Creating Efficient Markets

According to Aswath Damodaran, In order for markets to be more efficient, the following three conditions must exist:

1. If trades can’t be executed then markets will be inefficient. Thus, trading should be “both inexpensive and easy.”[i]

2. Information about the firms should be wide, deep and freely available.

3. Caveat Emptor: Buyers should reap the rewards and suffer the slides of an investment.

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[i] Damodaran, Aswath. Applied Corporate Finance, p 42, John Wiley and Sons, 2006, Hoboken, New Jersey

Corporate Finance the Investment Decision

The Investment Decision

Invest in assets that earn a return greater than the minimum acceptable hurdle rate.

The hurdle rate should reflect the riskiness of the investment and the mix of debt and equity used to fund it.[i]

Any thorough business model will attempt to measure the risk involved in a particular investment and will therefore provide the necessary return given the risk which becomes the hurdle rate for the project.

Among other things, a good risk and return model should a) come up with standardized risk measures that allows investors to draw individual asset conclusions as to whether its risk is above or below-average, b) “it should translate the measure of risk into a rate of return that the investor should demand as compensation for bearing the risk”[ii] and c) in addition to explaining past returns it should also predict future results.

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[i] Damodaran, Aswath, Applied Coroporate Finance, John Wiley and Sons, Hoboken, NJ p 50, 2004

[ii] Damodaran, Aswath, Applied Coroporate Finance, John Wiley and Sons, Hoboken, NJ p 52, 2004

Peter Frampton and Perpetuities - Yay!

An Annuity and Ye Olde BA II Plus Business Calculator

For example’s sake, let’s say you can purchase a coin operated laundry machine business for $80,000 outright or you can make installment payments of 10,000 a year for 10 years. Which is the better deal? If the discount rate is 8%, we would break out our hand BA II Plus business calculator and enter the digits as follows:

P/Y = 1

N = 10

I/Y = 8

PMT = $10,000

CPT PV

The result is $67,101. Thus, it would be wiser to take the installment payment deal and use the rest to stock up the detergent dispensers with Tide.

A Perpetuity Goes on Forever, Just Like the Peter Frampton Song Do You Feel Like We Do

To find the present value of a perpetuity, you simply divide the annual payment by the interest rate. For example, a bond that pays a $50 coupon each year with an interest rate of 10 percent has a present value of $500.

PV = $50 / .10 = $500

Mark A. White provides us with a very interesting example of a perpetuity in his workbook, Financial Analysis With an Electronic Calculator: “Former US President John F. Kennedy’s grave in Arlington Cemetery is marked by an ‘eternal flame,’ which has burned continuosly since his assassination in 1963. Suppose that annual fuel expenses were estimated at $1,200 per year, and the annual interest rate at that time was 5 percent. How much should this portion of the monument have cost at the time of its construction?”[i]

Answer = $24,000

PV = $1,200 / .05

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[i] Financial Analysis With an Electronic Calculator, Mark A. White, Fourth Edition, McGraw Hill, 2000, p30

Two Types of Valuation

Ultimately, two types of valuation exist: Intrinsic and Relative.

In intrinsic valuation, the price of an asset is determined by "the cash flows you expect that asset to generate over its life and how uncertain you fell about these cash flows."1.

In other words, you want an asset that delivers consistent, steady cash flows so those future cash flows so that an accurate valuation may be formed.

Chart 1.1 for example represents the cash flow of asset to the income column. A) Cash flow must exist and B) in order to form a reasonable valuation they must be strong and steady.

Chart 1.1 The Picture of Cash Flow

You can see this valuation at work in the Warren Buffet model of valuation ...

Intrinsic Value, The Earnings Approach ... Same Thing

This method is closest to how Warren Buffett values a stock investment. In this approach, the average earnings from the past three to five years are divided by a capitalization rate, typically the rate of return expected from the investment. Average earnings of $100,000 divided by a cap rate of 20 percent gives you a business value of $500,000. The $500,000 investment provides a 20 percent rate of return. Cap rates are typically bucketed off into different classes based on the size and type of business.⁴

1. 10 to 15 percent—large-sized businesses, over $10 million in sales.

2. 15 to 20 percent—medium to large-sized businesses with $2 million to $10 million in sales.

3. 20 to 30 percent—small to medium-sized businesses with $500,000 to $2 million in sales.

4. 30 to 50 percent—small-sized retail or service businesses.

With an existing business, ask for the income tax returns, ideally, 10 years’ worth.

The second approach, relative valuation is the same method used to value a house in which a Realtor pulls a list of similar houses that have sold recently and adjusts the selling price of the house in question up or down based on inferior or superior features. With a stock, this means comparing pricing to similar stock using the price to earnings ratio. A stock trading at 40 times earnings compared to a peer group that trades around 20, for all intents and purposes, appears overvalued.

1. The Little Book of Valuation, Aswath Damodaran, p. 4, John Wiley and Sons,2011

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The over-arching vision of Building a Small Business That Warren Buffett Would Loveis to create

One Million Jobs.

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Principles of Corporate Finance

Table 1.1 Corporate Finance Principles

Source: Applied Corporate Finance, Aswath Damodaran

The Investment Decision

Invest in assets that earn a return greater than the minimum acceptable hurdle rate.

The hurdle rate should reflect the riskiness of the investment and the mix of debt and equity used to fund it.

The return should reflect the magnitude and the timing of the cash flows as well as all side effects.

The Financing Decision

Find the right kind of debt for your firm and the right mix of debt and equity to fund your operations.

The optimal mix of debt and equity maximizes firm value.

The right kind of debt matches the tenor of your assets: the term of the debt should match the term of the need.

The Dividend Decision

If you cannot find investments that make your minimum acceptable rate, return the cash to owners of your business.

How much cash you can return depends on current and potential investment opportunities. In other words, if you can no longer find optimal investments that meet the firm’s hurdle rate, it may be time to distribute.

How you choose to return cash to the owners will depend on whether they prefer dividends or buybacks. Stock buybacks are beneficial for existing shareholders as earnings per share will increase.[i]

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[i] Applied Corporate Finance, Aswath Damodaran, John Wiley and Sons, INC, Hoboken New Jersey, 2006

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Building a Small Business That Warren Buffett Would Love, available at Amazon.comorBarnesandNoble.com.

The over-arching vision of Building a Small Business That Warren Buffett Would Loveis to create

One Million Jobs.

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New Disney Destination: To Infinity and Beyond! Part 4

The Numbers

Shares of Disney were down 3.5% year to date in 2011 due in part to a lackluster movie performance and softer park attendance, but fourth quarter 2011 saw the company’s EPS increase 24% to a record $2.52 compared to $2.03 in the prior year. (For a full run-down of a long-term analysis, see the supplemental, Warren Buffett Diagnostic.)

Disney is trading at 89% of its 52 week trading range, 15.6 times earnings and has a 13.5% marginal growth rate. Although it does not appear cheap right now, the long-term prospect looks like it will reach infinity and beyond.

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Building a Small Business That Warren Buffett Would Love, available at Amazon.comorBarnesandNoble.com.

The over-arching vision of Building a Small Business That Warren Buffett Would Loveis to create

One Million Jobs.

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An Improving Economy?

Private-sector job growth showed 170,000 new jobs added in January, in line with economists expectations. This coupled with strong economic news out of Europe led to a rally in stock futures this morning. DJIA gains for January were the biggest in 15 years. December jobs added were revised down to 292,000 from 325,000.

For each copy sold of Building a Small Business That Warren Buffett Would Love, an eBook will be given to an unemployed person or needy entrepreneur ... in-line with the Toms Shoes campaign.

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Building a Small Business That Warren Buffett Would Love, available at Amazon.comorBarnesandNoble.com.

The over-arching vision of Building a Small Business That Warren Buffett Would Love is to create

One Million Jobs.

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Toms Shoes - The Inspiration for One Million Jobs

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Building a Small Business That Warren Buffett Would Love, available at Amazon.com orBarnesandNoble.com.

The over-arching vision of Building a Small Business That Warren Buffett Would Love is to create

One Million Jobs.

Like us on Facebook to find out how you can support this mission!

Available at Amazon.com and BarnesandNoble.com!

New Disney Destination: To Infinity and Beyond! Part 2

But I Want to Ride the New Spaceship Earth - Theme Parks and Hotels

Coming in at 17% of operating income, the theme parks represent the traditional Disney brand that every kid and dad with an open wallet tends to remember, and they are growing. Shanghai Disneyland, is slated to open in 2016 in one of the world’s fastest growing economies[i] and a new Fantasyland is slated to open at Disney World in the fall of 2012. Although Disney theme parks tend to metastasize indefinitely, once these park expansions and associated costs are complete, revenues should flow like train cars on Big Thunder Mountain Railroad as the company realizes additional cash flows.

Waning attendance issues troubled the parks in 2010 and early 2011 as a result of lackluster consumer confidence, but the parks have reported strong fourth quarter results in which revenues Increased 11% to $3.1 billion and segment operating income increased by 33%.[ii] I can personally vouch for the Christmas 2011 attendance levels as at one point on my vacation, the gates to the Magic Kingdom were shuttered because it was “at capacity.”

_________________________________________________________________

Building a Small Business That Warren Buffett Would Love, available at Amazon.com orBarnesandNoble.com.

The over-arching vision of Building a Small Business That Warren Buffett Would Love is to create

One Million Jobs.

Like us on Facebook to find out how you can support this mission!

Available at Amazon.com and BarnesandNoble.com!

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[i] http://www.china-mike.com/facts-about-china/economy-investment-business-statistics/

[ii] http://corporate.disney.go.com/corporate/pdfs/Q411_PR_FINAL.pdf

A New Disney Destination: To Infinity and Beyond!

Giant Mouse-Ears, Big Dividend

At the End of November 2011 the Walt Disney Company increased its dividend from $.40 to $.60, a 50% boost bringing its yield close to 1.7%. This fact coupled with the company’s stock buyback plan of 400 million shares,[i] indicates that a “great big, beautiful tomorrow”[ii] exists for this company.

Typically, a dividend increase is a signal of confidence for the business and its long-term prospects since a dividend after-all is a commitment to put money in investors’ pockets and should not soon be cut. In the case of the company that Mickey built, this increase represents a three-fold hike over historic bumps: in the last eight years, the Disney dividend has been raised six times [iii] and never by more than 15%. This current dividend liftoff is bigger than Spaceship Earth.

A Fabulous Log Flume of a Company

The Walt Disney Company is a not-so small world of cable properties, theme parks, hotels, cruise ships, movies and merchandise. The cable properties, the hugest portion of this animal safari, represent 67% of operating income and include the ABC, ESPN, and Disney Channel networks. Highlighting its importance even further are the huge transmission fees that the cable segment generates from cable and satellite providers for ABC. Disney is not so much a theme park and animated feature company nowadays as it is a cable network which recently secured a contract with the NFL to broadcast its games through 2021. Can I get a“Yo-Ho” anyone?

Building a Small Business That Warren Buffett Would Love, available at Amazon.com orBarnesandNoble.com.

Available at Amazon.com and BarnesandNoble.com!

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[i] Walt Disney Company May 10th, SEC 10-Q

[ii] Richard M. Sherman and Robert B. Sherman, “There’s a Great Big Beautiful Tomorrow,” .1964

[iii] http://www.fool.com/investing/dividends-income/2012/01/21/do-these-dividend-tightwads-belong-in-the-dow.aspx?source=isesitlnk0000001&mrr=1.00

One Million Jobs

The overarching vision for "Building a Small Business That Warren Buffett Would Love" is to create 1 million jobs. For each copy sold, I will give a free eBook to an unemployed individual or entrepreneur, similar to the Tom's Shoes campaign in which they give a pair of shoes to a child in need for each pair sold.

The Path to One Million Jobs

The material itself can lead to employment through entrepreneurship for the reader, but it can also lead to additional job creation with the small business start. Additionally, I encourage unemployed folks with limited options to start a part-time business doing something you love and to pick up the rest of the hours in a part time job. In this way you will be fulfilling a passion and receiving a paycheck.

With this message I hope to make a significant dent in the unemployment rate and help others.

Like if you support and pre-order if you wish if you wish to make an impact:http://www.barnesandnoble.com/w/building-a-small-business-that-warren-buffett-would-love-adam-brownlee/1105112831?ean=9781118138885&itm=1&usri=building+a+small+business+that+warren

Building a Small Business That Warren Buffett Would Love, available at Amazon.com orBarnesandNoble.com.

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Steve Jobs

Your time is limited so don't waste it living someone else's life.

Don't be trapped by dogma which is living with the results of other people's thinking.

Don't let the noise of other people's opinions drown out your own inner voice.

And most importantly, have the courage to follow your heart and own intuition, they somehow know what you truly want to become.

Everything else is secondary.

- Steve Jobs addressing the 2005 Stanford graduating class

Building a Small Business That Warren Buffett Would Love, available at Amazon.com orBarnesandNoble.com.

Available at Amazon.com and BarnesandNoble.com!