May72009

Help! Where can I plug in my umbilical cord?

I present to you Exhibit 1 titled: “EFFECT”

Wall Street Journal Clip 1

And, now I present to you Exhibit 2 titled: “CAUSE”

Wall Street Journal Clip 2

Sorry in advance for the small font size on the images.  These two news clippings, from Tuesday 5/5/09 of the Wall St. Journal show something that struck me as very funny and very sad.  Same paper, same day.  Unbelievable.

You may dispute this ‘causal’ determination - that spending nearly half the day eating and sleeping lead to economic decline and stagnation.  But, you can’t help but wonder if all the people in the unemployment line take their customary breaks for napping and eating.

One of my favorite authors, Dan Kennedy, once said:

“most people are running around with their umbilical cords in their hands looking for another place to plug it in.”

Kennedy was referring to a marketing more effectively to consumers.  But to me, this perfectly sums up the mass amounts of people in developed nations across the globe that are lining up for a pull on the public teet.

At present, no place on earth exemplifies sucking on the government teet more than the countries of Western Europe.  God bless their food, art and rich culture of chain smoking - but take another gander at the first clipping.  If you can’t read it, here are some highlights:

  • it is anticipated that the EU economy will shrink by 4% in 2009
  • Fiscal deficits (large ones) for member nations
  • Unemployment is at 17% in Spain (the picture is of an unemployment line in Spain)

Scroll to the next clipping above (Sleeping Giant) and some of the gems you will find are as follows:

  • The French sleep more on average than any other nation - 530 minutes per day (8.83 hours)
  • Americans sleep for 518 minutes per day on average (8.63 hours)
  • Koreans sleep for 469 minutes per day on average (7.8 hours)
  • The French spend 2 hours and 15 minutes per day eating and drinking, Italians spend 1:54 and Spain 1:46 the U.S. spends 1:14 on average
  • France has mandatory 30 paid vacation days (government required) per year

Ok.  Let’s put this in the form of a game show question just for fun:

Q: The European Union is shrinking in terms of output and population and the best response to this ____?

A) Sleep more than anybody else in the world

B) Spend more time eating and drinking than anybody else in the world

C) A and B

D) Neither A nor B

5 seconds to buzz in…..3….2…1……if you said “C”give yourself a big pat on the back, you have just passed the qualifying exam to become a government official in France, Spain or Italy.

Now, I am all for balancing out your work with your personal life - I don’t take that away from anybody. But this is taking it to the extreme.  Kinda like the ‘no kid gets cut from the soccer team and everyone gets a trophy’ mindset that has gripped America in recent years.

What’s funny and sad about what these two short articles is that they unintentionally capture a culture in a few words that is quickly becoming accepted in a country you know…the USA.

In my previous post, I mentioned some of the Q/A session from the 2009 Berkshire Hathaway Annual Shareholder meeting.  During the meeting, Vice Chairman Charlie Munger said that he thought that American health care was going to eventually become very similar to that of Western Europe.  My view is that more things are going to be similar to Western Europe than just health care.

For those of you that haven’t noticed, the government bailout line that everyone from banks to auto companies is standing in looks a lot like the Spanish unemployment line from the WSJ article.

I fear that we will increasing live in a world where non-producers will live off of the productive work of others - invariably creating a negative economic effect that could lead to serious problems damaging living standards and retracting many years of productive capital and labor.  It will be very hard to tear people’s umbilical cords away from the mother ship they are plugging them into when the ship runs dry.

Published
by
Adam Davis
on May 7, 2009
in Bailout and globalization
. 10 Comments
May52009

Words from the Oracle and Experiences from the Pilgrimage to Omaha

I just got back from the 2009 Berkshire Hathaway Annual Shareholder meeting in Omaha, Nebraska.  The meeting was on Saturday, May 2nd.  Over 35,000 shareholders packed into the Qwest Center in Downtown Omaha to hear what Berkshire Hathaway Chairman Warren E. Buffett (aka the Oracle of Omaha) and Vice Chairman Charles T. Munger had to say on all matters of business, economics and everything in between.

Warren Buffett

Most annual shareholder meetings are boring and mundane, with various motions and minutes being taken (unless there is something unusual, like a proxy fight or other activist issue these meeting are super boring).  In a contrasting style, for years, Berkshire Hathaway has conducted its annual meetings with a significant portion of time dedicated to a question and answer session - where shareholder post questions to Buffett and Munger about anything that vexes them.  The Berkshire Hathaway shareholder meeting has evolved to be a “Woodstock for Capitalists” (Buffett’s term) with a huge exhibit floor containing Berkshire subsidiary companies as vendors and a ‘rock-star’ like atmosphere for Munger and Buffett.

When I got to the venue the morning of the meeting, the line to get inside was already wrapped around the huge Qwest Center by several hundreds of yards.  I heard people speaking in different languages and regional dialects - which I found to be very interesting (thought to self: American capitalism must not be dead yet, people from all over the world are here to see the greatest living capitalist).

Once inside the Qwest Center, I mulled the exhibit floor.  The exhibits ran as far as the eye could see with products from all over the map: ice cream (Dairy Queen), chocolates (See’s Candies), boots (Justin Brands), jet services (NetJets) and on and on and on.  Over at the “Bookworm” section, William H. Gates II (aka Bill Gates’ father) was doing a book signing, with Mr. Buffett himself not far away.

Charlie Munger

After perusing for a while, I met up with my friend Joe Ponzio of FWallStreet fame.  Joe is an investor, writer and investment adviser operating out of the Chicagoland area.  I also met Joe’s business partner, Mike, and we headed into the meeting.  Lo and behold we were not able to find a seat in the packed area 45 minutes before the meeting started!  We ended up standing and watching the jumbo tron for the first half of the meeting.  Later, we managed to sneak some good seats for the second half of the meeting.

If you have never been there, you wouldn’t believe how large and diverse the Berkshire Hathaway shareholder group is.  You have hedge fund types from Wall Street and farmer types from Wisconsin.  John Deere hats to Armani suits.  Plain and simple: people from all walks of life travel many miles to hear what Warren Buffett has to say.  Here are some snippets (nessesarily abridged) from the Q/A session with Warren and Charlie:

***To Kick off the Q/A, Buffett showed a slide with a picture of a trade ticket for $5,000,000 face value of U.S. treasuries that Berkshire sold on 12/18/08.  The sale price for the face value of the $5,000,000 in notes was $5,000,090.00.  For those readers not intimate with the way bond markets work, the bottom line is that the buyer of these treasuries from Berkshire was actually paying for the right to lose money.  That’s right - they paid $5,000,090.00 in December to receive $5,000,000.00 back from the U.S. treasury in March - a negative yield.  Wow! is all I can say***

Q: What type of discounted cash flow analysis do you use in valuing companies?

A:  Buffett: investing is all about laying cash out now to get cash back in the future.  The timing, certainty and amount of this are what you need to evaluate.   A bird in the hand is worth two in the bush - Aesop said this in 400 B.C. and it is true today.  If you need a spreadsheet or a calculator to get to an answer, you should probably pass.  The number should scream at you from the paper.  Munger:  high and fancy math can be dangerous and lead you down the wrong roads

Q: What is a worst-case scenario for Berkshire’s insurance business?

A: Buffett: Big Catastrophe would hurt but not kill, we can withstand this based on our underwriting  Munger: Public outcry and government nationalization that may result (as it has in other countries) is a worst case.

Q: How well have our government leaders responded to the economic crisis?

A: Buffett: quite well all things considered.  Munger: nobody makes perfect decisions in these situations, the good outweighs the bad

Q:Will the U.S. face inflation in the future as a result of government policies?

A: Buffett: Yes, but it had to be done.  Munger: yes

Q: Isn’t Berkshire Hathaway’s competitive advantage Buffett and Munger?  If so, won’t this disappear when you guys die?

A: Buffett: Berkshire’s competitive advantage lies in an ingrained culture.  We get first crack at great deals and businesses, this has been cultivated over many years and makes us strong.  Berkshire will continue to be strong after we are gone.

Q: Why have you not named a successor to Buffett and had him/her doing an apprenticeship with Warren?

A: Buffett: Successor candidates are running businesses and allocating capital.  Pulling them from their daily activities to watch me read or have a meeting an hour with me in the office would be counter productive.  Munger: the candidate for successor is properly prepared by what they are doing now

Q:  What was the compelling reason for the BYD investment?

A: Munger:  this is an amazing company, run by an amazing guy, adding lots of value to society.  Capitalizes on growing Chinese market.  Buffett: $4b per year business and profitable - good fit for Berkshire long term

Q:  What should China do about it’s mounting U.S. dollar reserves?

A: Buffett: they will continue to build up as long as the U.S. buys more from the Chinese than we sell to them. China consciously makes this decision to sell to us.  They can buy U.S. assets like stocks, bonds, real estate.  Munger: China has done a fantastic job moving their economy from third world up.  They have a great success story.

Q: What is the main problem with CEO pay and bonus compensation that helped facilitate the current credit crisis?

A:  Buffett: bad incentives.  CEO’s can push around boards and comp. committees much easier than you would think.  The CEO’s want Cocker Spaniels not Pitbulls on their boards.  Rubber stamp mentality.  Munger: public officials and board members should not have to rely on salaries from serving to put food in their mouths - problem of not wanting to upset the applecart.  Buffett:  CEOs hire consultants to come in and everyone serves the same master from H.R. on through.

Q:  Why take on more derivative contracts?  Aren’t they ‘financial weapons of mass destruction’?

A: Buffett: Berkshire has no collateral posting requirements for our contracts and we think they are mis-priced and can make money with them.  Berkshire receives money now and only has to pay out if certain situations happen with regard to equity indexes and bond indexes many year from now.  Our estimation is that these will play out well for us.

Q: What would Ben Graham have thought about derivatives?

A: Buffett: he wouldn’t have liked them.  But, he may have taken advantage of a mis-priced situation.  Munger: the accountants should be ashamed of themselves for the standards and enforcement of the accounting for derivatives.

Q: What led to the financial meltdown?

A: Buffett: unlimited belief in ever-rising property values

Q: What will happen in the housing market?

A: Buffett:  huge oversupply.  3 million new households created every year, as long as supply stays stagnant, demand should build up supply by its natural course and things should return to normal levels.  Already some pickup in activity, but not pricing, in California markets.  Munger: places that did not go up into the stratosphere should be ok (like Omaha), but places like Florida and others have a very long way to go.

Q:  When is Berkshire going to pay a dividend based on its policy of $1 increase in market value for stock for every $1 in retained earnings?

A:  Buffett: even though 12/31/08 stock close has not kept up with the 5 year rolling metric we use, the book value of Berkshire, which we use as a proxy for intrinsic value, has kept pace - our intrinsic value has grown at a faster rate than retained earnings - which means no need to pay dividend.  Munger: we could suck dividend out of subsidiary but that may cut off their growth and long term profits.

Q: What about problems with rating agencies and Moodys holding?  Should Berkshire have done something with its large stake in Moodys to prevent it from partaking in the shenanigans of the subprime fiasco?

A:  Buffett: conflict of interest problem with rating agencies was overblown, real issue was false beliefs in property values.  Munger: fancy mathematical and ivory tower formulas played neat tricks on the rating agencies - they drank their own Kool-aid.  Buffett: I didn’t write to Moody’s to tell them how to do their business because we don’t tell Burlington Northern how to handle safety issues or American Express what interest rate to charge its customers.

Q: How well did the investment management successor candidates do with their portfolios last year?

A: Buffett: down, about in line with the S&P.  Munger: we would not want somebody that went timely into cash last year - not our kind of person.

Q: What effect will national health care have on businesses?

A: Munger: the U.S. will have a system like that of Western Europe in the future.  Buffett: all businesses will need to stay in tune and adjust to this.

Q:  Was Berkshire stock selling below intrinsic value recently?  If so, would Buffett consider buying back stock?

A:  Buffett: at 12/31/08, I felt that the market price was below intrinsic value.  We did not buy back, mostly b/c other opportunities were there for us and we were committed to them and the stock was not selling for substantially below intrinsic value.  If we announced share buyback, market would bid up the price and we would not be buying back at a discount.

Q: What makes a good business leader?

A: Buffett: emotional intelligence.  You don’t need a 150 IQ to invest well or run a business well.  Munger: it is VERY dangerous to have an IQ of 140 and think you have a 150 IQ.  If you have a 150 IQ, sell 30 points to someone else!

Q: What is the impact of government bail out money in banks on Berkshire’s businesses?

A:  Buffett: harder for us to compete, like Clayton, will have higher funding costs than banks with TARP money, etc. Going up against government backing and guarantees is tough.  Munger: we have more flexibility than those companies who have taken government money.

Q: What advice did you give the college students that you spent time with last year?

A: Buffett: I told them that if I was teaching business school, there would only be two classes: how to value a business and how to think about markets - this is why I am not a teacher.  I don’t know how you would kill an hour class if you were teaching efficient markets - first minute “everything is priced correctly all the time. Ok, 59 more minutes and a whole semester to go.”  I would have put my entire net worth into Wells Fargo at $9 per share.

Q: Are stocks as cheap as they were in 1973-1974?

A: Buffett: No.  Great companies were selling for 4 times earnings.  Munger: No.  Don’t wait for another 1974.  Prices were just silly then.

Q: Are newspapers a good thing to invest in right now since they are so beaten down?

A: Buffett: their competitive advantages are shrinking rapidly, likely will never return to the profit levels even remotely close to what they had before.

Q: Is Berkshire managing the economic downturn with layoffs?

A: Buffett: Yes.  Some places, like Acme Brick, nobody is buying any bricks, so they are shut down.  Other companies have shared sacrifice - but that doesn’t work for all types of businesses.  Munger: shared sacrifice is good for some businesses, but others simply need to make cuts - you can’t pay people for idle plants.

Q: Will GEICO continue spending huge sums on advertising?

A:  Buffett: Yes!  We love spending money on advertising at GEICO because it results in more people knowing about our brand - a brand is a promise - and results in more policies.  When we bought GEICO it had 2% of the domestic auto insurance market, now it has over 8% and climbing and we are the 3rd largest auto insurer in the country.  Our advertising dollars are well spent.

Q:  Why do you prefer non-capital intensive businesses to capital intensive businesses?

A: Buffett: non capital intensive businesses tend to achieve higher returns than capital intensive businesses, we much prefer a company like BusinessWire to an auto company.

Q: How should non U.S. investors feel about investing in Berkshire amid a falling dollar?

A: Munger: dollar fall relative to what?  Other countries are having massive stimulus and government spending as well.   Buffett: Berkshire’s businesses have great earning power and derive a good deal from overseas businesses.  A cautious investor might hedge

Q: How has the financial meltdown affected Berkshire Hathaway’s businesses?

A: Buffett: our operating businesses have been hurt.  GEICO has gotten a boost because of the people looking to save money.

Q: Who will take over making the big Reinsurance decisions once you/Ajit Jain are gone?

A: Buffett: Ajit is irreplaceable.  We would not give the same ‘power of the pen’ to anyone new.  Not even close.  I don’t make decision for Ajit, I talk to him because I am extremely interested in what he does.  Like writing life insurance policies for Mike Tyson.

Q: What are some problems with leverage in this whole financial mess?

A: Buffett: You don’t want to be in a position where someone can pull the rug out from under you.  You can get confused emotionally and pull it out from yourself as well.

——————-

I suppose I could go on for a few more, but these were the main points that I took away.   The whole meeting was quite an experience and I look forward to going next year.

The challenge is to take Warren Buffett’s wisdom to heart and start making wise investment decisions.  The framework is there - what are you waiting for?

Published
by
Adam Davis
on May 5, 2009
in Investing
. 11 Comments
Apr22009

On the Record

For historical purposes, I would to be on the record for a few musings that I hope will find there way into Google’s search indexes so as to be preserved for my children to read one day (kind of like cryogenics for your thoughts).

Lately, I have been reflecting on the absolute madness of what is going on in virtually every market imaginable (stocks, bonds, real estate, etc.).  One day, a hundred years from now, kids will be reading about this stuff in their history classes - or, perhaps having things beamed into their heads telepathically.  They will perhaps wonder: ‘what were they thinking?’ The overwhelming answer will be: “they weren’t”

My pipe dream for the day, which usually involves time travel or playing in the NFL, is that someone could get through to the pigs at the trough in the government before Old Major and  Napolean take over.

  • This bailout stuff is a bad idea - borrowing to de-leverage? does this sound a bit screwy to anyone? A Wall Street personality was on NPR the other day saying that if there was no bailout the recovery in banks would take 10 years.  My thought: “so…?”  All we are doing with this bailout stuff is creating more moral hazard, more future problems that perfectly embodies the spirit of “push it off to the next generation - at least we won’t be here for the shit storm” that has prevailed in recent years.
  • America will forever be addicted to leverage - two generations (soon to be three) have come of age where the culture of “buy now, pay later”, “you deserve it”, and “..but all the other kids have one!” is ubiquitous.  It’s hard to remove something from your DNA - it’s just kinda there.
  • Our country had many years of freedom and prosperity - both will diminish in the future.  However, we should be thankful that we had any at all - remember, several generations passed in countries like the former Soviet Bloc where subsistence and repression was a way of life.  More government control (by default if anything else with all of the spending and administration) means less freedom. More restricted markets mean less overall prosperity.
  • The size, scope and level of government intervention is analogous to pouring oil into the drinking water supply - America will soon resemble the nations of western Europe as they currently are - old, stodgy, bloated, bureaucratic and functionally obsolescent  in terms of creating higher standards of living and being a beacon for those with high aspirations.
  • The American Taxpayer will soon be an indentured servant all the way around - to his government, to foreign governments and to foreign and domestic corporations and financial institutions
  • The American Entrepreneur is being cast aside -when was the last time President Obama or any of these other so called political ‘leaders’ paid any  meaningful verbage or time to small businesses and entrepreneurs?  My question to them is: “where is your future tax base going to come from?” (you can’t tax the foreign companies and countries that are buying up America by the day Mr. Obama)  What will inevitably happen is that the entrepreneurs (and other producers) are going to be expected to pick up the slack for everybody else- all the government spending and programs will be heaped on the “producers’ by those that produce nothing - this makes me sick to my stomach. State and local governments take every chance they get to stomp and spit on small businesses - whether it is hiking their taxes, passing encumbering ordinances or taking land through eminent domain for “public good”.

I don’t want this to sound too much  like a whiny rant.  I generally hate it when people present problems and do not put forth solutions.  My solution is simple: when you find yourself in a hole, the first thing to do is STOP DIGGING.

Published
by
Adam Davis
on April 2, 2009
in Bailout and Business
. 13 Comments
Mar32009

Feeding the Machine

All apologies for my posting hiatus.  I enjoy writing this blog just about as much as I enjoy grabbing deals…but not quite as much!

At times, when I get really busy with  my company, I feel like I don’t spend enough time on self-improvement (e.g. reading, listening to podcasts, etc.).  As such, I recently rolled back my alarm clock an extra 45 mins (yes, 4:45 am is early) so I could squeeze in some extra neuron stimulation in the morning before a day of swashbuckling.

In the spirit of sharing, I thought I would throw out what I’m reading/listening to in hopes that anybody out there reading this might pick up something good and helpful.

What I’m reading:

Blogs:

Books:

What I’m Listening to:

Well, there is my eclectic mix of what’s pouring into my brain.

Hope you can find something in there worth giving a shot to.

Back with more soon.

adamjdavis.com brain homer simpson

Published
by
Adam Davis
on March 3, 2009
in Business and Business Books
. 1 Comment
Feb142009

Sex and the Art of Over-Complicating - Part II

A few months ago, I wrote a post about how people tend to over-complicate things in all aspects of their lives. The main point I was trying to make in that post was that problem solving in your business/personal life is greatly complicated by the human tendency to make things more complicated than they really are.

The proverbial ‘mountain out of a molehill.‘

Alas, it is often said in budding or troubled relationships that “sex will just make things more complicated,” and there aren’t many times where this is not true.  Yet, people do it (no pun intended) anyway and the web of complexities is spun. I find this to be true in many other aspects of life.

This doesn’t affect just a few people, it affects virtually every one every day. In fact, it often goes to the next level.

I routinely come across situations that are made with the malicious intent to deceive people through over-complicating what is essentially a simple situation or simple problem.  You are wondering: why are you surprised by this? The fact is that I am not surprised by this myself (usually) but I am surprised how insidious and prevalent this problem is.

Through a brief reflection, I drummed up a few instances where over-complexity might be affecting you.

1. Wording in contracts/agreements, financial statements, warranties, etc.

Here’s a little experiment: go to Bank of America’s website and download their annual report.  Read through it for a few minutes and let me know how far you get into the footnotes before you drift off into never-never land.  This stuff is nearly impossible for the above average intelligence level person to read, let alone understand.  You might wonder why anyone that wasn’t a financial analyst or regulator would want to read this stuff, but that would be missing the point.  The point is, that the annual report is supposed to communicate business results and other relevant information to stakeholders (not just shareholders) to make decisions.  Decisions are impeded when the information needed to make them is clouded in a secret code of accountant and legal speak.

Take a look at the last legal contract you signed.  Maybe it was a lease for an apartment.  Maybe it was a contract for work to be done to your home.  Either way, I bet that if you compared the length and language to that of 20 years ago, you would be offended at the amount of trees killed and ink spilled in the modern creation.  There aren’t many things that really require a lawyer, if you get right down to it.  Our society has just created enormous complexities because a select few realize that by creating the complexity they can pull the wool over everyone else’s eyes for their own benefit.

Have you looked at your extended vehicle or iPod warranty lately?  If you haven’t, let me save you some time: if anything goes wrong with it, it’s probably your fault and not covered in the warranty.  In the rare, cataclysmic event that the thing that went wrong is really the fault of the manufacturer, it is your responsibility to prove it and if you do, you have to wait 8-12 weeks for your situation to be remedied.

You might discern that from reading the indefinite small print that we have all the product liability lawyers out there over the years for coming up with it to justify their billing.

2. Business Compliance with Government Regulators

Those of you that are business owners or managers will definitely know what I mean on this.   I know that “we don’t have it as bad in America as other countries” when it comes to Big Brother looking over our shoulder,  however, there is a difference between smart regulation (a registered oxymoron) and ribbons of red tape that do nothing but confuse and dillute value.  The last time I tried to set up a payroll (before I started outsourcing virtually all administrative tasks for my business), it took me several hours to weed through all of the paperwork necessary to get it started.  Once I got it started, it took several more hours each week to keep it up.  Then, to top it all off, when I ended it (sold business), it took at least a dozen more hours to shut it off.  I contined to get notices of delinquent taxes due from both federal and state regulatory bodies.

The million dollar question here is:  why can’t the damn payroll form be ONE PAGE?  Instead, it’s got to be maze of “check this box, then go here, check that box, go there, etc.” I don’t here anything being talked about in this enormous waste of taxpayer money (aka the Stimulus Bill) that will go toward making things easier and less complicated for business owners and managers to deal with the government.

If you’ve ever raised outside capital for a business (outside of family and friends), than you have likely come into contact with the securities law.  While raising capital for my real estate business several months ago, I became ensnared in the vagaries of how the federal and state governments intertwine, overlap and promulgate the Securities Act of 1933 and the Uniform Securites Act.

Now, don’t get me wrong: I see and understand that we need measures in place to protect the average person from the Charles Ponzi’s and Bernie Madoff’s of the world.  However, in the process of this the baby is often thrown out with the bath water. There is enough language  in all of these laws to virtually scare anyone but a securities lawyer away from doing anything with securities.  In case you didn’t notice, securities lawyers are some of the most expensive ones to hire.   Billable rates of the 600+ per hour are routine.  It is almost to the point where if  you aren’t raising over $10,000,000 at once that it isn’t worth it to raise capital from non-family and friends.  Is this really what we need in America to encourage entrepreneurship, creativity and innovation?  That no small businesses should raise small amounts of capital from outsiders?  What if there was a $500 per person limit? Or, increase the regulations in accordace with the amount of capital raised, etc?

I think that the over-complexities in this area create absolutely zero net economic benefit and, in fact, deduct from the creative capacities of American entrepreneurs.  Once again, a few people over-complicate to pull the wool over the eyes of the layman so that they may extract dollars from the layman’s pocket.

3. Dealing with Incentives and Incentive Clauses

Have you ever hired a commission sales person?  Have you ever tried to work with an employee or independent contractor who had ‘performance-based’ incentives?  If so, this will hit close to home.

Many moons ago, I worked as a sales person at GNC (General Nutrition Center) while in college.  It was the perfect job.  I got to make money, get a discount on vitamin supplements and read weightlifting and nutrition magazines in between customers.  On top of all of this, I was paid minimum wage plus commission.  Commissions were paid a set dollar amount for certain products sold.  At that time, GNC’s private label brands received higher commissions than the other brands and selling a ‘Gold Card’ (what was then a first Tuesday of the month 20% discount) was a high commission earner ($5 per card sold).

Now, let’s take a breath for a second and look at the incentive here.  What would a young guy do that was hungry to make a few bucks?  Sell the multi-vitamin that was $5 less to the customer or sell the product that was $5 more but has a $2 commission? You probably guessed right.  Sell the GNC brand multi-vitamin I did - boatloads of them.  I could have probably saved some of the customers more money, but that wouldn’t have made me any money.  The customers, most of them, were none the wiser.  They assumed that the suggestions I gave them were the ones that were best for them.

Ok, now, lets take a a look at a very famous and close-to-home example of a similar situation of incentives and the problems they can cause in your every day life: selling your home.

When most people sell their home, they hire a real estate agent.  The agent lists the house on the MLS, tells a bunch of people about it, shows it to prospective buyers, and so on.  Finally, they get an interested buyer.  You are asking $200,000 for your house.  The buyer offers $180,000.   What to do?

Your first inclination as seller might be to make a counter-offer or to pass and wait for an offer closer to your asking price.  But, your agent has other ideas.  The agent encourages you to take the offer, they mention that a better one might not come along for a while.  Here is what is going on in your agent’s mind:

Selling Price: $180,000

Commission (6%): $10,800

or…

Selling Price: $190,000

Commission (6%): $11,400

Unless the market is RED HOT, the agent is probably not going to want to jeopardize a sure-fire payday of $10,800 for a measly $600 gain.  However, the difference to you (the seller) is a $9,400 ($10,000 higher selling price less 6% commission).  This is the power of underestimating the complexities that come with incentives.  The agent has a strong vested interest in selling at $180,000 - and urges you to do the same.   Just like the GNC employee.

When you look at or encounter incentive-based situations in your everyday business or personal life, it would benefit you to slash through all the B.S. and look at the alignment of incentives.  If you are running into a problem with an employee, take a look at their incentives.  Most employees get paid to show up, do the job, and go home.  The business owner gets frustrated when the employee doesn’t go the extra mile, stay late, make the additional customer call.  The business owner further thinks that there may be some sort of moral problem or other issue.  The business owner spends valuable time thinking about the causes of the employees acting ‘at the margin’ when they need look no further than the incentive.

How about the issue causing the current ‘credit market crunch?’  Is is really a problem of indefinite causes (housing for everyone from the Clinton presidency, bad mortgage brokers, bad underwriters, shady appraisers, shady title companies, crooks, politicians, cheap money, etc.)?  I think it is simply a matter of what people were incentivized to do.  They were incentivized, at every level, to do exactly what they did.  There were no incentives for the behavior that would have led to an orderly market correction.  The guys on one side made billions while the guys paid to prevent it made thousands. The Wall St. guy goes home at 10:00 at night.  The Fed. regulator goes home at 5:00- do the math.

————–

As I descend from my soapbox. I feel a bit lighter of burden but strongly galvanized in a quest to seek simplicity when situations seem overly complex.  It has worked for me many times to strip as much of the B.S. away as I can and focus on the bare bones of the issue.  For example, when looking at a recent real estate deal, I found myself getting caught up in the probabilities of certain scenarios playing out; caught up with the variables in play and what would happen if A, B or C.  Suddenly, I stopped for a moment, shut off my computer, pulled out some scratch paper and a pencil, remembered some second grade math, came up with my number for the deal and my sanity promptly returned.  Like magic.

Give SIMPLE a shot.

Published
by
Adam Davis
on February 14, 2009
in Bailout, Opinion and economics
. 7 Comments
Jan262009

The Great Derby

Over the holidays of 2008 and for the past three weeks of 2009, I consulted my crystal ball (hey, give me a break, my magic 8 ball is in the shop).   Guess what it came back and told me?“Now is the time to BUY.”

crystal ball

“Buy what?” I replied?

“BUY” the crystal ball spelled out again.

I guess I would have to figure out what it meant all on my own.  Thus I began a three week intellectual odyssey: “what did the crystal ball mean?”

For days and weeks on end, as I made my merry way purchasing bargain real estate and common stocks, my mind would dance around the word ‘buy.’

“What more could I do?” I wondered to myself.  “What am I missing here?”

One morning, while re-reading a portion of one of my favorite investing books of all time (Security Analysis by Graham & Dodd), something dawned on me: I wasn’t fully committed enough to ‘buying’ my favorite undervalued asset classes.  Although I had written about it and attempted to put it to work in my daily business of investing, I realized that I was still only dipping a portion of my leg in the water - I had not yet ‘jumped in.’

This may seem like a matter of semantics, but it really is not.  It’s a matter of night and day.

As I have mentioned in previous posts, back in one of my former lives, I was a competitive weightlifter.  Psychology is one of the biggest factors in lifting big weights.  Our coach used to teach us: “commit fully to the weight - or your dead!”  While this wasn’t exactly the most comforting thought in the world, neither was the thought of 350+ pounds crashing onto your bones!  In fact, taking his counsel to heart in this matter bore a lot of fruit (= less injuries).  I had seen many lifters move huge weights in preparation for a big lift, only to see them fail because they had not ‘committed themselves to the weight’ when attempting a lift on the platform.  Weightlifting is an “all or nothing” sport.

Snatch

 (no, this is not a picture of me)

Sort of like a lot of other things I know.

You see, as an investor and entrepreneur, you are constantly swimming upstream.  The negative media attention on the economy and business right now as well as the naysayers can pick apart your psyche.  These things can wreak havoc on you quickly or, they can be insidious - slowly growing in the back of your mind.  If you aren’t fully committed, both in thought and in action to your investing and business objectives, the insidious creep of doubt will work against you.

What I realized upon my crystal ball reflection was that I still did not have the absolute full strength of my convictions behind me.  I realized that I had to put to bed questions like: “what if the market continues to go down.”  I simply put the full faith of my judgment behind my decisions - becoming more confident that my framework was solid.  I started to think less and less about things like “what would Warren Buffett do? (WWWD)” and realized that he never had a perfect map for success either.  He was/is guided by a basic framework that is effective and he sticks to it, through thick and thin.

A great calm came over me as I felt better and better about relying on the strength of my own convictions and faithfully ignoring the rampant pessimism.  I realized better what some of the classic investors, like Graham, Heine, Munger and Klarman talk about when they continually emphasize that the psychological aspect of the investors mind is the most important.

Saying  that you are ingnoring the crowd and actually ignoring the crowd are two completely different things.  I think that I made it past a fork in the road in the begining of our year 2009 and look forward to pushing ahead.

———————-

Speaking of real estate investing, the upcoming Real Estate Investors Association of Macomb (REIA of Macomb) meeting is going to be great.  It is the 2 year anniversary of one of the best networking and education focused groups that you may have the pleasure of attending.  This Thursday, January 29th and 6:00 Pm at the Royalty House in Warren, MI will be a great event.  If you are in the Southeast Michigan area this week, please check it out!

———————-

P.S. I really don’t have a crystal ball.

P.P.S.  My Magic 8 ball really is getting fixed (by a gnome somewhere, I think)

Published
by
Adam Davis
on January 26, 2009
in Finance and Investing
. 7 Comments
Dec312008

Let it die with 2008

You got it right.  Party animal I am not.  It’s 11:15pm on New Year’s Eve and I find myself compelled to write a small piece in effort to put some amount of good karma into the universe to eliminate the lunacy that has increased in the financial, real estate and stock markets in the last four months.

The best example I can find to top it all off, I mean, the real icing on the cake - the GMAC bailout.  The red flags and bells and whistles going off for this one are astounding.  For this company to get $5 billon in government bailout money and to then turn around and offer 0% financing with that money to General Motors customers with sub-prime credit positively astounding. An interesting short take on the GMAC situation can be read here.

Apparently, moral hazard is now a hollow concept.

————————————————————

Propelling forward into 2009 - there are a few tenets that, in spite of economic conditions, war, government intervention and the like, should prove profitable for investors and entrepreneurs:

  •  irrational markets bring opportunties to patient investors- whether panic selllig in real estate, stocks or bonds, the time to pick up great deals is to buy when others must sell
  • tough economic conditions force weaker and marginal players out-this is good news if you can keep swimming
  • new opportunities are opening up - technologies and innovations are stil coming down the pipe
  • it is good to be alive - I just like to throw this one in there for perspective

In a slight departure from 2008, I will be broadening my asset classes for investment in 2009.  I have been increasingly scaling back my consulting company and focusing more on equity investments and some busines acquisition deals.  I am still very excited about real estate, though a little bit more on the commercial side now than at any other time.  Deals are literaly falling from the sky.  A few of them, believe it or not, have hit me on the head.

Please stay tuned for more from Radical Wealth Accumulation in 2009.  Things are looking up.

Published
by
Adam Davis
on December 31, 2008
in Bailout
. 4 Comments
Dec182008

Proforma Pariahs

Number cruncher.  Bean Counter.  Captain Spreadsheet.

Abacus

I freely plead guilty to being all of the above - for part of the day at least.  Being a ‘dyed in the cloth finance man’ as one of my former Indian colleagues labeled me, I cannot help but pass comment on one of the things that routinely trips up my fellow entrepreneurs and investors nearly right out of the gate - disillusion financial projections.

Trust me.  I have learned this lesson the hard way more than a few times over.  Your humble author would have gladly forked over a few more grand in college tuition than have forked over several times that in money lost in business.

In spite of the general contempt I felt toward “the man” when I was a crunching numbers in a cubicle, one of the most valuable lessons I learned while working in corporate finance was the art (and I use the word ‘art’ quite offensively to any true artists out there) of thoroughly evaluating financial numbers of businesses and operating units.

Many venture capitalists have grown quite long in the tooth preaching that it isn’t a good idea to plan in fantasy land, i.e.: “the market size is ‘X’, if we can capture just one percent of ‘X’, our company will make a killing,” or something along these lines.

Now, I know that many entrepreneurs are not finance people by nature, so they may be inclined to hire a CPA or consultant to assist with putting together their financial projections. Inevitably, most of these proformas are no good, still focused on obtaining some level of sales and working down to a bottom line number from there, often engineering a result that an SBA loan approval committee or venture capital investor wants to see.

Based on some experience, the best way to prepare financial projections, in my view, is to work from the bottom up, build in a healthy margin of safety and remove illusions of grandeur and 3 year IPO ‘liquidity events’.

1. Work from Bottom UP

Start with the basics:  what will it cost you to get a customer? what do you need to cover fixed costs?  Working from here will help you learn what it will really take to achieve the minimum profitability necessary to make your business start-up or acquistion a worthwhile endeavor.

2. Margin of Safety

Make sure to establish revenue projections that give you pricing flexibility.  Market forces could put pressure on your prices right away, even if you are a premium provider.  If you are going for a cost leadership-type position, someone else could have a similar idea or a new innovation could spark margin pressure for you.  Also, give yourself multiple marketing options and customer acquisiton options.  When companies limit themselves (and base financial forecasting upon) strategies that are too focused, bad things like ‘red-ink’ quickly follow.

3. No grandeur

Aim to build a profitable and sustaining enterprise.  Be happy if you have to keep your business forever.  If you can’t be happy with owning your business for a long period of time, then you are starting it (or buying it) for the wrong reasons.  Even though CNBC glorifies the leveraged private equity buyouts and raiding takeovers that aim to take quick profits and fip companies around like pancakes, very few of these stories ever end well (but it sure makes for good TV).  Don’t start with the 3 year exit in mind, it will only further delude you into thinking you are superman and batman combined.

Accomplishing these things in financial forecasting for entrepreneurs is going to be difficult, but not impossible.  If you need assistance, feel free to hire a consultant to help you. Of course, as many of you know, you can tap a global community of service providers that can aid you in this endeavor, and give you a good perspective from their viewpoint.

As an investor, the golden rule is to run far, far away and very fast from rosy financial projections.

Published
by
Adam Davis
on December 18, 2008
in Entrepreneurship and Finance
. 7 Comments
Dec162008

Fools Rush In (not the movie) + Bonus: Learn Why Banks Aren’t Lending to You

There isn’t much more to say than already has been said in the unfolding Madoff scandal (read more here) that has demolished portfolios from Wall St. to Palm Beach.

What I, and other people in the world are wondering is: “how?”

  • How could millionaire Palm Beach Florida residents blindly throw money at this guy?  Aren’t these millionaires supposed to be smart and have smart and expensive advisors to help them?
  • How could pension funds from muncipalities and companies lose so much money for their investors?  Why are they even allowed to invest in hedge funds in the first place?
  • How could a guy keep up a Ponzi scheme for longer than even Ponzi himself did?

The sad fact, I think is that this is another classic example of the powerful social psychology of “group think.” If a person, in this case Madoff, gets a few fat cats to throw some money in, the rest wonder if they are missing something and follow suit.  Reminds me a little bit like the ‘dot-com’ stock bubble of almost a decade ago.

Since emotional intelligence - that is, the ability to not be swayed by things other than fact and principle -  is the most fundamental principal of successful investing, it is only fitting that people continue to lose money in schemes like Madoff, Pets.com and others.

——————————–

60 Minutes had a great program this past Sunday.  I was most intrigued by the opening piece featuring House Banking Committee Chairman Barney Frank.  You can watch some of the clips from the show here.

During the piece, one of the things that Frank expressed was disappointment that Treasury Secretary Paulson had not done enough to force bailout participating banks to lend money.  Note the key word there: force.

Hold on a second…Isn’t this one of the large contributing factors to the credit disaster that we are suffering through now: Government madated lending?  I mean, Fannie Mae and Freddie Mac having their fires stoked by Congress and Presidential Administrations to ‘make home ownership available’ to more and more Americans - even those that were not qualified borrowers?

For those of you that want to know why banks aren’t lending money right now, I will tell you in one word: Capital.

As in, most borrowers don’t have any.  There used to be an old adage in banking that went like this: “banks only lend money to people that don’t need it.” The reason for this adage are the core issues of financial market intermediation (I usually try not to use big words, sorry).

If borrowers don’t have capital to contribute to their projects, then banks don’t want to lend on them.  Think about it, we just got done with institutions making ‘zero-down’ and 125% financing loans to people, effectively eliminating any financial risk (save for maybe a credit score) from the borrower - the institutions were taking all the risk - or, better yet, some investor in a convoluted mortgage pool was actually taking the risk.

Since most borrowers, businesses and consumers alike, are still leveraged to the hilt right now - think credit cards and maxed out business lines of credit - they don’t have any of their own organic capital to invest into projects.   This = a ‘no-go’ from a banker with half a brain cell.

When borrowers can come forward with good capital to invest, and the project is good, banks will make loans. I am sure that this stance won’t win as many votes for Mr. Frank as the “force them to lend!” rhetoric will, but I hope and trust logic will prevail.

Published
by
Adam Davis
on December 16, 2008
in Finance and Investing
. 2 Comments
Dec152008

How to get ahead…the Magic “P” Word

If I could impart the most important lesson that I have learned to date in business and investing, it would be: “patience.”

Warren Buffett has been quoted as follows: “the financial markets involves the transfer of wealth from the impatient to the patient. “  How true this is.

What is worth doing is worth doing well and usually takes time to implement and work.  There are no shortcuts, however much every late night information marketing genius would like to tell you about for three easy installments of $39.95.

The wealthiest investors and business owners that I know do not chase after quick and easy profits.  They don’t go for projects with marginal proforma profitability and based on heavy leverage.  They don’t take risks without commensurate reward.

When business and market conditions are tough and getting tougher, like they are now (and have been before) the route to take is patient, intelligent and rational.  Knee-jerk reactions simply won’t do much good for your net worth.  Unfortunately (or fortunately for some), most people will jump in and out of investments and projects, will push prices to and fro with their actions and open up opportunities for patient and rational investors to grow their wealth.

Keep watching for bargain investment opportunities to fall out of the sky.  Assets are going to continue to go off at ‘fire sale’ prices as the collective global economy “de-leverages” itself and purges the remains of the great credit hangover.

———————-

I’m going to be launching another blog in the near future that is going to focus more on the financing aspect of my businesses and more of my personal interests and thoughts in that arena.  I will continue to post on this blog as regularly as I can, but it will be more of a general business and investing commentary and writing focus.

Stay tuned!

Published
by
Adam Davis
on December 15, 2008
in Business, Finance and Investing
. 3 Comments
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