This is a follow up post from the last post. The question goes like this:-
Imagine a farmer has bought a goose for $36 that lays one egg each day that one can sell for $0.01. Only a few months after he bought the goose, a second farmer comes along and offers to buy the goose for $54. Should the first farmer sell his goose which can help him derive regular income for the next 15 years (assuming the goose can live another 15 years)? The potential capital gains is 50% for the first farmer if he sells.
What if yet a third farmer comes along and offers to buy the first farmer's goose at $72. The potential capital gains is 100% if the first farmer sells his goose.
Should the first farmer sell his goose, and to the second or third farmer does he sell should he decide to sell?
As I mentioned before, everyone is entitled to their own choice in making decisions, especially investment decisions depending on their personality and financial objectives. However, I believe there is an objective way of looking at things, doing things that really make good sense.
The first farmer in my humble opinion should sell his goose to the third farmer. If no farmers come along to offer him a higher price for his asset (the goose) which is currently generating recurring cashflow for him, he should stick to his asset since it is giving him a consistent 10% yield annually (assuming his yield can be always adjusted to account for inflation maintaining a consistent 10% annual yield). The second farmer offered him a capital gain potential which is much lower than the third farmer.
The third farmer's offer of 100% potential capital gain for the first farmer is attractive enough for him to let go of his cashflow generating asset. By doing so, he will now receive $72 for his goose. Assuming the price of a goose has not increased yet, the first farmer should go back to the market and buy back two geese now with $72. With two gesse in his hand, he can now receive more recurring cashflows, in fact double the amount of recurring cashflows he once received with only one goose.
Of course, one may question is there likely to have such a person as the third farmer who will offer a potential capital gain of 100% to the first farmer. In life, anything can happen. All kinds of people exist. Some are shrewd, some are impulsive, some are careful, some are careless, some are calculative and yet some are generous. So, such a third farmer character may not always come along. The idea here is 'may not' but does not mean 'do not'. There is still a probability for one to capitalise on a substantial capital gain (in magnitude of at least 100%) just that this scenario does not happen easily.
When this happens for the farmer's case, he should grab the chance to realise his capital gains. And, the important thing here is after he has got his capital gains, he went back to buy two geese with his money. For the first farmer, he saw the importance of recurring cashflow income in his business of selling eggs. So, he places his priority on building his cashflow generating assets (his geese). Capital gains is but only an icing on the cake, good to have only if it is really good to have. In his case, the capital gains has allowed him to further his acquiring of more cashflow generating assets.
So, come to the conclusion of the matter. Invest for both cashflows and capital gains. The foundation of investment is on building up and generating good amount of recurring cashflows. To accelerate this purpose, capital gains on any assets must be reinvested to acquire more cashflow generating assets. Then, this makes some good sense to go for capital gains in addition to just collecting cashflows alone from investments.
The problem with many is that one can be blinded by immediate gratification of a capital gains and tip the scale in favour of always going for capital gains in investments. This brings me to the title of this post, "Wealthy or rich?".
To be wealthy, one has to acquire cashflow generating assets. It does not matter how much in total value one's assets is. It is not the total value of assets that matter, but the yield on the assets one is receiving that matters. A person may only have for example $500,000 in total value for all his assets. However, if he is receiving $250,000 annually from all his cashflow generating assets, he is getting a yield of 50% (this is just for illustration - it is not easy to get such high yields).
On the other hand, one who is rich has a lot of money, but no cashflow generating assets. For example, one can be a millionaire with $1,000,000. But he may not be receiving any cashflows at all if all his money is held as money. So, effectively, his yield is 0% annually. No cash flows into his pocket since he does not own any cashflow generating assets. But, cash is constantly flowing out of his pocket. He has to use his money somehow if not for buying luxury items, at least for minimal survival needs.
For such a person, he is rich but not wealthy. The problem with him is that his money will be drained out sooner or later through his expenses. Another invisible force that is slowly draining away his money is inflation. Due to the US free printing of currency, the value of currency will be eroded. More money is flooding the market as time goes by. So, even if this person does not use a single cent of his $1,000,000, the same $1,000,000 will not be worth this amount some years down the road because one has to use more money to buy the same goods and services in future. That is why prices of houses has increased through the years. It is not the houses that have increased in value, but our money that has decreased in it's value due to printing of currency and inflation. We have to use more money to buy the same type of house in future.
So, be wealthy or rich? To be wealthy means deriving good amounts of recurring cashflows from cashflow generating assets. To be rich means having a lot of money, pure money that can potentially erode in value until zero with the passing of time.
Thursday, December 30, 2010
Friday, December 24, 2010
Investing for capital gains or cashflows??
I am thinking hard recently as to whether to invest for capital gains or cashflows. I believe everyone should know the meaning for capital gains. Buy a stock at a certain price and then sell at a higher price at a later time. The duration to hold the stocks can be short or long depending on the amount of capital gains one desires. I have also touched on how much capital gains one should preferably aim for (for a trading mindset or long term investing mindset) in an earlier post based on my own research.
As for cashflows, I am referring to the dividends one receives for all his stock holdings in his portfolio. This question is important to ask as we are surely approaching the next bear market anytime in future. Nobody knows when. But, everybody should know the "bear will surely wake up from hibernation" sometime in future. The valuation for most if not all stocks will be send to the depths again during the next bear market. Again, nobody knows how much the extent of the next bear market in terms of duration and damage to valuations of equities globally.
I believe it is always wise to think one step ahead and make preparations for something that is certainly to come. So, this raises the question of whether one should go for capital gains or cashflows. I have heard from a friend who has invested through a few market cycles of bull and bear holding on to his same stocks which were bought many years ago. He told me that the valuation of his stocks now compared to his initial bought in valuations many years back is higher. However, the difference in valuation is not much. He does agree that it would be wiser for him to sell at the height of a bull market locking in his capital gains and buy back again during the depths of a bear market and keep repeating the same process through the few market cycles he had seen. The only problem is even as he knew about this simple possible strategy, he did not commit himself to do it and so left his stock holdings through the years to the mercy of the many market cycles.
However, one thing he commented is that he still receive good amount of dividends from his stock holdings and the total amount of dividends had increased through the years. Of course, he does reinvest his dividends and make further capital investments to buy more stocks through the years so his total amount of dividends received has been growing through the years.
So, back to the same question again. Invest for capital gains or cashflows? My answer is a consolidation of thoughts from all my earlier blog posts based on the summation of all my research so far. I do not count myself as a knowledgeable investor as knowledge is never ending and I am always learning new things about investment everyday. The answer I arrived at is that one should invest for both capital gains as well as cashflows.
Both ways of investing, for capital gains or cashflows, have their merits and shortfalls. Capital gains of a substiantial amount (at least 30% for short-term trading and 100% for longer term investing) can help to lift one's net worth in his stocks portfolio at a fast rate. However, one does not always have the good fortune to buy into a stock that can have such magnitude of capital gains (please note that I am discussing based on the Singapore stocks market; other stocks market such as the US stocks markets may have much wider swing in valuations). Even with penny stocks, it is also not a guarantee to see substantial capital gains even after one has bought into a penny stock with a popular theme or fundamentals (whatever you call it). So, investing for substiantial capital gains has a low chance of realisation. Nevertheless, one can still lower his expectations and sell any stocks at a lower capital gains as long as it is still attractive enough for the holding period in consideration. Also, selling stocks for capital gains does make sense when one is trying to escape an impending bear market. Why leave it to chance and let the valuations of one's stock holdings that has increased have the potential to drop back to the original bought in valuations or even lower?
Thus, investing for substantial capital gains though having a low strike chance, is still well worth the effort to do so to accelerate one's rate of return on his investments. The other way of investing for cashflows has it's own merits as well. Cashflows investing is a stable consistent way of deriving recurring income from one's portfolio. Cashflows income is difficult to build in the initial stages but when one's stocks portfolio size is big enough, the amount of regular dividend income one can derive is not to be looked down upon. However, when investing for cashflows, one needs to hold his dividend paying stocks for a long term to keep building and sustaining his dividend income.
The frustrating question comes when his dividend paying stocks have risen so much in valuations to allow him to have the possibility to capitalise on a substantial capital gains by selling off his regular dividend income paying stocks. Imagine a farmer has bought a goose for $36 that lays one egg each day that one can sell for $0.01. Only a few months after he bought the goose, a second farmer comes along and offers to buy the goose for $54. Should the first farmer sell his goose which can help him derive regular income for the next 15 years (assuming the goose can live another 15 years)? The potential capital gains is 50% for the first farmer if he sells.
What if yet a third farmer comes along and offers to buy the first farmer's goose at $72. The potential capital gains is 100% if the first farmer sells his goose. I believe we might have reach a simple conclusion ourselves whether the first farmer should sell or not, and if he sells, to which farmer should he sell.
For those interested to share your ideas as to what action the first farmer should take, you can drop in your thoughts under the comments for this blog post.
Lastly, my conclusion is that one should invest both ways, for capital gains and cashflows. An analogy for this is that cashflows represents a normal car while capital gains represents a turbo engine that can be fitted to the car. The turbo engine can not be fully utlilised during the entire duration of operations of the car as it will cause the car to overheat and wear out very fast. But, if the car does not have a fitted turbo engine, it cannot achieve another quantum leap in it's maximum speed and torque. So, use both capital gains and cashflow investing to one's advantage. A basal amount of cashflows from recurring dividend income is always welcomed. In addition, some capital gains can also help to accelerate the rate of return on one's investments.
PS: Please note that this post is just a simple discussion and by no means an indepth discourse on both ways of investing. There are certainly more considerations (e.g. investor's individual personality and financial objectives to look at when investing).
As for cashflows, I am referring to the dividends one receives for all his stock holdings in his portfolio. This question is important to ask as we are surely approaching the next bear market anytime in future. Nobody knows when. But, everybody should know the "bear will surely wake up from hibernation" sometime in future. The valuation for most if not all stocks will be send to the depths again during the next bear market. Again, nobody knows how much the extent of the next bear market in terms of duration and damage to valuations of equities globally.
I believe it is always wise to think one step ahead and make preparations for something that is certainly to come. So, this raises the question of whether one should go for capital gains or cashflows. I have heard from a friend who has invested through a few market cycles of bull and bear holding on to his same stocks which were bought many years ago. He told me that the valuation of his stocks now compared to his initial bought in valuations many years back is higher. However, the difference in valuation is not much. He does agree that it would be wiser for him to sell at the height of a bull market locking in his capital gains and buy back again during the depths of a bear market and keep repeating the same process through the few market cycles he had seen. The only problem is even as he knew about this simple possible strategy, he did not commit himself to do it and so left his stock holdings through the years to the mercy of the many market cycles.
However, one thing he commented is that he still receive good amount of dividends from his stock holdings and the total amount of dividends had increased through the years. Of course, he does reinvest his dividends and make further capital investments to buy more stocks through the years so his total amount of dividends received has been growing through the years.
So, back to the same question again. Invest for capital gains or cashflows? My answer is a consolidation of thoughts from all my earlier blog posts based on the summation of all my research so far. I do not count myself as a knowledgeable investor as knowledge is never ending and I am always learning new things about investment everyday. The answer I arrived at is that one should invest for both capital gains as well as cashflows.
Both ways of investing, for capital gains or cashflows, have their merits and shortfalls. Capital gains of a substiantial amount (at least 30% for short-term trading and 100% for longer term investing) can help to lift one's net worth in his stocks portfolio at a fast rate. However, one does not always have the good fortune to buy into a stock that can have such magnitude of capital gains (please note that I am discussing based on the Singapore stocks market; other stocks market such as the US stocks markets may have much wider swing in valuations). Even with penny stocks, it is also not a guarantee to see substantial capital gains even after one has bought into a penny stock with a popular theme or fundamentals (whatever you call it). So, investing for substiantial capital gains has a low chance of realisation. Nevertheless, one can still lower his expectations and sell any stocks at a lower capital gains as long as it is still attractive enough for the holding period in consideration. Also, selling stocks for capital gains does make sense when one is trying to escape an impending bear market. Why leave it to chance and let the valuations of one's stock holdings that has increased have the potential to drop back to the original bought in valuations or even lower?
Thus, investing for substantial capital gains though having a low strike chance, is still well worth the effort to do so to accelerate one's rate of return on his investments. The other way of investing for cashflows has it's own merits as well. Cashflows investing is a stable consistent way of deriving recurring income from one's portfolio. Cashflows income is difficult to build in the initial stages but when one's stocks portfolio size is big enough, the amount of regular dividend income one can derive is not to be looked down upon. However, when investing for cashflows, one needs to hold his dividend paying stocks for a long term to keep building and sustaining his dividend income.
The frustrating question comes when his dividend paying stocks have risen so much in valuations to allow him to have the possibility to capitalise on a substantial capital gains by selling off his regular dividend income paying stocks. Imagine a farmer has bought a goose for $36 that lays one egg each day that one can sell for $0.01. Only a few months after he bought the goose, a second farmer comes along and offers to buy the goose for $54. Should the first farmer sell his goose which can help him derive regular income for the next 15 years (assuming the goose can live another 15 years)? The potential capital gains is 50% for the first farmer if he sells.
What if yet a third farmer comes along and offers to buy the first farmer's goose at $72. The potential capital gains is 100% if the first farmer sells his goose. I believe we might have reach a simple conclusion ourselves whether the first farmer should sell or not, and if he sells, to which farmer should he sell.
For those interested to share your ideas as to what action the first farmer should take, you can drop in your thoughts under the comments for this blog post.
Lastly, my conclusion is that one should invest both ways, for capital gains and cashflows. An analogy for this is that cashflows represents a normal car while capital gains represents a turbo engine that can be fitted to the car. The turbo engine can not be fully utlilised during the entire duration of operations of the car as it will cause the car to overheat and wear out very fast. But, if the car does not have a fitted turbo engine, it cannot achieve another quantum leap in it's maximum speed and torque. So, use both capital gains and cashflow investing to one's advantage. A basal amount of cashflows from recurring dividend income is always welcomed. In addition, some capital gains can also help to accelerate the rate of return on one's investments.
PS: Please note that this post is just a simple discussion and by no means an indepth discourse on both ways of investing. There are certainly more considerations (e.g. investor's individual personality and financial objectives to look at when investing).
Wednesday, December 1, 2010
Built to last.....what makes an enduring business?
I read up on this book "Built to last" long time ago and find it a good read. It talks about what makes certain businesses last for a long time. I cannot remember details of the reading but some parts of the book are still vivid in my mind. I guess remembering and internalising the essence in any reading is more important than trying to recall all details of the read.
In my sharing below, I shall present the information I got from the reading together with my own reflections.
What makes an enduring business last for long?
1. A strongly cherished vision that does not change and is not easily changed through time.
2. A great succession plan ensuring vision of the company is passed on from predecessors to successors.
3. Focus on getting the right people onto the train (company) and getting the wrong people off the train quickly.
4. Ability to allow each employee to discover what they are best at and let them do what they are best at.
5. Keeping to the core business that the company is best at and most suitable for.
1. A strongly cherished vision that serves a great meaningful purpose
Every great company has a strongly cherished vision that does not change through time. To be able to achieve this, the vision must be a great one that can endure the test of time. Everyone in the company owns the vision and it is clearly communicated from top to bottom in the company. The success of an enduring company depends on how much ownership the employees of the company have of it's vision. For example, a great pharmaceutical company has the vision of "we seek to save lives by offering the best possible drugs at affordable prices so that no one will suffer poor health or die because he cannot afford to pay for drugs." The vision must be strongly cherished by every employees in the company and all the routine business activities revolve around fulfiling the vision. Whenever anyone speaks about the company, they tell of it's vision. Whenever anyone acts in the course of the business, they act in the interest of fulfiling the vision. The vision is why the company existed from start and it is the only reason the company will continue to exist.
Every great enduring company grows out from it's vision. It feeds from it's vision just as a green plant depends on sunlight to exist, because it is that strongly cherished vision by all employees that allows the company to even exist. A great enduring vision ensures the company endures. The vision creates value for all it's employees from top to bottom. Every employee enjoys their work because they enjoy fulfiling the meaning of the vision in every little detail of their work. For the great pharmaceutical company example above, the top management enjoy coming out with strategies to keep the company researching on the best possible drugs to cure deadly diseases. The management seeks ways to sell the drug directly as far as possible to the patients so as to minimise distribution costs so that any cost savings can be passed on to the patients and the drugs can be bought at affordable prices. The researchers work hard at coming out with the best possible drugs to save lives. The sales and marketing team enjoy helping to bring the drugs to sell at places where it is most needed and not because it is most lucrative.
Therefore, from top to bottom in a company, everyone believes strongly in the same vision and they know they must live out the vision in the way they work. Anyone who deviates from the vision cannot belong to the company. The vision serves a great purpose and the purpose is not always the case of profitability for the business. In the example of the great pharmaceutical company, it's vision serves the purpose of cherishing and helping to save lives.
2. A great succession plan ensuring vision of the company is passed on from predecessors to successors
A great vision must stand the test of time. Thus, enduring companies always ensure they have a great succession plan to groom talents from within the company who will rise up to steer and lead the company to continue to grow on it's vision. As such, successors of CEOs most often come from within the company since these capable people have long embraced the vision of the company and now they will rise up to take on the most important responsibility to lead the company to grow on it's vision.
3. Focus on getting the right people onto the train (company) and getting the wrong people off the train quickly
Great enduring companies take pains to hire the right people who will embrace their vision. Hiring is a very important process as the right people hired will help the company to continue it's growth. Hiring the wrong people who do not believe in the vision of the company will slowly erode away the vision and corrupts the rest of the employees who believes in the vision. So, it may not be always a matter of hiring based on talents alone. The right talented people must be hired so that there is a good fit with the vision of the company. So, hiring is a very important process that must be done with upmost care as it is always easy to get people onto the train (company) but hard to get the wrong people off the train (company). However, when a wrong hire has been done, the company must quickly dismiss the wrong people to avoid the wrong people corrupting the rest of the employees to deviate from their cherished vision. Thus, hire slowly with careful consideration for a good fit into the vision of the company (apart from considering needed talents) and quickly dismiss any wrong hire to ensure the vision of the company can be preserved. Anyway, the wrong hire will function at their best eventually in another company that they can be of good fit to it's vision.
4. Ability to allow each employee to discover what they are best at and let them do what they are best at
Great enduring companies after hiring the right talented people, ensure their employees enjoy what they do best in the company. Every person is unique having their unique personality, beliefs, strengths and weaknesses. So, not everyone is made for the same job. The worker that functions the best functions out of the best job that he enjoys doing. So, care must be taken not only to ensure a good hire that is a good fit into the vision of the company. Care must also be taken to ensure the right hire can function at his best in the job that he enjoys doing his best in. It may take time to find the best fit into a suitable job role in a company. However, it is worth the effort and time to allow every employee to find a suitable job role so that they can function at their best.
5. Keeping to the core business that the company is best at and most suitable for
Just as it is important to ensure every employee does what he is best at, great enduring companies understand they must do what they are best suited at and do it even better than it's competition. Thus, they stick to their core business and continue to grow better at doing their core business. They are usually leaders or aspiring leaders in their market. They are careful not to deviate too far out and become distracted from becoming best at doing it's core business that it is suited at doing. Thus, every acquisition and merger has to be under very careful consideration by the company to ensure a good fit so that the company does not deviate from it's vision and core business that it is best suited at doing.
Conclusion
Be it on a personal level or organisational level, realise a great vision that one truly cherishes and commit to doing one's best at it and even becoming one of the best at doing than others. It may not always be a must to be at the top. Just being able to function at one's best in something one believes passionately in is already a bliss.
In my sharing below, I shall present the information I got from the reading together with my own reflections.
What makes an enduring business last for long?
1. A strongly cherished vision that does not change and is not easily changed through time.
2. A great succession plan ensuring vision of the company is passed on from predecessors to successors.
3. Focus on getting the right people onto the train (company) and getting the wrong people off the train quickly.
4. Ability to allow each employee to discover what they are best at and let them do what they are best at.
5. Keeping to the core business that the company is best at and most suitable for.
1. A strongly cherished vision that serves a great meaningful purpose
Every great company has a strongly cherished vision that does not change through time. To be able to achieve this, the vision must be a great one that can endure the test of time. Everyone in the company owns the vision and it is clearly communicated from top to bottom in the company. The success of an enduring company depends on how much ownership the employees of the company have of it's vision. For example, a great pharmaceutical company has the vision of "we seek to save lives by offering the best possible drugs at affordable prices so that no one will suffer poor health or die because he cannot afford to pay for drugs." The vision must be strongly cherished by every employees in the company and all the routine business activities revolve around fulfiling the vision. Whenever anyone speaks about the company, they tell of it's vision. Whenever anyone acts in the course of the business, they act in the interest of fulfiling the vision. The vision is why the company existed from start and it is the only reason the company will continue to exist.
Every great enduring company grows out from it's vision. It feeds from it's vision just as a green plant depends on sunlight to exist, because it is that strongly cherished vision by all employees that allows the company to even exist. A great enduring vision ensures the company endures. The vision creates value for all it's employees from top to bottom. Every employee enjoys their work because they enjoy fulfiling the meaning of the vision in every little detail of their work. For the great pharmaceutical company example above, the top management enjoy coming out with strategies to keep the company researching on the best possible drugs to cure deadly diseases. The management seeks ways to sell the drug directly as far as possible to the patients so as to minimise distribution costs so that any cost savings can be passed on to the patients and the drugs can be bought at affordable prices. The researchers work hard at coming out with the best possible drugs to save lives. The sales and marketing team enjoy helping to bring the drugs to sell at places where it is most needed and not because it is most lucrative.
Therefore, from top to bottom in a company, everyone believes strongly in the same vision and they know they must live out the vision in the way they work. Anyone who deviates from the vision cannot belong to the company. The vision serves a great purpose and the purpose is not always the case of profitability for the business. In the example of the great pharmaceutical company, it's vision serves the purpose of cherishing and helping to save lives.
2. A great succession plan ensuring vision of the company is passed on from predecessors to successors
A great vision must stand the test of time. Thus, enduring companies always ensure they have a great succession plan to groom talents from within the company who will rise up to steer and lead the company to continue to grow on it's vision. As such, successors of CEOs most often come from within the company since these capable people have long embraced the vision of the company and now they will rise up to take on the most important responsibility to lead the company to grow on it's vision.
3. Focus on getting the right people onto the train (company) and getting the wrong people off the train quickly
Great enduring companies take pains to hire the right people who will embrace their vision. Hiring is a very important process as the right people hired will help the company to continue it's growth. Hiring the wrong people who do not believe in the vision of the company will slowly erode away the vision and corrupts the rest of the employees who believes in the vision. So, it may not be always a matter of hiring based on talents alone. The right talented people must be hired so that there is a good fit with the vision of the company. So, hiring is a very important process that must be done with upmost care as it is always easy to get people onto the train (company) but hard to get the wrong people off the train (company). However, when a wrong hire has been done, the company must quickly dismiss the wrong people to avoid the wrong people corrupting the rest of the employees to deviate from their cherished vision. Thus, hire slowly with careful consideration for a good fit into the vision of the company (apart from considering needed talents) and quickly dismiss any wrong hire to ensure the vision of the company can be preserved. Anyway, the wrong hire will function at their best eventually in another company that they can be of good fit to it's vision.
4. Ability to allow each employee to discover what they are best at and let them do what they are best at
Great enduring companies after hiring the right talented people, ensure their employees enjoy what they do best in the company. Every person is unique having their unique personality, beliefs, strengths and weaknesses. So, not everyone is made for the same job. The worker that functions the best functions out of the best job that he enjoys doing. So, care must be taken not only to ensure a good hire that is a good fit into the vision of the company. Care must also be taken to ensure the right hire can function at his best in the job that he enjoys doing his best in. It may take time to find the best fit into a suitable job role in a company. However, it is worth the effort and time to allow every employee to find a suitable job role so that they can function at their best.
5. Keeping to the core business that the company is best at and most suitable for
Just as it is important to ensure every employee does what he is best at, great enduring companies understand they must do what they are best suited at and do it even better than it's competition. Thus, they stick to their core business and continue to grow better at doing their core business. They are usually leaders or aspiring leaders in their market. They are careful not to deviate too far out and become distracted from becoming best at doing it's core business that it is suited at doing. Thus, every acquisition and merger has to be under very careful consideration by the company to ensure a good fit so that the company does not deviate from it's vision and core business that it is best suited at doing.
Conclusion
Be it on a personal level or organisational level, realise a great vision that one truly cherishes and commit to doing one's best at it and even becoming one of the best at doing than others. It may not always be a must to be at the top. Just being able to function at one's best in something one believes passionately in is already a bliss.
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