Monday Thoughts as Worldwide Markets Slide

Blindly following folksy mantras and not doing research can cost you tremendously. If you don’t know about something then your risk-taking in that area should be moderate at best.

I have an article draft, which I have not finished yet, comparing the virtues of real economic/investment research to the regurgitated mantras that people on TV spit out daily. I have not found a way to word this article yet that pleases me, but I think it is important. Especially on a day like today – let me share a thought to explain what I mean.

For example, let’s say you have money to invest but are not sure if you should buy now or wait. In fact, let’s say you really don’t have any criteria that would drive your decision making (and when one doesn’t have any criteria, one is likely working on emotion). So let’s compare a sample type of criteria to a regurgitated mantra. I will select (for this exercise) the popular and regurgitated-often mantra of “buying on the dips.” This sounds intelligent, I suppose. But it’s only intelligent if the buyer knows what he is buying.

Case in point: while giving a talk last fall, an older gentleman asked my opinion on his large (I think almost exclusive) holding of GE. At the time GE was around $30/share. I told him that I had not researched GE thoroughly but that it was mostly a financial company (in my opinion) and that I would simply avoid financials. He countered that we should “buy on the dips” and I told him I didn’t know enough to have that opinion and told him that he should probably do more research himself before making any decisions. he shot me the dismissive look that you might see when an 85 year old hears something he doesn’t like from a thirty five year old – but I felt I had to tell him what I thought, especially if it could help him.

Compare that “mantra” to some very basic analysis. Interestingly, and this is NO recommendation to buy or sell anything by the way (just my site’s goal to educate a bit), many well-known and not so well-known solid companies are trading at prices where, if the company decided to do this, they could buy back their entire company from all the shareholders and go private in 5-6 years. Where can you see this? Go to Yahoo Finance and look at the key statistics. You will see listed a couple of basic fundamental facts – market capitalization, enterprise value (market cap – net cash in the bank), operating cash flow and free cash flow.

For example, Disney has a market capitalization currently just under 30 billion dollars (as of Monday 12;30PM march 2, 2009). Their operating cash flow (for the past 12 months – key word is “past”) is a bit over 5 billion dollars. 30/5 = 6 – if Disney took all of their cash flow and did nothing but buy back stock over the next 6 years, and assuming Disney stock stayed at the current price (or declined), there would be no stock left and the company would be private! it’s somewhat amazing to think of! Business owners are usually aware that a private business would fetch 3-4 times cash flow in a good market – and that only in the fantasyland of stock market world do investors price companies at 20-100 times future possible earnings, but often the average investor does not know the differences in valuations of private and public companies. So now it is very interesting that public companies are selling for close to private market valuations (assuming cash flows stay the same of course!).

It’s safe to say that this gentleman I spoke with at my talk never did even this simple level of analysis. he simply has acquired this belief over years of watching mindless financial shows. I caution my clients not to watch what my mentor Bill Bachrach calls “financial pornography.” These commentators can poison your mind – remember their job is to keep you watching, or sell you magazines – it is NOT primarily to provide you specific, customized advice.

What is the lesson here? As I say to anyone who asks me – if you don’t know much about an investment, then you should never take more than a moderate level of risk. If you are starting your own business, or buying local real estate, then you do know or should know a lot about what you are doing, and in my opinion, could accept more risk. The problem I find is that many people take enormous stock market risk but they know nothing about what they own – OTHER THAN WHAT THE MEDIA SAYS (or some other random source of information).

Risk is rapidly becoming more “appreciated” now that people have lost 50% of their money. I hope that you are being realistic about the risks in your life. This is an excellent time to review possible risks you face – including legal, insurance, and investment risks.

Note: I am not making any recommendation on any investment and no recommendation in general other than to research more and take time to review your risks before acting irrationally. Also, the data shown above is as of Monday March 2, 2009 at 12:30PM.

Chris Grande

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