Whether investors can take advantage of bubbles to make money seems to be a more difficult question to answer. Part of the reason for the failure to exploit bubbles seems to stem from greed �even investors who believe that assets are over priced want to make money of the bubble � and part of the reason is the difficulty of determining when a bubble will burst.
Over valued assets may get even more over valued and these overvaluations can stretch over years, thus imperiling the financial well being of any investor who has bet against the bubble.
There is also an institutional interest on the part of investment banks, the media and portfolio managers, all of whom feed of the bubble, to perpetuate the bubble.
Wednesday 30 December 2009
THE PAUSE AT THE TOP OF THE ROLLER COASTER
There is only one strategy that works for value investors when the market is high – patience. The investor can do one of two things, both of which require steady nerves.
· Sell all stocks in a portfolio, take profits, and wait for the market to decline. At that time, many good values will present themselves. This may sound easy, but it pains many investors to sell a stock when its price is still rising.
· Stick with those stocks in a portfolio that have long-term potential. Sell only those that are clearly overvalued, and once more wait for the market to decline. At this time, value stocks may be appreciating at slow pace compared with the frisky growth stocks, but not always.
But come the correction, be it sudden or slow, the well-chosen value stocks have a better chance of holding their price.
-----
http://myinvestingnotes.blogspot.com/2009/01/pause-at-top-of-roller-coaster.html
The portfolio of one value investor shows what can happen when markets stumble off a cliff. In early September 1987, Walter Schloss’s portfolio was up 53%. The market as a whole had risen 42%, after a DJIA peak of 2722.42. Then in October the market fell off the mountain and the Dow lost 504 points in a single day. The market struggled back and Schloss finished 1987 with a 26% gain while the overall market made only a 5% advance. Schloss followed one of the first rules of investing – don’t lose money. Making up for lost ground puts an investor at a serious disadvantage when calculating long-term average returns.
Schloss is an experienced investor, and not all value investors will do as well in a rising market. It takes patience, “At a guess I’d say that (the value investor) should do a good 20% better than the market over a long period – although not during the most dynamic period of a bull market – if he is rigorous about applying the method,” says author John Train.
As for the hot stocks, when they take a hard hit the investor is cornered. If the stock is sold, the loss becomes permanent. The lost money cannot grow. If the investor hangs on to the deflated stock, the long trail back to the original purchase price will deeply erode the overall return.
· Sell all stocks in a portfolio, take profits, and wait for the market to decline. At that time, many good values will present themselves. This may sound easy, but it pains many investors to sell a stock when its price is still rising.
· Stick with those stocks in a portfolio that have long-term potential. Sell only those that are clearly overvalued, and once more wait for the market to decline. At this time, value stocks may be appreciating at slow pace compared with the frisky growth stocks, but not always.
But come the correction, be it sudden or slow, the well-chosen value stocks have a better chance of holding their price.
-----
http://myinvestingnotes.blogspot.com/2009/01/pause-at-top-of-roller-coaster.html
The portfolio of one value investor shows what can happen when markets stumble off a cliff. In early September 1987, Walter Schloss’s portfolio was up 53%. The market as a whole had risen 42%, after a DJIA peak of 2722.42. Then in October the market fell off the mountain and the Dow lost 504 points in a single day. The market struggled back and Schloss finished 1987 with a 26% gain while the overall market made only a 5% advance. Schloss followed one of the first rules of investing – don’t lose money. Making up for lost ground puts an investor at a serious disadvantage when calculating long-term average returns.
Schloss is an experienced investor, and not all value investors will do as well in a rising market. It takes patience, “At a guess I’d say that (the value investor) should do a good 20% better than the market over a long period – although not during the most dynamic period of a bull market – if he is rigorous about applying the method,” says author John Train.
As for the hot stocks, when they take a hard hit the investor is cornered. If the stock is sold, the loss becomes permanent. The lost money cannot grow. If the investor hangs on to the deflated stock, the long trail back to the original purchase price will deeply erode the overall return.
Tuesday 29 December 2009
The Process of Fundamental Analysis
http://spreadsheets.google.com/pub?key=thrIJu34ZkHzDDZwDLtNIHw&output=html
The figure outlines the 5-Step process of fundamental analysis that produces an estimate of the value.
In the last step in the diagram, Step 5, this value is compared with the price of investing. This step is the investment decision.
The figure outlines the 5-Step process of fundamental analysis that produces an estimate of the value.
In the last step in the diagram, Step 5, this value is compared with the price of investing. This step is the investment decision.
The man in charge of US$1tril assets warns about stocks
Updated: Monday December 28, 2009 MYT 1:20:42 PM
The man in charge of US$1tril assets warns about stocks
NEW YORK: Homes are selling at their fastest clip in nearly three years, the unemployment rate is falling and stocks are up 66 percent since their March lows - the best performance since the 1930s. What's not to like?
Plenty, according to Mohamed El-Erian, chief executive of giant bond manager Pimco.
The investor says the recovery may be gaining steam but is no different than a kid who eats too much candy at one of the birthday parties his 6-year-old daughter attends.
FILE PIX - In this Feb. 12, 2008 file photo, Mohamed El-Erian, Co-Chief Executive Officer and Co-Chief Investment Officer of PIMCO, talks about sovereign wealth funds in New York. - AP
"We're on a sugar high," El-Erian says.
"It feels good for a while but is unsustainable."
His point: This burst of economic activity fed by government spending and near-zero interest rates will soon peter out.
As CEO at Newport Beach, Calif.-based Pimco, El-Erian, 51, oversees nearly $1 trillion in assets, more than the gross domestic product of most countries.
So when he talks, people listen.
What he's saying now:
-Stocks will drop 10 percent in the space of three or four weeks, bringing the Standard & Poor's 500 index below 1,000 - though he's not predicting when.
-The unemployment rate will be hovering above 8 percent a year from now.
-U.S. gross domestic product will grow at an average 2 percent or so for years to come - a third slower than we're used to.
El-Erian and his famous partner, Pimco founder Bill Gross, are watched closely because they've made investors a lot of money over the years.
The Pimco Total Return Fund, which at $203 billion is the world's largest mutual fund, has returned an average 7.6 percent annually over 10 years, after fees, versus 6.3 percent for Barclays Capital U.S. Aggregate fixed income index fund.
The hotshots at Pimco have made money by anticipating big moves in the economy and interest rates way before other investors.
In the depths of the financial crisis last year, for instance, Pimco sold some of its Treasury bonds to panicked investors looking for a safe haven and put the proceeds into government-backed mortgages and bank debt - in time to catch the big upswing in prices of those and other riskier securities this year.
Now Pimco is once again changing tack. El-Erian says people are fooling themselves if they think all the bullish data of late means a strong recovery is in the offing.
So he's buying Treasurys and selling riskier stuff.
His bet: Investors will get scared again and want U.S.-guaranteed debt so they know they'll get repaid.
At Total Return, government-related securities, including Treasurys and corporate debt backed by Washington, comprised 48 percent of the fund's holdings in September.
That was up from 9 percent at the beginning of the year.
One of Pimco's newest funds, the Global Multi-Asset Fund, a hybrid stock-bond offering, is 35 percent in equities now, down from 60 percent earlier this year.
Investors betting on stocks or high-yield bonds are likely to be disappointed, El-Erian says.
Markets for those securities are rallying not because people like them but because they hate the puny yields of safer investments like money markets and feel they have no choice but to buy, he says.
He quips that that makes the bull market as likely to last as a forced marriage.
The danger: If stock and junk bond prices start falling, lots of investors are likely to bail, feeding the drop.
Of course, there are plenty of true believers in the bull who are not buying the El-Erian line.
James Paulsen, chief strategist at Wells Capital Management in Minneapolis, with $355 billion under management, has been pounding the table for months to buy stocks.
Just like in the early 1980s, the recovery will take the form of a "V," he says. The reason: Companies have cut inventories and payrolls to the bone, so just a little revenue growth could translate into a bumper crop of profits.
El-Erian says many of the bulls don't appreciate just how much the government props still under the economy are masking its weakness.
Instead of focusing on the fundamentals today, he says, they're looking to the past, expecting a quick economic rebound because that's what's happened before.
We're trained to think the "farther you fall, the higher you'll bounce back," El-Erian says. "We're hostage to the V."
El-Erian says he learned to be open to many different views on the world (and markets) from his father, an Egyptian diplomat who insisted on reading several newspapers everyday, both on the right and the left.
El-Erian had hoped to become a college professor.
But when his father died, he took a job at the International Monetary Fund to support the family.
He rose through the ranks, eventually becoming deputy director.
In 1999 he joined Pimco, where he quickly made a name for himself with some prescient bets on emerging markets.
One of his biggest wins: selling Argentine bonds in 2000 while they were still popular with investors.
When the country defaulted the next year, the emerging markets fund that El-Erian managed returned 28 percent versus negative 1 percent for the Emerging Market Bond Index.
He eventually left to head the group that manages Harvard University's massive endowment, returning to Pimco in January 2008 in time catch the depths of the financial crisis.
El-Erian says we've probably seen the worst of the crisis but consumers, and not just Washington, need to start spending again for the recovery to really take hold.
He doesn't expect that to happen soon. Like in the Great Depression, Americans are saving more and borrowing less - a shift in attitudes toward family finances that Pimco thinks will last a generation.
That, plus the impact of more regulation and higher taxes, El-Erian says, will crimp growth for years to come.
Whatever the merits of that view, Pimco is not exactly knocking the lights out right now. So far this year, the Total Return Fund has returned 14 percent, impressive in normal times but no better than average for similar funds during the rally, according to Morningstar.
The 19.1 percent return for Global Multi-Asset, which El-Erian co-manages, lags two-thirds of its peers.
El-Erian says he sold equities "too early" but is convinced his view on the market will prove correct - even if it strikes many as a tad too pessimistic.
"I'm calling it as I see it," he says. "I'm not optimistic or pessimistic - I'm realistic." - AP
http://biz.thestar.com.my/news/story.asp?file=/2009/12/28/business/20091228081257&sec=business
The man in charge of US$1tril assets warns about stocks
NEW YORK: Homes are selling at their fastest clip in nearly three years, the unemployment rate is falling and stocks are up 66 percent since their March lows - the best performance since the 1930s. What's not to like?
Plenty, according to Mohamed El-Erian, chief executive of giant bond manager Pimco.
The investor says the recovery may be gaining steam but is no different than a kid who eats too much candy at one of the birthday parties his 6-year-old daughter attends.
FILE PIX - In this Feb. 12, 2008 file photo, Mohamed El-Erian, Co-Chief Executive Officer and Co-Chief Investment Officer of PIMCO, talks about sovereign wealth funds in New York. - AP
"We're on a sugar high," El-Erian says.
"It feels good for a while but is unsustainable."
His point: This burst of economic activity fed by government spending and near-zero interest rates will soon peter out.
As CEO at Newport Beach, Calif.-based Pimco, El-Erian, 51, oversees nearly $1 trillion in assets, more than the gross domestic product of most countries.
So when he talks, people listen.
What he's saying now:
-Stocks will drop 10 percent in the space of three or four weeks, bringing the Standard & Poor's 500 index below 1,000 - though he's not predicting when.
-The unemployment rate will be hovering above 8 percent a year from now.
-U.S. gross domestic product will grow at an average 2 percent or so for years to come - a third slower than we're used to.
El-Erian and his famous partner, Pimco founder Bill Gross, are watched closely because they've made investors a lot of money over the years.
The Pimco Total Return Fund, which at $203 billion is the world's largest mutual fund, has returned an average 7.6 percent annually over 10 years, after fees, versus 6.3 percent for Barclays Capital U.S. Aggregate fixed income index fund.
The hotshots at Pimco have made money by anticipating big moves in the economy and interest rates way before other investors.
In the depths of the financial crisis last year, for instance, Pimco sold some of its Treasury bonds to panicked investors looking for a safe haven and put the proceeds into government-backed mortgages and bank debt - in time to catch the big upswing in prices of those and other riskier securities this year.
Now Pimco is once again changing tack. El-Erian says people are fooling themselves if they think all the bullish data of late means a strong recovery is in the offing.
So he's buying Treasurys and selling riskier stuff.
His bet: Investors will get scared again and want U.S.-guaranteed debt so they know they'll get repaid.
At Total Return, government-related securities, including Treasurys and corporate debt backed by Washington, comprised 48 percent of the fund's holdings in September.
That was up from 9 percent at the beginning of the year.
One of Pimco's newest funds, the Global Multi-Asset Fund, a hybrid stock-bond offering, is 35 percent in equities now, down from 60 percent earlier this year.
Investors betting on stocks or high-yield bonds are likely to be disappointed, El-Erian says.
Markets for those securities are rallying not because people like them but because they hate the puny yields of safer investments like money markets and feel they have no choice but to buy, he says.
He quips that that makes the bull market as likely to last as a forced marriage.
The danger: If stock and junk bond prices start falling, lots of investors are likely to bail, feeding the drop.
Of course, there are plenty of true believers in the bull who are not buying the El-Erian line.
James Paulsen, chief strategist at Wells Capital Management in Minneapolis, with $355 billion under management, has been pounding the table for months to buy stocks.
Just like in the early 1980s, the recovery will take the form of a "V," he says. The reason: Companies have cut inventories and payrolls to the bone, so just a little revenue growth could translate into a bumper crop of profits.
El-Erian says many of the bulls don't appreciate just how much the government props still under the economy are masking its weakness.
Instead of focusing on the fundamentals today, he says, they're looking to the past, expecting a quick economic rebound because that's what's happened before.
We're trained to think the "farther you fall, the higher you'll bounce back," El-Erian says. "We're hostage to the V."
El-Erian says he learned to be open to many different views on the world (and markets) from his father, an Egyptian diplomat who insisted on reading several newspapers everyday, both on the right and the left.
El-Erian had hoped to become a college professor.
But when his father died, he took a job at the International Monetary Fund to support the family.
He rose through the ranks, eventually becoming deputy director.
In 1999 he joined Pimco, where he quickly made a name for himself with some prescient bets on emerging markets.
One of his biggest wins: selling Argentine bonds in 2000 while they were still popular with investors.
When the country defaulted the next year, the emerging markets fund that El-Erian managed returned 28 percent versus negative 1 percent for the Emerging Market Bond Index.
He eventually left to head the group that manages Harvard University's massive endowment, returning to Pimco in January 2008 in time catch the depths of the financial crisis.
El-Erian says we've probably seen the worst of the crisis but consumers, and not just Washington, need to start spending again for the recovery to really take hold.
He doesn't expect that to happen soon. Like in the Great Depression, Americans are saving more and borrowing less - a shift in attitudes toward family finances that Pimco thinks will last a generation.
That, plus the impact of more regulation and higher taxes, El-Erian says, will crimp growth for years to come.
Whatever the merits of that view, Pimco is not exactly knocking the lights out right now. So far this year, the Total Return Fund has returned 14 percent, impressive in normal times but no better than average for similar funds during the rally, according to Morningstar.
The 19.1 percent return for Global Multi-Asset, which El-Erian co-manages, lags two-thirds of its peers.
El-Erian says he sold equities "too early" but is convinced his view on the market will prove correct - even if it strikes many as a tad too pessimistic.
"I'm calling it as I see it," he says. "I'm not optimistic or pessimistic - I'm realistic." - AP
http://biz.thestar.com.my/news/story.asp?file=/2009/12/28/business/20091228081257&sec=business
Monday 28 December 2009
Chart wise: These stocks continue to climb
Will these stocks continue to climb further uncorrected?
Adventa, Petdag, PBB, LPI, Latexx, GAB, HaiO, HLBank, QL, KPJ, JobSt, KLK, IOICorp, Sime
Adventa, Petdag, PBB, LPI, Latexx, GAB, HaiO, HLBank, QL, KPJ, JobSt, KLK, IOICorp, Sime
Chart wise: These stocks settled lower than their recent peaks
The prices of these stocks rose from March 09 and peaked in June 09. The prices subsequently settled below their peaks.
BStead, LionDiv, KNM, PohKong, POS
BStead, LionDiv, KNM, PohKong, POS
Chart wise: These stocks rose and plateau at their peaks
The prices of these stocks started the climb in March over variable periods and all subsequently flatten out at higher prices.
iCap, Coastal, DLady, GenM, Genting, Integra, Maybank, Nestle, Parkson, Tenaga, UMW, Maybulk, UtdPlt, UMCCA, SOP, KMLoong
Chart wise: This stock is back to its March 09 lows.
Interestingly, the price of this stock is back to its March 09 low.
Sunday 27 December 2009
Dividends are the key to a sensible investment strategy
Dividends are the key to a sensible investment strategy
As we entered 2009, no one would have predicted the strong rally in the FTSE 100, which is now up 22pc as we approach the end of the year.
By Garry White
Published: 7:32PM GMT 26 Dec 2009
In fact, sentiment was so grim that the FTSE 100 fell by almost a quarter over the first three months of 2009.
Questor has therefore been particularly defensive over the last year and focused on yield plays, recovery shares and defensives. This strategy has proved sound, with some real successes, although there have been one or two less than perfect calls along the way.
A dividend strategy should be the cornerstone of any sensible investor's portfolio. Various studies have suggested that more than 70pc of the long-term return in a portfolio is generated by reinvested dividend payments. In the UK we have some of the highest-yielding shares in the world – and UK investors should continue to exploit this.
Yield plays over the last 12 months include National Grid, Northern Foods, Imperial Tobacco and Primary Health Properties. All of these shares remain buys as we enter 2010.
The mining sector has proved lucrative as commodity prices jumped after being oversold last year. The falling dollar has boosted the price of basic materials significantly, as a falling dollar makes them attractive to investors in currencies other than the dollar. Vedanta (up 368pc), Centamin Egypt (up 191pc), Petropavlovsk (up 67pc) and Randgold Resources (up 38pc) have been notable success. A buy stance remains on Russian gold miner Petropavlovsk and Egyptian gold miner Centamin. However, Questor did tip South African ferrochrome producer International Ferro Metals at the wrong time and the shares have plunged by more than 50pc.
Investments in the oil sector have also proved good investments, including Tullow Oil, Afren, BP and Dana Petroleum. The oil services sector has proved even more lucrative, with shares in Petrofac up 116pc and Cape shares up 226pc. The stance on Petrofac shares is hold and Cape shares remain a buy.
It was not all a success, however. A bet on the direction of the oil price using an exchange-traded fund in the earlier part of 2009 proved disastrous – and led to a 30pc loss. All these shares except for Tullow remain a buy.
Next year prospects look brighter than they did 12 months ago, but there is still scope for substantial upset. Dubai World's bond default is a recent example of the potholes that could be faced by investors next year – and the chances of a double-dip recession are very real. Questor has said on a number of occasions that he would not start to become more positive on the outlook until global unemployment started to fall. There has been scant evidence of this so far.
One thing investors should bear in mind next year is that the FTSE 100 is not a reflection of the UK economy – and that's why it should do quite well. About 30pc of the index's weighing is comprised of commodity-related plays such as mining and oil and gas groups. These shares will be influenced by changes in global GDP and prospects for the dollar. The FTSE 250 is by far a clearer reflection of what is going on in UK industry. If the UK economy starts to get back onto its feet, it should be positive for this index.
One sector that should continue to perform is the outsourcing sector – no matter which party wins the election in the first half of the year. In his pre-Budget report, Alistair Darling said: "We will sell those assets that can be managed better by the private sector." As governments all over the world strain to cut debt, this trend will be global and will be around for many years to come.
Over the past year Questor has recommended a number of outsourcing groups and still has buy ratings on Serco, Capita and VT Group.
Questor will reveal his tips for 2010 in The Daily Telegraph on Monday, January 4.
http://www.telegraph.co.uk/finance/markets/questor/6890986/Dividends-are-the-key-to-a-sensible-investment-strategy.html
As we entered 2009, no one would have predicted the strong rally in the FTSE 100, which is now up 22pc as we approach the end of the year.
By Garry White
Published: 7:32PM GMT 26 Dec 2009
In fact, sentiment was so grim that the FTSE 100 fell by almost a quarter over the first three months of 2009.
Questor has therefore been particularly defensive over the last year and focused on yield plays, recovery shares and defensives. This strategy has proved sound, with some real successes, although there have been one or two less than perfect calls along the way.
A dividend strategy should be the cornerstone of any sensible investor's portfolio. Various studies have suggested that more than 70pc of the long-term return in a portfolio is generated by reinvested dividend payments. In the UK we have some of the highest-yielding shares in the world – and UK investors should continue to exploit this.
Yield plays over the last 12 months include National Grid, Northern Foods, Imperial Tobacco and Primary Health Properties. All of these shares remain buys as we enter 2010.
The mining sector has proved lucrative as commodity prices jumped after being oversold last year. The falling dollar has boosted the price of basic materials significantly, as a falling dollar makes them attractive to investors in currencies other than the dollar. Vedanta (up 368pc), Centamin Egypt (up 191pc), Petropavlovsk (up 67pc) and Randgold Resources (up 38pc) have been notable success. A buy stance remains on Russian gold miner Petropavlovsk and Egyptian gold miner Centamin. However, Questor did tip South African ferrochrome producer International Ferro Metals at the wrong time and the shares have plunged by more than 50pc.
Investments in the oil sector have also proved good investments, including Tullow Oil, Afren, BP and Dana Petroleum. The oil services sector has proved even more lucrative, with shares in Petrofac up 116pc and Cape shares up 226pc. The stance on Petrofac shares is hold and Cape shares remain a buy.
It was not all a success, however. A bet on the direction of the oil price using an exchange-traded fund in the earlier part of 2009 proved disastrous – and led to a 30pc loss. All these shares except for Tullow remain a buy.
Next year prospects look brighter than they did 12 months ago, but there is still scope for substantial upset. Dubai World's bond default is a recent example of the potholes that could be faced by investors next year – and the chances of a double-dip recession are very real. Questor has said on a number of occasions that he would not start to become more positive on the outlook until global unemployment started to fall. There has been scant evidence of this so far.
One thing investors should bear in mind next year is that the FTSE 100 is not a reflection of the UK economy – and that's why it should do quite well. About 30pc of the index's weighing is comprised of commodity-related plays such as mining and oil and gas groups. These shares will be influenced by changes in global GDP and prospects for the dollar. The FTSE 250 is by far a clearer reflection of what is going on in UK industry. If the UK economy starts to get back onto its feet, it should be positive for this index.
One sector that should continue to perform is the outsourcing sector – no matter which party wins the election in the first half of the year. In his pre-Budget report, Alistair Darling said: "We will sell those assets that can be managed better by the private sector." As governments all over the world strain to cut debt, this trend will be global and will be around for many years to come.
Over the past year Questor has recommended a number of outsourcing groups and still has buy ratings on Serco, Capita and VT Group.
Questor will reveal his tips for 2010 in The Daily Telegraph on Monday, January 4.
http://www.telegraph.co.uk/finance/markets/questor/6890986/Dividends-are-the-key-to-a-sensible-investment-strategy.html
Coastal Contracts year-to-date has topped RM148 million
Coastal to sell vessels for RM49.2m
Tags: Bursa Malaysia | Coastal Contracts Bhd | deck barge | Ng Chin Heng | offshore support vessel(OSV) | tugboat
Written by The Edge Financial Daily
Thursday, 24 December 2009 11:45
KUALA LUMPUR: Coastal Contracts Bhd have secured contracts for the sale of an offshore support vessel (OSV), a tugboat and a deck barge for RM49.2 million, the company announced yesterday.
Including the new contracts, the value of vessel orders clinched by Coastal Contracts year-to-date has topped RM148 million, it told Bursa Malaysia.
Coastal Contracts currently has about RM1.4 billion worth of vessel sales orders awaiting delivery to customers up to 2011.
The group said revenue stream from these three vessels was expected to contribute positively to its bottomline performance for the financial year ending Dec 31, 2010.
In a statement, its executive chairman Ng Chin Heng said: “Despite the challenging market conditions since the latter part of last year, we have been steadily replenishing our vessel sales order book, the ‘building blocks’ that will buoy the group’s future revenue and earnings clarity.”
http://www.theedgemalaysia.com/in-the-financial-daily/156290-coastal-to-sell-vessels-for-rm492m.html
Tags: Bursa Malaysia | Coastal Contracts Bhd | deck barge | Ng Chin Heng | offshore support vessel(OSV) | tugboat
Written by The Edge Financial Daily
Thursday, 24 December 2009 11:45
KUALA LUMPUR: Coastal Contracts Bhd have secured contracts for the sale of an offshore support vessel (OSV), a tugboat and a deck barge for RM49.2 million, the company announced yesterday.
Including the new contracts, the value of vessel orders clinched by Coastal Contracts year-to-date has topped RM148 million, it told Bursa Malaysia.
Coastal Contracts currently has about RM1.4 billion worth of vessel sales orders awaiting delivery to customers up to 2011.
The group said revenue stream from these three vessels was expected to contribute positively to its bottomline performance for the financial year ending Dec 31, 2010.
In a statement, its executive chairman Ng Chin Heng said: “Despite the challenging market conditions since the latter part of last year, we have been steadily replenishing our vessel sales order book, the ‘building blocks’ that will buoy the group’s future revenue and earnings clarity.”
http://www.theedgemalaysia.com/in-the-financial-daily/156290-coastal-to-sell-vessels-for-rm492m.html
Measurement in the Balance Sheet
Book values measurement determines the price-to-book ratio. To evaluate the price-to-book ratio, we must understand how book values are measured.
The values of some assets and liabilities are easy to measure, and the accountant does so. He applies mark-to-market accounting, thus recording these items on the balance sheets at fair value (in accounting terms). These items do not contribute to the premium over book value.
But for many items, the accountant does not, or cannot, mark to market. He applies historical cost accounting. U.S. GAAP gives measurement rules for items commonly found on balance sheets, with those carried at fair value and historical cost indicated. International accounting standards broadly follow similar rules.
-----
Example:
Company A Balance Sheet
Cash and cash equivalent $7.764 million
Short term investments $208 million
Long term investments (mainly interest bearing debt securities) $1,560 million.
Comment: A market value is usually available for these securities, so they can be marked to market.
Accounts payable $11,492 million
Long term debt $362 million
Comment: The accounts payable is close to market value and, while the long-term debt is not marked to market, its book value approximates market value unless interest rates change significantly.
So all these items above do not contribute to price premium over book value.
Net accounts receivable $5,961 million
Financing receivables $1,732 million
Accrued expenses $4,323 million
Other "liabilities" $2,070 million
Comment: All the above 4 items involve estimates, but if these are made in an unbiased way, these items, too, are at fair value.
Company A
2,060 outstanding shares
Market Price $20 per share.
Market value of these shares: $41,200 million.
Book value $3,735 million
Therefore the market premium was $37,465 million.
Comments:
The market saw $37,465 million of shareholder value that was not on the balance sheet.
And it saw $37,465 million of net assets that were not on the balance sheet.
With 2060 million shares outstanding,
How does one account for Company A's large market premium of $37,465 million over the book value of its equity?
The large market premium of $37,465 million over the book value of its equity arises largely from
-----
Short term investments $208 million
Long term investments (mainly interest bearing debt securities) $1,560 million.
Long term debt $362 million
So all these items above do not contribute to price premium over book value.
Financing receivables $1,732 million
Accrued expenses $4,323 million
Other "liabilities" $2,070 million
2,060 outstanding shares
Market Price $20 per share.
Market value of these shares: $41,200 million.
Book value $3,735 million
Therefore the market premium was $37,465 million.
The market saw $37,465 million of shareholder value that was not on the balance sheet.
And it saw $37,465 million of net assets that were not on the balance sheet.
With 2060 million shares outstanding,
- the book value per share (BPS) was $1.81 and
- the market premium was $18.19 per share.
- tangible assets, recorded at (depreciated) historical cost, and
- unrecorded assets.
- its innovative "direct-to-customer" process,
- its supply chain, and
- its brand name.
- Nor might we want them to be.
- Identifying them and measuring their value is a very difficult task, and we would probably end up with very doubtful, speculative numbers.
The Market Price-to-Book and Intrinsic Price-to-Book Ratio
The balance sheet equation corresponds to the value equation.
The value equation can be written as:
Value of the firm = Value of equity + Value of debt
or
Value of equity = Value of firm - Value of debt
The value equation and the balance sheet equation are of the same form but differ in how the assets, liabilities, and equity are measured.
The measure of stockholders' equity on the balance sheet,l the book value of equity, typically does not give the intrinsic value of what the equity is worth.
Intrinsic premium = Intrinsic value of equity - Book value of equity
The difference between the market price of equity and its book value is called the market premium:
Market premium = Market price of equity - Book value of equity
If these premiums are negative, they are called discounts (from book value). Premiums sometimes are referred to as unrecorded goodwill because someone purchasing the firm at a price greater than book value could record the premium paid as an asset, purchased goodwill, on the balance sheet; without a purchase of the firm, the premium is unrecorded.
Premiums can be calculated for the total equity or on a per-share basis.
-----
Example:
Company A
2,060 outstanding shares
Market Price $20 per share.
Market value of these shares: $41,200 million.
Book value $3,735 million
Therefore the market premium was $37,465 million.
Comments:
The market saw $37,465 million of shareholder value that was not on the balance sheet.
And it saw $37,465 million of net assets that were not on the balance sheet.
With 2060 million shares outstanding,
The ratio of market price to book value is the price-to-book ratio or the market-to-book ratio.
The ratio of intrinsic value to book value is the intrinsic price-to-book ratio.
In asking such questions, it is important to have a sense of history so that any calculation can be judged against what was normal in the past. The history provides a benchmark for our analysis.
What causes the variation in ratios?
The low P/B ratios in the 1970s certainly preceded a long bull market.
Company A's P/B of 11.0 in 2008 looks high relative to historical averages.
The fundamental investor sees himself as providing answers to these questions. He estimates the intrinsic value of equity that is not recorded on the balance sheet.
You can screen for firms with particular levels of P/B ratios using stock screener from links on the Web.
or
Value of equity = Value of firm - Value of debt
- The value of the firm is the value of the firm's assets and its investments.
- The value of the debt is the value of the liability claims.
- Correspondingly, the net assets are not measured at their values.
- If they were, there would be no analysis to do! It is because the accountant does not, or cannot, calculate the intrinsic value that fundamental analysis is required.
Company A
2,060 outstanding shares
Market Price $20 per share.
Market value of these shares: $41,200 million.
Book value $3,735 million
Therefore the market premium was $37,465 million.
The market saw $37,465 million of shareholder value that was not on the balance sheet.
And it saw $37,465 million of net assets that were not on the balance sheet.
With 2060 million shares outstanding,
- the book value per share (BPS) was $1.81 and
- the market premium was $18.19 per share.
- Investors talk of buying a firm for a number of times book value, referring to the P/B ratio.
- The market P/B ratio is the multiple of book value at the current market price.
- The intrinsic P/B ratio is the multiple of book value that the equation is worth.
- An investor will spend considerable time estimating intrinsic price-to-book ratios and asking if those intrinsic ratios indicate the the market P/B is mispriced.
- P/B ratios in the 1990s were high relative to historical averages, indicating that the stock market was overvalued.
- The medican P/B ratios (the 50th percentile) for the U.S. listed firms were indeed high in the 1990s - over 2.0 - relative to the 1970s.
- But they were around 2.0 in the 1960s.
- The 1970s experienced exceptionally low P/B ratios, with medians below 1.0 in some years.
- Is it due to mispricing in the stock market?
- Is it due to the way accountants calculate book values?
- Could this bull market have been forecast in 1974 by an analysis of intrinsic P/B ratios?
- Were market P/B ratios in 1974 too low?
- Would an analysis of intrinsic P/B ratios in the 1990s find that they were too high?
- Was it too high?
Measurement in the Financial Statements
Balance sheet reprots the stock of shareholder value in the firm.
Income statement reports the flow, or change, in shareholder value over a period.
In valuation terms:
Value and value added have to be measured, and measurement in the balance sheet and income statement is less than perfect.
Income statement reports the flow, or change, in shareholder value over a period.
In valuation terms:
- The balance sheet gives the shareholders' net worth.
- The income statement gives the value added to their net worth from running the business.
Value and value added have to be measured, and measurement in the balance sheet and income statement is less than perfect.
Saturday 26 December 2009
The Articulation of the Financial Statements (Graphic)
How the Statements Tell a Story
http://spreadsheets.google.com/pub?key=tFepEVcjqq1iGBfbXis2cUA&output=html
The stock of cash in the balance sheet increases from cash flows that are detailed in the cash flow statement.
The stock of equity value in the balance sheet increases from net income that is detailed in the income statement and from other comprehensive income and from net investments by owners that are detailed in the statement of shareholders' equity.
http://spreadsheets.google.com/pub?key=tFepEVcjqq1iGBfbXis2cUA&output=html
The stock of cash in the balance sheet increases from cash flows that are detailed in the cash flow statement.
The stock of equity value in the balance sheet increases from net income that is detailed in the income statement and from other comprehensive income and from net investments by owners that are detailed in the statement of shareholders' equity.
How the Financial Statements Tell a Story: Stocks and Flows
Articulation is the way in which the statements fit together, their relationship to each other.
The articulation of the income statement and balance sheet is through the statement of shareholders' equity and is described by the stocks and flows relation.
Beginning equity
+ Comprehensive income
- Net payout to shareholders
= Ending equity
Balance sheets give the stock of owners' equity at a point in time. The statement of shareholders' equity explains the changes in owners' equity (the flows) between two balance sheet dates, and the income statement, corrected for other comprehensive income in the equity statement, explains the change in owners' equity that comes from adding value in operations.
By recognising the articulation of the financial statements, the reader of the statements understands the overall story that they tell. That story is in terms of stocks and flows. (Stocks here refere to stocks of value at a point in time). The statements track changes in stocks of cash and owners' equity (net assets).
----
Consolidated Balance Sheet of Company A (in millions)
February 1, 2008
Cash and cash equivalent 7764
Total shareholders' equity 3735
February 2, 2008
Cash and cash equivalent 9546
Total shareholders' equity 4328
Consolidated Statement of Income (in millions)
Net Revenue 61133
Total Operating expenses 8231
Operating income 3440
Investment and other income, net 387
Income tax provision 880
Net income 2947
Consolidated Statement of Cash Flows (in millions)
Cash flows from operating activities 3949
Cash flows from investing activities (1763)
Cash flows from investing activities (4120)
Effects of exchange changes on cash and cash equivalents 152
Net (decrease) increase in cash and cash equivalents: (1782)
Cash and cash equivalents at beginning of year 9546
Cash and cash equivalents at end of year 7764
Consolidated Statements of Shareholders' Equity (in millions)
Balances at (February 2, 2007) 4328
Net income 2947
Impact of adoption of SFAS 155 6
Cahnge in net unrealised gain on investments, net of taxes 56
Foreign currency translation adjustments 17
Change in net unrealised loss on derivative instruments, net of taxes (38)
________________________________________________
Total comprehensive income 2988 (Total of all the above)
Impact of adoption of FIN 48 (62)
Stock issuances under employee plans 153
Repurchases (4004)
Stock-based compensation expense under SFAS 123(R) 329
Tax benefit from employee stock plans 3
Balance at (February 1, 2008) 3735
----
A Summary of Accounting Relations
The Balance Sheet (in millions)
Assets
- Liabilities
=Shareholders' equity
Beginning of 2008 fiscal year:
9546 in cash
4328 in equity
Ending of 2008 fiscal year:
7764 in cash
3735 in equity
Cash decreased by 1782
Equity decreased by 593
The Income Statement (in millions)
Net revenue 61133
- Cost of goods sold
= Gross margin
- Operating expenses 57693
= Operating income before interest and taxes (ebit)
- Interest expense & other incomes 387
= Income before taxes
- Income taxes 880
= Income after tax and before ordinary items
+ Extraordinary items
= Net income 2947
- Preferred dividends
= Net income available to common 2947
or
Net revenue 61133
Operating expenses 57693
Other Income & Expenses 387
Pretax Income
Taxes 880
Net Income 2947
Cash Flow Statement (and the Articulation of the Balance Sheet and Cash Flow Statement) (in millions)
Cash flow from operations 3949
+ Cash flow from investing -1763
+ Cash flow from financing -4120
+ Effect of exchange rate 152
= Change in cash 1782
Statement of Shareholders' Equity (and the Articulation of the Balance Sheet and Income Statement) (in millions)
Beginning equity 4328
+ Comprehensive income 2988
- Net payout 3581
= Ending equity 3735
Net Income 2947
+ Other comprehensive income 41
= Comprehensive income 2988
Dividend
+ Share repurchases 4004
= Total payout
- Share issues 153
- Others 270
= Net payout 3581
----
The cash flow statement reveals that the $1782 million decrease came from a cash inflow of $3949 million in operations, less cash spent in investing of $1763 million, net cash paid out to claimants of $4120 million, and an increase in the US dollar equivalent of cash held abroad of $152 million.
But the main focus of the financial statements is on the change in the owners' equity during the year.
The Company A owners' equity decreased from $4328 million to $3735 million over the year by earning $2988 million in its business actiivities and paying out a net $3851 million ($4004 million - $153 million) to its owners (plus those other items in the equity statement $270 million).
The income statement indicates that the net income portion of the increase in equity from business actiivities ($2947 miillion) came from revenue from selling products and financing revenue of $61133 million, less expenses incurred in generating the revenue of $57693 million, plus investment and other income of $387 million, less taxes of $880 million.
So Company A began its fiscal 2009 year with the stocks in place in the 2008 balance sheet to accumulate more cash and wealth for shareholders. Fundamental analysis involves forecasting that accumulation.
For analysis of the fundamentals, the ability to see how the accounting relations is important in developing forecasting tools.
+ Comprehensive income
- Net payout to shareholders
= Ending equity
Cash and cash equivalent 7764
Total shareholders' equity 3735
Cash and cash equivalent 9546
Total shareholders' equity 4328
Total Operating expenses 8231
Operating income 3440
Investment and other income, net 387
Income tax provision 880
Net income 2947
Cash flows from investing activities (1763)
Cash flows from investing activities (4120)
Effects of exchange changes on cash and cash equivalents 152
Net (decrease) increase in cash and cash equivalents: (1782)
Cash and cash equivalents at beginning of year 9546
Cash and cash equivalents at end of year 7764
Net income 2947
Impact of adoption of SFAS 155 6
Cahnge in net unrealised gain on investments, net of taxes 56
Foreign currency translation adjustments 17
Change in net unrealised loss on derivative instruments, net of taxes (38)
________________________________________________
Total comprehensive income 2988 (Total of all the above)
Impact of adoption of FIN 48 (62)
Stock issuances under employee plans 153
Repurchases (4004)
Stock-based compensation expense under SFAS 123(R) 329
Tax benefit from employee stock plans 3
Balance at (February 1, 2008) 3735
A Summary of Accounting Relations
The Balance Sheet (in millions)
- Liabilities
=Shareholders' equity
9546 in cash
4328 in equity
7764 in cash
3735 in equity
Equity decreased by 593
- Cost of goods sold
= Gross margin
- Operating expenses 57693
= Operating income before interest and taxes (ebit)
- Interest expense & other incomes 387
= Income before taxes
- Income taxes 880
= Income after tax and before ordinary items
+ Extraordinary items
= Net income 2947
- Preferred dividends
= Net income available to common 2947
Operating expenses 57693
Other Income & Expenses 387
Pretax Income
Taxes 880
Net Income 2947
+ Cash flow from investing -1763
+ Cash flow from financing -4120
+ Effect of exchange rate 152
= Change in cash 1782
+ Comprehensive income 2988
- Net payout 3581
= Ending equity 3735
+ Other comprehensive income 41
= Comprehensive income 2988
+ Share repurchases 4004
= Total payout
- Share issues 153
- Others 270
= Net payout 3581
Comments:
- Understand how the statements fit together.
- Understand how financial reporting tracks the evolution of shareholders' equity, updating stocks of equity value in the balance sheet with value added in earnings from business activities.
- And understand the accounting equations that govern each statement.
The Footnotes
The Footnotes and Supplementary Information to Financial Statements
The notes are an integral part of the financial statements, and the statements can be interpreted only with a thorough reading of the notes. A lot of information on the financial statements are embellished in the footnotes.
You will see that the footnotes are supplemented with a background discussion of the firm - its strategy, area of operations, product portfolio, product development, marketing, manufacturing, and order backlog. There may be a discussion of regulations applying to the firm and a reveiw of factors affecting the company's business and its prospects. Details of executive compensation also are given. This material, along with the more detailed formal annual report, is an aid to knowing the business but is by no means complete. The industry analyst should know considerably more about the industry before attempting to research a company.
The notes are an integral part of the financial statements, and the statements can be interpreted only with a thorough reading of the notes. A lot of information on the financial statements are embellished in the footnotes.
You will see that the footnotes are supplemented with a background discussion of the firm - its strategy, area of operations, product portfolio, product development, marketing, manufacturing, and order backlog. There may be a discussion of regulations applying to the firm and a reveiw of factors affecting the company's business and its prospects. Details of executive compensation also are given. This material, along with the more detailed formal annual report, is an aid to knowing the business but is by no means complete. The industry analyst should know considerably more about the industry before attempting to research a company.
How Parts of the Financial Statements Fit Together
A Summary of Accounting Relations
The Balance Sheet
Assets
- Liabilities
=Shareholders' equity
The Income Statement
Net revenue
- Cost of goods sold
= Gross margin
- Operating expenses
= Operating income before interest and taxes (ebit)
- Interest expense
= Income before taxes
- Income taxes
= Income after tax and before ordinary items
+ Extraordinary items
= Net income
- Preferred dividends
= Net income available to common
Cash Flow Statement (and the Articulation of the Balance Sheet and Cash Flow Statement)
Cash flow from operations
+ Cash flow from investing
+ Cash flow from financing
= Change in cash
Statement of Shareholders' Equity (and the Articulation of the Balance Sheet and Income Statement)
Beginning equity
+ Comprehensive income
- Net payout
= Ending equity
Net Income
+ Other comprehensive income
= Comprehensive income
Dividend
+ Share repurchases
= Total payout
- Share issues
= Net payout
The Balance Sheet
Assets
- Liabilities
=Shareholders' equity
The Income Statement
Net revenue
- Cost of goods sold
= Gross margin
- Operating expenses
= Operating income before interest and taxes (ebit)
- Interest expense
= Income before taxes
- Income taxes
= Income after tax and before ordinary items
+ Extraordinary items
= Net income
- Preferred dividends
= Net income available to common
Cash Flow Statement (and the Articulation of the Balance Sheet and Cash Flow Statement)
Cash flow from operations
+ Cash flow from investing
+ Cash flow from financing
= Change in cash
Statement of Shareholders' Equity (and the Articulation of the Balance Sheet and Income Statement)
Beginning equity
+ Comprehensive income
- Net payout
= Ending equity
Net Income
+ Other comprehensive income
= Comprehensive income
Dividend
+ Share repurchases
= Total payout
- Share issues
= Net payout
The Statement of Shareholders' Equity
The statement of shareholders' equity starts with beginning-of-the period equity and ends with end-of-the period equity, thus explaining how the equity changed over the period.
For purposes of analysis, the change in equity is best explained as follows:
Ending equity = Beginning equity + Comprehensive income - Net payout to shareholders
----
Beginning equity
+Comprehensive income
- Net payout
___________________
=Ending equity
___________________
This is referred to as the STOCKS AND FLOWS EQUATION for equity because it explains how stocks of equity (at the beginning and end of the period) changed with flows of equity during the period.
Owners' equity increases from value added in business activities (comprehensive income) and decreases if there is a net payout to owners.
Net payout is amounts paid to shareholders less amounts received from share issues. As cash can be paid out in dividends or share repurchases, net payout is stock repurchases plus dividends minus proceeds from share issues.
----
Dividends
+ Share repurchases
_______________
= Total Payout
-Share issues
_______________
= Net Payout
_______________
Comprehensive income includes net income reported in the income statement pl,us some additional income reported in the equity statement. The practice of reporting income in the equity statement is known as DIRTY SURPLUS ACCOUNTING, for it does not give a clean income number in the income statement. The total of dirty surplus income items is called OTHER COMPREHENSIVE INCOME and the total of net income (in the income statement) and other comprehensive income (in the equity statement) is COMPREHENSIVE INCOME:
Comprehensive income = Net Income + Other comprehensive income
----
Net Income
+ Other comprehensive income
________________________
Comprehensive income
________________________
A few firms report other comnprehensive income below net income in the income statement and some report it in a separate "Other Comprehensive Income Statement."
For purposes of analysis, the change in equity is best explained as follows:
Ending equity = Beginning equity + Comprehensive income - Net payout to shareholders
----
Beginning equity
+Comprehensive income
- Net payout
___________________
=Ending equity
___________________
This is referred to as the STOCKS AND FLOWS EQUATION for equity because it explains how stocks of equity (at the beginning and end of the period) changed with flows of equity during the period.
Owners' equity increases from value added in business activities (comprehensive income) and decreases if there is a net payout to owners.
Net payout is amounts paid to shareholders less amounts received from share issues. As cash can be paid out in dividends or share repurchases, net payout is stock repurchases plus dividends minus proceeds from share issues.
----
Dividends
+ Share repurchases
_______________
= Total Payout
-Share issues
_______________
= Net Payout
_______________
Comprehensive income includes net income reported in the income statement pl,us some additional income reported in the equity statement. The practice of reporting income in the equity statement is known as DIRTY SURPLUS ACCOUNTING, for it does not give a clean income number in the income statement. The total of dirty surplus income items is called OTHER COMPREHENSIVE INCOME and the total of net income (in the income statement) and other comprehensive income (in the equity statement) is COMPREHENSIVE INCOME:
Comprehensive income = Net Income + Other comprehensive income
----
Net Income
+ Other comprehensive income
________________________
Comprehensive income
________________________
A few firms report other comnprehensive income below net income in the income statement and some report it in a separate "Other Comprehensive Income Statement."
Shareholders' equity: the retained earnings portion is often the largest component.
Shareholders' Equity
What Does Shareholders' Equity Mean?
A firm's total assets minus its total liabilities. Equivalently, it is share capital plus retained earnings minus treasury shares. Shareholders' equity represents the amount by which a company is financed through common and preferred shares.
Also known as "share capital", "net worth" or "stockholders' equity".
Shareholders' equity comes from two main sources.
Shareholders' equity comes from two main sources.
- The first and original source is the money that was originally invested in the company, along with any additional investments made thereafter.
- The second comes from retained earnings which the company is able to accumulate over time through its operations. In most cases, the retained earnings portion is the largest component.
Friday 25 December 2009
If you fall into a million dollars, you probably aren't set for life
$1 Million: Does It Still Mean You're Rich?
Posted: December 22, 2009 9:32AM
by Douglas Rice
Becoming a millionaire used to mean you were on top of the world. Nowadays, it means you are climbing up the ladder. While a million dollars is completely out of reach for many people, it's just a step along the way for many others. Why? Because it doesn't go as far as it used to.
The term millionaire has been synonymous with being rich ever since we became a country. The person most often credited to be the first American millionaire, Elias Hasket Derby, made his fortune as a privateer during the American revolution. Back then a millionaire did really mean rich.
Also, we all love round numbers. We love to see 1999 become 2000, and our odometer roll over to 100,000 miles. So it's only natural we would fixate on $1,000,000. It's a milestone with a lot of zeros. It's even got an additional comma. Now that's rich – having two commas in your net worth! But what does that get you? Not as much as you would think. (Learn more in Retiring: Is $1 Million Enough?)
Housing
Housing is where most people hold their largest chunk of wealth and with real estate falling considerably in many areas, some might think that the lifestyle a million dollars would provide would be luxurious. But that depends on where you live.
There are plenty of nice places to live that don't cost very much, but according to the California Association of Realtors, the median house price in Palo Alto, Los Altos, Manhattan Beach and Cupertino is over $1 million. The median price for the entire San Francisco Bay Area tops $500,000 and Orange County is right behind at just under that. And those are just averages, not even something special. While other areas of the country aren't nearly this expensive, being a millionaire in some areas just means you paid off the mortgage.
Retirement
Another aspect of becoming a millionaire is not working. If you had a $1 million right now, could you retire and would your money last? This is a simple calculation. If you want to try to live off the interest and you invest the money in tax exempt municipal bonds that pay 4%, then you would have $40,000 a year to live on. (Learn more in What's The Minimum I Need To Retire?)
But that doesn't account for inflation going forward. If $1 million today doesn't feel like much, imagine what it will feel like in 30 years. At 3% inflation compounding for the next 30 years, $1 million dollars will have the purchasing power of $412,000 today and your $40,000 income will feel like $16,500. So retiring when you have $1 million may sound nice, but it's likely that it won't be what many people have in mind when they think of retiring a millionaire.
Instead of living on the interest, you could tap into the principal as well. Those are slightly more difficult calculations. For example, if you were 50 years old right now and wanted to plan for your money to last until you were 95, then you need money for 45 years in retirement. If you stick with the 4% return, then you could withdraw about $48,000 a year. Again this doesn't account for inflation going forward. Each year if prices rise, your standard of living would fall. In this example, you have 45 years of prices going up at 3%. So that last year will feel like $12,600 does today.
Combining Retirement and Real Estate
If we factor in a house, this gets even worse. If we take the price for a house out of the $1 million, even in a reasonable area and not San Francisco, it's going to be a big piece of your net worth and cut into your funds for retirement. For example, if you bought a nice $250,000 home, you would only have $750,000 left to live on. At 4% that would be $30,000 a year or $2,500 a month. That's before inflation takes a bit every year.
These retirement calculations show that even if your house is paid off, that living off a million dollars isn't what it's cracked up to be. And if your house isn't paid off, it's probably not even close to what you want to do.
Bottom Line
So the bad news is that even if you fall into a million dollars, you probably aren't set for life, especially if you are young. But the good news is, you'll still be a millionaire, and that's better than the alternative. (Learn how to make it happen, read 10 Steps To Retire A Millionaire.)
http://financialedge.investopedia.com/financial-edge/1209/1-Million-Does-It-Still-Mean-Youre-Rich.aspx
Posted: December 22, 2009 9:32AM
by Douglas Rice
Becoming a millionaire used to mean you were on top of the world. Nowadays, it means you are climbing up the ladder. While a million dollars is completely out of reach for many people, it's just a step along the way for many others. Why? Because it doesn't go as far as it used to.
The term millionaire has been synonymous with being rich ever since we became a country. The person most often credited to be the first American millionaire, Elias Hasket Derby, made his fortune as a privateer during the American revolution. Back then a millionaire did really mean rich.
Also, we all love round numbers. We love to see 1999 become 2000, and our odometer roll over to 100,000 miles. So it's only natural we would fixate on $1,000,000. It's a milestone with a lot of zeros. It's even got an additional comma. Now that's rich – having two commas in your net worth! But what does that get you? Not as much as you would think. (Learn more in Retiring: Is $1 Million Enough?)
Housing
Housing is where most people hold their largest chunk of wealth and with real estate falling considerably in many areas, some might think that the lifestyle a million dollars would provide would be luxurious. But that depends on where you live.
There are plenty of nice places to live that don't cost very much, but according to the California Association of Realtors, the median house price in Palo Alto, Los Altos, Manhattan Beach and Cupertino is over $1 million. The median price for the entire San Francisco Bay Area tops $500,000 and Orange County is right behind at just under that. And those are just averages, not even something special. While other areas of the country aren't nearly this expensive, being a millionaire in some areas just means you paid off the mortgage.
Retirement
Another aspect of becoming a millionaire is not working. If you had a $1 million right now, could you retire and would your money last? This is a simple calculation. If you want to try to live off the interest and you invest the money in tax exempt municipal bonds that pay 4%, then you would have $40,000 a year to live on. (Learn more in What's The Minimum I Need To Retire?)
But that doesn't account for inflation going forward. If $1 million today doesn't feel like much, imagine what it will feel like in 30 years. At 3% inflation compounding for the next 30 years, $1 million dollars will have the purchasing power of $412,000 today and your $40,000 income will feel like $16,500. So retiring when you have $1 million may sound nice, but it's likely that it won't be what many people have in mind when they think of retiring a millionaire.
Instead of living on the interest, you could tap into the principal as well. Those are slightly more difficult calculations. For example, if you were 50 years old right now and wanted to plan for your money to last until you were 95, then you need money for 45 years in retirement. If you stick with the 4% return, then you could withdraw about $48,000 a year. Again this doesn't account for inflation going forward. Each year if prices rise, your standard of living would fall. In this example, you have 45 years of prices going up at 3%. So that last year will feel like $12,600 does today.
Combining Retirement and Real Estate
If we factor in a house, this gets even worse. If we take the price for a house out of the $1 million, even in a reasonable area and not San Francisco, it's going to be a big piece of your net worth and cut into your funds for retirement. For example, if you bought a nice $250,000 home, you would only have $750,000 left to live on. At 4% that would be $30,000 a year or $2,500 a month. That's before inflation takes a bit every year.
These retirement calculations show that even if your house is paid off, that living off a million dollars isn't what it's cracked up to be. And if your house isn't paid off, it's probably not even close to what you want to do.
Bottom Line
So the bad news is that even if you fall into a million dollars, you probably aren't set for life, especially if you are young. But the good news is, you'll still be a millionaire, and that's better than the alternative. (Learn how to make it happen, read 10 Steps To Retire A Millionaire.)
http://financialedge.investopedia.com/financial-edge/1209/1-Million-Does-It-Still-Mean-Youre-Rich.aspx
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