at $61 a month or 4% on the initial investment providing small wiggle room. When rents decrease, cash flow turns negative and the property owner may now have trouble paying the bills.

The same income statement scenario applies to small business as well. You would just supplement cost of goods sold for vacancy loss, supplies instead of yard work, so on and so forth.

More to follow ...

The Confusion of Good Debt Versus Bad Debt

Warren Buffett, Your Small Business and Debt

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For more information, check out my first book, My Happy Assets athttp://www.myhappyassets.com/ and the complete second book, Small Business Coffee Hour, Three Essential Ingredients for a Successful Businessathttp://www.smallbizcoffee.com/. Both are also available at lulu.com. Happy Reading!

Also be on the lookout for my fourth book due out in February 2012 by Wiley. To stay tuned in go tohttp://www.facebook.com/myhappyasset and "like" away.

Debt: Friend or Foe ...

In the world of talking head, personal finance, there exists two, opposite extreme viewpoints on the subject of debt:

Either ...

1. Debt is a good thing and should be used in large quantities for leverage, especially in the realm of real estate.

Or ...

2. The presence of any amount of personal debt is equivalent to standing next to the gates of hell.

So, which one is right? Let us turn to the Oracle of Omaha for the answer. First though, let us evaluate the two debt paradigms in the eyes of the paradigmers ...

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For more information, check out my first book, My Happy Assets athttp://www.myhappyassets.com/ and the complete second book, Small Business Coffee Hour, Three Essential Ingredients for a Successful Businessathttp://www.smallbizcoffee.com/. Both are also available at lulu.com. Happy Reading!

Also be on the lookout for my fourth book due out in February 2012 by Wiley. To stay tuned in go tohttp://www.facebook.com/myhappyasset and "like" away.

How Warren Buffett Puts a Future Value on a Stock ... Yo

Using Equity Share Value
	MCD	KO	DIS
Average ROE	21.1%	32.2%	9.1%
Average Annual Dividend Yield	3.0%	3.0%	0.9%
True Equity Rate of Growth of Shareholder's Equity	18.1%	29.2%	8.2%
Total Shares (in millions)	1,080	2,295	1,899
Total Equity (in millions)	15,458	31,003	37,519
Per Share Shareholders Equity Value	$ 14.31	$ 13.51	$ 19.76
N	10	10	10
I/Y	18.1%	29.2%	8.2%
PV	14.31	$ 13.51	$ 19.76
CPT FV - Future Per Share Value of Co's Shareholder's Equity	$ 75.82	$ 175.37	$ 43.30
Projected Future EPS	$ 16.03	$ 56.50	$ 3.94
Avg. 10 yr. P/E	20	23	25
Company's per share projected future 2020 trading price	$ 320.64	$ 1,299.60	$ 98.41
PV (company's current price)	$ 75.78	$ 65.22	$ 42.97
FV	320.64	$ 1,299.60	$ 98.41
N	10	10	10
CPT I/Y (This is the company's projected annual compounding rate of return.)	15.5%	34.9%	8.6%
Projected Future Trading Price of the Company's Stock	$ 320.64	$ 1,299.60	$ 98.41
Current Trading Price	$ 75.78	$ 65.22	$ 42.97

Using Historics
	MCD	KO	DIS
PV (EPS 2000 or 1999)	$ 1.46	$ 1.33	$ 0.30
FV (EPS 2010 or 2009)	$ 4.58	$ 2.93	$ 2.07
N	10	10	10
CPT I/Y (Per Share Annual Compounding Growth Rate for 2000 to 2010)	12.1%	8.2%	21.3%
PV (EPS 2010)	$ 4.58	$ 2.93	$ 2.07
I/Y	0.1211	0.0822	0.2131
N	10	10	10
CPT FV (Projected EPS for 2020)	$ 14.37	$ 6.46	$ 14.29
Avg. 10 yr. P/E	20	23	25
Company's per share projected future 2020 trading price	$ 287.40	$ 148.58	$ 357.25
PV (company's current price)	$ 75.78	$ 65.22	$ 42.97
FV	287.4	148.58	357.25
N	10	10	10
CPT I/Y This is the company's projected annual compounding rate of return using historics.	14.26%	8.58%	23.59%

	MCD	KO	DIS
Projected 2020 Trading Range Using Historics	$ 287.40	$ 148.58	$ 357.25
Projected 2020 Trading Range Using Per Share Equity	$ 320.64	$ 1,299.60	$ 98.41
Average	$ 304.02	$ 724.09	$ 227.83
Projected Rate of Return Using Historics	14.3%	8.6%	23.6%
Projected Rate of Return Using Per Share Equity	15.5%	34.9%	8.6%
Average	14.9%	21.7%	16.1%

Inflation is Not Your Baby Daddy

Inflation as It Applies to a Four-Plex

As prices increase, so do operational expenses. Revenues (rents) can increase as well. Fixed interest payments though, remain static. Thus, a four -plex owner is able to pay off fixed debt with cheaper dollars.

Inflation as it Applies to a Public Company

A company with shares outstanding will realize the same effects of inflation as a four-plex owner: prices go up, expenses increase, if they are not in a price competitive industry, the business can increase product prices as well. In addition to long term fixed debt, shares can remain the same or potentially decrease if the company buys back shares. If the number of shares outstanding remain the same, as revenues increase with inflation then earnings per share will increase.

Inflation as it Applies to a Small Business

Typically, a small business will not have shares outstanding (some will) so in most cases, a small business with the ability to increase prices with inflation will benefit from long term fixed debt that can be paid off with inflated dollars.

Also keep in mind thought that it is wise to not have a hefty amount of debt on the balance sheet. Warren Buffett likes companies that can retire their entire long term debt in one to two years from revenue.

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For more information, check out my first book, My Happy Assets at http://www.myhappyassets.com/ and the complete second book, Small Business Coffee Hour, Three Essential Ingredients for a Successful Business athttp://www.smallbizcoffee.com/. Both are also available at lulu.com. Happy Reading!

Also be on the lookout for my fourth book due out in February 2012 by Wiley. To stay tuned in go tohttp://www.facebook.com/myhappyasset and "like" away.

Inflation,Inflation, Inflation ...

It is important when evaluating a potential investment or when building a business to ensure

that either has the ability to keep up with inflation.

Case in point ...

In 1955 a McDonald's hamburger cost $.15. In 2011 it cost $.95. A Coke cost $.05 in 1950 and approximately $1.00 (depending on location) in 2011. Believe it or not, a ticket to Disney World cost $3.50 in 1971 and $80.00 in 2010.

So What

A company with the ability to increase prices along with inflation benefits when shares outstanding stay the same or are bought back (earnings per share go up in both cases typically) of if they have long term fixed debt (the interest payments remain the same while revenues increase.)

Small businesses typically benefit in the fixed debt scenario; a business has long term fixed debt, as prices inflate, revenues increase and the business is able to pay off the long term debt with inflated dollars. In other words, the business is receiving more bucks but the debt payment i

s remaining the same.

In the static or reduced share scenario, a business earns more, again through inflated prices, the number of shares outstanding remain the same or shrink via buyback, and the shareholder benefits via an increase in earnings per share.

All of the above as opposed to price competitive industries in which companies have to fight it out price-wise in order to eek out a slim profit. (think aluminum, oil, steel.)

________________________________________________________________________

For more information, check out my first book, My Happy Assets at http://www.myhappyassets.com/ and the complete second book, Small Business Coffee Hour, Three Essential Ingredients for a Successful Business at http://www.smallbizcoffee.com/. Both are also available at lulu.com. Happy Reading!

Also be on the lookout for my fourth book due out in February 2012 by Wiley. To stay tuned in go to http://www.facebook.com/myhappyasset and "like" away.