Some companies have far more tangible* assets than liabilities (Intel, Public Storage, Skechers USA). Unlike the previous examples, most US companies are not so strong; about 12% of the largest 1,000 US companies have over $1.30 in debts for every $1.00 in tangible assets. Many of the largest US companies are even far more leveraged. The risks of a company rise in direct proportion to the degree to which its’ debts are larger than its tangible assets. What percentage of your retirement fund do want invested in companies with more debt than tangible assets?
Some companies have far more free-cash* than they could possibly need (Apple, Google, Nike). (Caution: while a company’s cash position adds greatly to the safety of the enterprise, it adds to the safety of their stock price!) Unlike the previous examples, most US companies are not nearly so strong; about 62% of the largest 1,000 US companies have less than 100% more free-cash than they have in current liabilities. Cash is the lifeblood of every company. The cash that a company can easily and freely distribute to its shareholders is an excellent measure of a company’s financial strength and its value. How much of your retirement funds should be invested in companies with poor cash production?
Many US companies have strong and predictable revenue streams, may do not. (Amazon, Netflix, Cree) Clearly, companies with growing revenues are preferable to those with declining revenue. However, when the debts of a company grow faster than their revenues, we worry. How much of your retirement funds should be invested in companies whose debts are growing faster than their revenues?
Many US companies have paid dividends reliably for a century or more. (Coca-Cola) Generally, the higher a company’s dividends are, the more valuable their stock is. However, if a corporation borrows money to pay its dividend, we worry. If a company pays out $2 billion over 5 years but it added $4 billion to its debt, its dividend payments may be a sign not of strength, but of weakness. For companies that pay dividends, we look at where the money to pay them comes from. Dividends financed through debt represent a far riskier scenario than those not corresponding to rising debt levels.
When Can “Earnings per Share” actually be Worthless?!
Can US public company’s report billions in annual earnings and rising earnings every year, for a decade or more, and yet not show any increase at all in the company’s net assets? Can company’s report tremendous earnings and even show a deteriorating balance sheet over time? (Sirius XM Holdings, El Paso Pipeline Holdings, Biogen Idec) Yes they can, on both counts; and never be convicted of fraud. In the words of Abraham Briloff, CPA, Ph.D., “Financial statements, like fine perfume, should be sniffed, not swallowed.” How much of your retirement funds are invested in companies with rising earnings, but deteriorating balance sheets?
Should a Pre-Retiree Invest in The Stock Market?
Because the stock market generally, and average stocks in particular are very risky, very volatile and entirely unpredictable, a person nearing retirement should NOT generally invest that portion of their assets that they need to produce retirement income in either common stocks or mutual funds. As one nears retirement, isn’t it wise to err on the side of caution? Therefore, because we do not know what the market will do, retirees must avoid the risks of the market with the funds they will live on until their death. In the next 20 years the stock market may rise and fall 10 times by 20% or 40% and leave you with no more than you started with. It could crash and not recover for 20 years just as easily as it could rise by an average of 7% a year for the next 15 years. No one knows. Should you gamble with your life savings? We don’t advise it.
How To Know What a Stock is Worth?
There are dozens of theories on how to “know” what a stock is worth. You’ll find conventional methods of “knowing” what a stock is worth in every other investors guide, but not this one! We think trying to “know” the true worth of a stock is as useless as chasing rainbows. We don’t even try. To be an exceptionally safe investor, you needn’t care what others think a stock is worth; the masses of investors are ignorant gamblers, every generation, the masses drive stock prices up to wholly irrational levels; and invariably the prices fall and crash. And sometimes it takes decades for stocks to return to their former highs. Any method that can lead to significant losses is not right for a pre-retiree.
How Much Should I Pay for a Company Stock?
An exceptionally safe investor has no need to know what a stock is worth. Investing exceptionally safely simply requires that we find a very reliable and conservative estimate of the minimum value of a stock, and refuse to pay more than this value for a stock. Then once he’s made a good profit, we sell the stock. We don’t need to try to squeeze every penny of profit from it. An exceptionally safe investor believes that, “A bird in the hand is worth two in the bush.” Agreed? You shouldn’t buy stocks, except when you can buy a stock for less than the most reliable and most conservative estimate of a company’s absolute minimum value!
The Price You Pay to Gamble!
Many companies report great earnings and just may be on the verge of bankruptcy. One of the biggest risks in investing in any company is paying too much for its stock. Stock price is commonly assumed to be equivalent to stock value, but the two figures are in fact only distantly related at best. The value of any given stock cannot be reliably assessed, but it is possible, by examining its balance sheet, to make a conservative, reliable and accurate estimate of the minimum a company could be worth. Our definition uses “net tangible equity”, or shareholders’ equity less total goodwill and other intangibles. The more you pay for a stock above its net tangible equity, the greater the risk you take on of potentially losing money if the stock goes south.