Category Archives: Business

Financial Decision-Making @ the Heart of Business | Forecasting Projects


Why forecasting is important:

  • Managers use it for future allocations
  • Analysts make forecast to communicate their view of a firm’s prospects
  • Creditors make forecasts in order to determine whether their debtors can repay
  • Investment bankers use it to determine who to engage in hostile takeovers.
Good Forecasts of three core elements:
  • Integrated Forecast: forecast the income statement, balance sheet and cash flow statements together; if we assume that growth rates hold for the next 10 years that means we are assuming the asset turnovers are increase substantially as sales are growing.
  • Realistic Assumptions: sales growth, assets growth, asset turnover, debt levels, profit marings should be realistic
  • Robustness: the forecasting process should produce numbers that are not too dependent on a few key assumptions.

EBIT * i-t)

+ Dep

  • DowC



  • Dangerous to put your work out to the public.
  • Reduce CAPEX. The net impact will have a higher FCF.
  • PP&E does down they are not investing in PP&E.
  • You shouldn’t start with Free Cashflow Assets; we need to come up with free
  • And then see what false.

Maybe we are adopting ratios:

  • Genera Mills; I have historical margins but what are we going to do.
  • If you have 100% mispricing.

Detailed Forecast

  • Forecast detailed line items on income statement and balance sheet
  • Can be tedious
  • Individual ratios can be volatile
  • Many line items may not have a natural “driver”
  • May be essential in settings where condensed forecasting is insufficient –and you care about individual assets/liabilities e.g. credit providers, bankruptcy

Condensed Forecast

  • Forecast condensed income statement and balance sheet
  • Fewer assumptions –can pay attention to each assumption
  • Less volatility
  • Wont work in some settings –as discussed above

Detailed Forecast:

Can be tedious…

Building your Business valuation Forecasts…

Assumption #1: Revenue Growth

Easy to have small growth for example Apple has returned to mean, you might say. That’s a cynical view but it’s a sensible one. Why can’t you have massive growth every year? The answer is that competitors will enter to disrupt the Apple’s of your industry. For example, Samsung phones look a lot like Apple’s. The operating system from Apple with it’s GUI seemed copied by Microsoft.

So, pay attention to recent growth, be aware of mean reversion.

Consider the Macroeconomics in Ontario: the new US tax and economic performance post-2016 election say the Canadian dollar go up.

Consider the Industry and Firm factors: is there a new evolutionary product.

Separate out sales from existing resources and sales from new resources.

When creating your forecast, try to consider the product line channels if the information is available around price and volume but you should look at aggregate sales growth in your analysis.

Assumption #2: Operating Expenses

Operating expenses are in the Income Statement. You need to forecast the operating expenses as a % of the Revenues.

Factors to consider:

So what factors should you consider?

You should look at the expenses ratio: levels and trends.

Expansion in to the new markets should lead to a) an increase in operating expenses. Here you would build a market. You might have to lower prices. Operating expenses then you expect margins to grow through efficient. However, recall that growth does not equal efficiency. Growth is very inefficient.

ROE and ROAs tend to mean revert they are driven by mean reversion in profit margin? Why? Again, competitors and structural changes to the company. Why if the ROE is below-> everything reverts to the mean. Remember that General Motors gave their employees 25% of the company so that they could get the union pensions off their books.

Your analysis may decide to have a more granular approach here ie. Forecast the COGS, SG&A, R&D separately.

Assumption #3: Net Interest Expense

This has nothing to do with revenue – it’s a function of lagged net debt. Pay more attention to recent information – interest rates from 3 to 4 years ago are less relevant. Interest expenses rises. Can a firm have a negative net debt? Apple has negative net debt. They have more cash. Apple can have negative net debt.

Usually a negative interest expense (i.e. income) – can estimate rate.

Assumption #4: Taxes

Examine the tax footnotes in the company Financial Statements. In most cases, can be extrapolated from prior data. Some times, tax rates are “all over the map”.

Remove the impractice of one item that can distort tax rates i.e. non-deductible goodwill impairments. Take a look at the historical analysis.

Assumption #5: Net Operating Working Capital

Operating Working Capital = working capital cash + non-cash current assets – current liabilities. Remember this is an ‘inverse’ turnover ratio – more implies a worsening turnover.

Examine the trend in prior lagged OWV/Sales. What should happen to this ratio if a firm is converting to a Just-In-Time inventory system b) decreases: inventory gets smaller therefore you would expect the efficiency of the firm to increases the FCF.

Negative Operating Working Capital/Sales may not be sustainable. You may need to forecast this ratio to zero and eventually positive.

Net Income


+ Depreciation

Change in OWC



Assumption 6: Net Long-term Assets

  • Net Longterm Assets = long term assets less depreciation and amortization – Lonterm liabilities not related to debt.
  • Remember this is also an ‘inverse’ turnover ratio more implies a worsening turnover.
  • Examing the trend in prior lagged Net Longterm Assets / Sales
  • What should happen o Net Longterm/Sales if you’re converting bricks and mortar stores to e-retailing:
  • It decrease CAPEX and increases FCF (Free Cash Flows).

Assumption 7: Liabilities

  • Payout Approach : you can calculate retention ratio – incorporating repurchases if necessary.
  • Startup Retention Ratio: retention percentage (a) 100%
  • You should not be chasing dividends. 100% were not paying any dividends what about the mature firms. Mature firms you’d expect 00%
  • What phase is the firm in based on the retention ratio.
  • Balance Sheet: net assets = net capital
  • Set = ShEt – 1 + Forecast Net Income * Retention Ratio.
  • Retention Ratio: is how much….DEFINITION HERE.
  • Payout Ratio = Annual dividend per share/ Net Income
  • Retention Ratio = Retained Earnings/Net Income
  • Retained Earning = – Dividend / Net Income
  • Startups have almost 100% retention ratio!
  • Some will buy into older companies because the dividend payout is usually higher.
  • Debt will be the implicit plug in this model: what if the firm has positive net debt? Maybe something happened. Debt to Equity is D/E More economic intuition in the retention price. You should look at higher growth: pessimistic scenarios our demand film.
  • We will do financial statement analysis

Capital Structure Approach:

Break up Net Assets into Net Debt and Equity using the targeted capital structure. Payout is the implicit plug here.

Sensitivity Analysis

  • Forecasts are based on the expected or most realistic set of assumptions.
  • Important to consider at least two other scenarios:
  • Optimistic scenario – higher growth, lower cost, lower asset ratios;
  • Pessimistic scenarios – lower growth, higher cost, higher asset ratios.
  • Advantage of condensed approach: can focus on some key ratios – sales growth, operating expenses, Net Longterm Assets.

Interpreting Forecasting Financials:

  • Can do ratio analysis as forecasting financials.
  • How well is the firm forecaste to perform?
  • Are assumptions reasonable> trends in longterm ROE – do try to make sense?

Estimate the Free cash Flows from Condensed Forecasts

  • Can one estimate Free Cash Flow? Forecasting is not a science! No kidding. False sense of precision. Paying excessive dividends.
  • Turns out one does not need them as: change Net Longterm Assets = Capex – Depreciation
  • It is easy to express enterprice Fress Cash Flow as follows;
  • FCF = Net inceom + Net Interst * (1-Tax Rate) – change Net Longterm Assets = Change net Operating Working Capital.

Excel for Financial Analysis

Instead of using =Sum(F10,F11) try =+F10+F11. If you want an amount that displays as positive to be negative try =-F13. Let’s say you want to test is your numbers are balance: try the following:

=+F12=’Income Statement’!E18

You are asking Excel to state that =Number equals another number: the output will be true or false. You want to minus 1 when doing the Revenue previous year.


  • Forecasting is not a science
  • False sense of precision
  • Forecasting is also not an “art”
  • In my opinion, forecasting is educated guesswork
  • A condensed approach allows one to capture most important elements without getting bogged down
  • Forecasts only as good as the assumptions and the underlying analyses
What shareholders have invested in the firm. Expectations operator. Cost of equity capital. What management accomplished. What shareholders expected.

Abnormal Earnings Valuation

Better than Discounted Free Cashflows:

  • Terminal value is misleading and is very sensitive to small changes in assumptions;
  • Current earnings are better predictors of future cash flow than current cash flows numbers
  • DCF ignores accounting numbers; there is an attempt to reverse out the effects of accrual accounting when we calculate free cash flows numbers; DCF completely ignores the balance sheet.
  • Terminal value estimates do not have an economic intuitive; 3% perpetual growth doesn’t really happen in the real world.
  • Negative cash flows happen and yet DCF invariably leaders to a positive terminal value.
  • Circularity of getting the WACC and using WACC to estimate value; which needs free cash flow to equity method.

Abnormal Earnings Valuation the Details

  • Terminal value numbers are smaller part of the valuation, thus reducing the sensitivity to estimate assumptions.
  • Earnings are used instead of cashflows.
  • We use the accounting numbers including the Balance Sheet through Book Value.
  • Uses industry economics the that in the long run profitability tends to converge to an industry level median.
  • Negative earnings are not a problem. Persistent negative earnings will simply mean the firm has negative abnormal earnings.
  • The most common form of AEV is conducted at the EQUITY level. Therefore the problem of circularity is avoided.

Abnormal Earnings How It Works

First what are normal earnings. Those earnings are that are equal between the ROE and the cost of Equity. Return on Equity as a percentage and the Cost of Equity as a percentage. Any earnings above the normal earnings are abnormal earnings. If a firm has a cost of equity of 15% and a book value of equity (BVE) of $1million and a Net Income of $200K, it’s normal earnings are 15%*$1million = $150K and it’s abnormal earnings are then $50K.

Abnormal Earnings should disappear overtime as firms move towards an Industry ROE.

Key Takeaways from “A Random Walk Down Wall Street”

[The following should not be used as the basis for any financial transactions. But this is a synopsis of A Random Walk Down Wall Street. The book is the “cat’s meow” for understanding how Wall Street works. Malkiel’s conclusion is that it makes more sense to invest in an Index (passive investment) in the long run given the underperformance of active investors…I don’t 100% agree or disagree; I’m merely seeking to understand.]

My initial interpretation of this book is that it further strengthens what I have studied in the social sciences (political science, economics, history). The book points out that humans are un-predictable in most instances. Perhaps humans are emotional creatures who occasionally act rationally, but only when they aren’t emotionally attached to the decision. Whether it’s the Berlin Wall coming down, or the Enron financial debacle, predicting future events seems like it would be something tough to do. And of course, humans are beholden to a lot of things that we do not fully understand from blood sugar levels to our daily dosage of mainstream media propaganda. Perhaps the way to predict the markets is still elusive, despite efforts made by various people.” – Professor Nerdster

Chapter 1: The Guide and His Core Idea: Shit is Random

This chapter talks about the qualification of Professor Malkiel as a guide, as well as, about investment and meaning of Random Walk Down Wall Street.

Professor Malkiel validates his expertise based on an impressive career. His first job was as a Market Professional with one of Wall Street’s leading investment firm, then he became an Economist specializing in securities markets and investment behaviour, and lastly he became as a lifelong investor and successful participant in the market. And a Prof at Princeton in New Jersey.

Random Walk is one in which future steps or directions cannot be predicted on the basis of past actions. When you apply this to the stock market, it means that short-run changes in stock prices cannot be predicted. This splits the professionals from academics and the “pros” have created their own techniques. Market professionals have two techniques: fundamental and technical analysis, while Academics created the “new investment technology theory”. Later on, the two joined forces with the conclusion that the stock market can be predictable somewhat but there are pockets of inefficiency….

Academics today accept what Malkiel is saying in this book: “predicting the future is kinda tough, eh?” Flash back to the professor’s lounge, the top finance professor G at B-school X says  “We need jobs so let’s use complex statistical methods to map out human behaviour and stock performance because, while that only works randomly, humans are emotional after all, we need jobs and we can say ‘it’s a learning tool’ and we can then get paid!” Finance professor Y smiles, “Right, I mean we do not have much predictive power, otherwise we would be working in the industry right?” And everyone laughed because they know that even portfolio managers can’t predict the future mathematically.

Professor Malkiel explains in this chapter that this book is not a book for speculators. He even expounds the difference between investing and speculating distinguishing it from its definition. Investing is a method of purchasing assets to gain profit in the form of reasonably predictable income like dividends, interest, or rentals, and appreciation over the long term. Investing involves time period for the investment return and predictability of the returns while speculation isn’t.

This book is not promising to make you rich but will help nourish and educate you about investing. It even gives a preview of the importance of inflation and gives suggestions that even with inflation, investors should not dismiss the possibility that growth in valuation can be over stated, for example.

Investing requires a lot of work, no mistake about it. You should embrace the fact that investing is fun. It is exciting to see your investment returns and how well they do.

All investment returns are dependent. It’s a gamble, you can only know your success if you have the ability to predict the future.

For pros in the investment community, they use two approaches to asset valuation: the firm-foundation theory or the castle-in-the-air theory. Professor Malkiel explains the difference between the two in this chapter.

The firm-foundation theory argues that each investment has a firm anchor of something called intrinsic value. It means that when market prices fall down, a buying or selling opportunity arises.  He explains that with the use of The theory of Investment Value, wherein they determine the intrinsic value of stock and then use the concept of discounting in the process. Discounting basically involves looking at the income backward rather than seeing how much money you will have in the next year; you look at the money expected in the future and see how much less it is currently worth. This approached is in accordance with John B. Williams’ study. Malkiel even explicates that intrinsic value of a stock is equal to the present or discounted value of all its future dividends. This theory is respectable in academia, taught in the MBA and the CFA and is best with common stocks.

The Castle-in-the-Air Theory of investing concentrates on psychic values. According to John Maynard Keynes, professional investors prefer to devote their energies not to estimate intrinsic values, but rather analyze how the crowd of investors is likely to behave in the future and how they tend to build their dreams: on castles in the air and selling stock to the ‘greater fool’. Keynes also applied psychological principles rather than financial evaluation to study the stock market.

Chapter 2: History Gets Repeated in New Ways All the Time

Greed becomes an essential feature in human history, it’s not a bug but a feature to use computer terminology. People use money in any activity with the assumption that it can reach their dreams. Although, the castle-in-the-air theory can explain such speculative activity, outguessing the reactions of a crowd is a most dangerous game. History does teach this lesson, over and over..

Unsustainable prices may persist for years but eventually, reverse and this reversal is often very sudden. The bigger the activity, the greater the results of the fall of the so-called cloud castle. Only a few ‘builders’ can anticipate and escape without losing a great deal of a money when everything falls apart.

Example of this happening in the past. First, the Tulip-Bulb Mania which is one of the most spectacular get-rich-quick schemes in history. Dutch speculators invested in tulips, expecting to increase their wealth, even selling their personal belongings to obtain what they think/thought was a smart investment, considering offers that are hard to resist that later on lead to deflation which grows at a rapid pace. The end result is that the price of tulips was a lot of wealth.

The key is applying the greater fool principle, all you need is someone more foolish than you to buy the stock you are selling in order for you to make a profit and get out from under the cloud castle when it collapses…hard to time that of course.

In South Sea Bubble there was a lot of prosperity in Britain as they led the world in financial and accounting innovation and also were an island, that was hard to invade etc etc. As an economy improves, the citizenry tend use their money for investment. By greed, companies arise where they fight with each other to prove who is the better investment; giving offers that are hard to resist. Apparently, this lead the South Sea Company to fall like another castle in the air, making the public suffer. To protect them from further abuses, the Parliament passed the Bubble Act that forbids the issuing of stock certificates by companies.

In The Florida Real Estate Craze, Professor Malkiel discusses the US as the land of opportunity. The US continued the British emphasis on freedom and growth. The country had been experiencing incomparable prosperity. Their mood of optimistic and faith in the business led to widespread enthusiasm about real estate and the stock market. But, inevitably the boom ended in 1929. New buyers could no longer be found and prices softened and there was a down turn, suddenly a mortgage is ‘under water’ and it doesn’t look so sharp to invest in all of the sudden…

With Florida’s experience, investors should avoid a similar misadventure on Wall Street. But, Florida is the start of what comes next; stock-market became a national pastime, the market’s percentage increase and the price rises for the major industrial corporations.

Not everybody is speculating in the market, but still, the speculative spirit is as widespread as it is intense. Remember that speculating = gambling. More importantly, stock-market speculation is central to the institutionalization of gambling in Anglo-culture. Unfortunately, there are hundreds of operators glad to help the public to construct their dreams. Manipulation of the stock exchange happens. Example of which is the operation of investment pools where they appoint a pool manager that promises not to double-cross each other through private operations. There is a kick-ass book on this topic call Business Adventures which I will be writing a synopsis of in the future.

Professor Malkiel points out that a study of these events can help equip the investors for personal survival. Losers are those who are unable to resist being carried away. It is not that hard to make money in the market, what is hard is to avoid the temptation of throwing your money into any and all speculative activities. The ability to avoid such mistakes is probably the most important factor in maintaining one’s capital and allowing it to grow. According to Professor Malkiel, the lesson is so obvious and yet so easy to ignore.

Chapter 3: Stock Valuation has been Bullshit for a long time

This chapter discusses the Stock Valuation from the sixties through the nineties involving examples and explanations of certain events.

Professor Malkiel starts by relating certain peculiar events, including when General Electric announced about the diamond that was unsuitable for sale but the shares still rise. He elaborates and cites the growth in stock in the new era where investors created any new offering could increase the valuation and thus the stock price through trading. There is this hilarious pattern from 1959 to 1962 called the of the tronics boom, because the offerings include the word electronics in their title, even though have nothing to do with electronics. The name was the game. This form of manipulation highlights how few investors knew what was really going on and just picked ‘good sounding’ investments.

Synergism is the quality of having two plus two equal five. Thus, two separate companies with earning power which might produce a consolidated higher value. This profitable new creation is often called conglomerate. The merger would allow for the achieving of a greater financial strength and enhances marketing capability. Definitely can work out if executed well and the cultures are similar enough.

In light of this the commandments for Fund Managers are simple: Concentrate your holdings in a few stocks and don’t hesitate to switch the portfolio around if there is more desirable investment appearing on the horizon. Make sure that the market recognizes the beauty of your stock now-not far into the future. Hence, the birth of the so-called concept stock.

He further talks about the Nifty Fifty. This is big capitalization stocks which means that an institution could buy a good-sized position without disturbing the market. The craze ends like all others. The problem is simple, the stocks become overpriced and collapse like any other cloud castle i.e. the greater fools cannot be found.

The Roaring Eighties have its fair share of excesses, and investors paid the price for building their dreams. The decade starts with another new-issue boom.

Professor Malkiel explains the success of this high-technology new-issue, the almost perfect replica of the 1960s episode. For investors, initial public offerings are the hottest game in town. The stocks are not quite ready and needed some development. They encounter significant technological obstacles that hinder the stock’s valuation.

Concepts of Biotechnology Bubble. This technology promises to produce a group of products where the valuation levels of stocks reach previously unknown levels to investors and since biotech companies have no current earnings and little sales, new valuation methods need to be formulated.

The lessons of market history are clear, according to Professor Malkiel. Style and fashions often do play a critical role in pricing. The stock market at times adjusts well to the castle-in-the-air theory. For this reason, the game of investing can be extremely dangerous.

The Nervy Nineties

Japan’s real estate and stock markets is considered one of the most spectacular booms and busts. During their growth, firms often make more money from trading stocks than from producing goods, but the collapse destroys the myth that Japan was different and its asset prices would always rise.

The Internet Craze of the Late 1990s

Stocks for companies “on the Internet” could rise tenfold in a single year, and this fascinated investors. The industry is strongly competitive and investors did not focus on the great risks that small companies may have faced. No one can deny that the Internet is a big deal, that it will enjoy explosive growth, but in a highly competitive industry, there will be many losers and only one victor per vertical (sub-category i.e. Facebook for social media, Google for search etc). Many firms like, were too speculative about the potential of increased information access to be profitable, oh and also a bag of dog food is very expensive to mail….

As Professor Malkiel‘s final word for this chapter, it seems that markets at times can be irrational, that we should abandon the firm-foundation theory. The market eventually corrects this irrationality. It eventually sees the true value and main lessons that investors must notice.

Chapter 4: Four Determinants that Affect Share Price

In the first chapter, the firm-foundation theorists viewed the worth of any share as the present value of all dollar benefits the investor expects to be received from it. ‘Present’ means that dollars expected and those anticipated later on must be discounted. In a very real sense, time is money, because if you have the money now you could be earning interest on it.

He even further explains that many corporations preferred to institute stock buy-back programs meaning, those activites tend to increase capital gains and the growth rate of the company’s earnings and stock price. It makes options more valuable.

Professor Malkiel believes there are major four determinants that affect share value. Each determinant has its rule:

The expected growth rate: A rational investor should be willing to pay a higher price for a share, the larger the growth rate of dividends and earnings. A rational investor should be willing to pay a higher price for a share the longer an extraordinary growth rate is expected to last.

The expected dividend payout: A rational investor should be willing to pay a higher price for a share, other things being equal, the larger the proportion of a company’s earnings that is paid out in cash dividends.

The degree of risk: A rational investor should be willing to pay a higher price for a share, other things being equal, the less risky the company’s stock. Risk plays an important role in the stock market. It also affects the valuation of a stock. The more respectable a stock is the less risk it has and the higher its quality. But, Professor Malkiel states that it is impossible to measure the risk. For most investors, you value the stable returns and not speculative hopes.

The level of market interest rates: A rational investor should be willing to pay a higher price for a share, other things being equal, the lower are interest rates.

He further cites that in using and testing these rules there are two Important Caveats or warnings to consider:

Warning 1: Expectations about the future cannot be proven in the present: Predicting future earnings and dividends is dangerous. It requires not only the knowledge and skill but also the intelligence of a psychologist and persuasion sciences. It is extremely difficult to be objective. The point is, no matter what you use for predicting the future, it always rests in part on the uncertain assumption.

Warning 2: Precise figures cannot be calculated from undetermined data: The longer one projects growth, the greater the stream of future dividends. The point is that the mathematical accuracy of a formula is based on the tricky ground of forecasting the future. They are estimates what might happen in the future, and depending on that, you can convince yourself to pay any price you want for a stock.

These rules and caveats were tested where Professor Malkiel cites examples and gives a conclusion that with these, market prices seem to behave in a way,  that can lead to expectation. It is comforting to know that to this extent there is an underlying rationality to the stock market. He attaches an additional caveat: What’s growth for the goose is not always growth for the gander.

Fundamental considerations do have an influence on the market price: the price-earnings multiples are influenced by expected growth, dividend payouts, risk, and the rate of interest. Higher expectations of earnings growth and higher dividend payouts tend to increase price-earnings multiples. Higher risk and higher interest rates tend to pull them down. There is a logic to the stock market. Stock prices tied to have fundamentals but this is easily pulled up and dropped at random. It seems very sensible that both views of security pricing tell us about the actual market behavior: 1) expectations about the future cannot be proven in the present, 2) precise figures cannot be calculated from undetermined date.

Chapter 5: The Weak, Semi Strong and Strong forms of Efficiency

In this chapter, Professor Malkiel starts the discussion about the three versions of random-walk or efficient-market theory. The weak, the semi-strong, and the strong. All these three embrace the general idea that except for long-run trends, future stock prices are difficult, if not impossible, to predict. The weak, you cannot predict future stock prices on the basis of past stock prices; in the semi-strong, you cannot even utilize published information to predict future prices and; in the strong, nothing, can be of use in predicting future prices. He further states that the weak form attacks the technical analysis, and the semi-strong and strong forms argue against many of the beliefs held by those using fundamental analysis.

Technical analysis is the method of predicting the appropriate time to buy or sell a stock using essentially the making and interpreting of charts. The chartists study the past for a clue to the direction of future change. They believe that the market is only 10 percent logical and 90 percent psychological. Fundamental analysis is the technique of applying the principles of the firm-foundation theory to the selection of individual stocks. It takes the opposite of Technical as fundamentalists seek to determine an issue’s proper value.

Principles of Technical Analysis

  1. All information about earnings, dividends, and the future performance of a company is automatically reflected in the company’s past market prices.
  2. Prices tend to move in trends: A stock that is rising tends to keep on rising, whereas a stock at rest tends to remain at rest.

Why is charting supposed to work? Professor Malkiel shares an explanation of why technical analysis/charting is supposed to work: First, it has been argued that the crowd instinct of mass psychology makes it so. When investors see the price of a speculative favourite going higher and higher. Second, there may be unequal access to fundamental information about a company. When some favourable piece of news occurs, it is alleged that the insiders are the first to know and they act, buying the stock and causing its price to rise (insider trading in my opinion).

Why Might Charting Fail to Work? According to Professor Malkiel, first, it should be noted that the chartist buys in only after price trends have been established, and sells only after they have been broken. Second, such techniques must ultimately be self-defeating. As more and more people use it, the value of any technique depreciates.

Chartists now use the services of a personal computer to put their data together. They are now known as Technicians where individuals can easily access the charts for different time periods.

Professor Malkiel illustrates the difference between the technician and the fundamentalist; wherein, the technician is interested only in the records of the stock’s price, while the fundamentalist’s primary concern is with what a stock is really worth; its true value.

Why Might Fundamental Analysis Fail to Work? There are three potential flaws that the author cites: First, the information and analysis may be incorrect, Second, the security analysts’ estimate of value may be faulty and third, the market may not correct its mistake and the stock price might not converge to its estimated value.

There are rules that are developed using Fundamental and Technical Analysis Together:

  1. Buy only companies that are expected to have above average earnings growth for five or more years;
  2. Never pay more for a stock than its firm foundation of value and;
  3. Look for stocks whose stories of anticipated growth are of the kind on which investors can build castles in the air.

Chapter 6: Predicting the Future Using Charts is not too smart…

Professor Malkiel elaborates about Technical Analysis where they build their strategies upon dreams and expect their tools to tell them which castle is being built and how to get in on the ground floor. By stating some examples, Professor Malkiel comes up with two considerations:

  1. after paying transactions costs, the method does not do better than a buy-and-hold strategy for investors, and;
  2. it’s easy to pick on.

The technician believes that knowledge of a stock’s past behavior can help predict its probable future behavior. In other words, the sequence of price changes before any given day is important in predicting the price change for that day. This might be called the wallpaper principle.

Just What Exactly Is a Random Walk?

Professor Malkiel states that this topic, for many people, appears to be nonsense; that even most reader of financial pages can easily spot patterns in the market. The chart seems to display some obvious patterns. He even tries an experiment in which he asked his students to participate a pattern but then reveals that this is derived from random coin tossing. Malkiel’s class trick is to have a chart that looks like a normal stock price chart and even appears to display cycles.

The Author further discusses some tests to elaborate Technical systems more and includes in this chapter some brief details.

The Filter System

Under the popular “filter” system, a stock that has reached a low point and has moved up is said to be in an uptrend. A stock that has reached a peak and has moved down is said to be in a downtrend. This scheme is very popular with brokers, and forms of it have been recommended. This filter method is what lies behind the popular “stop-loss” order favoured by brokers.

The Dow Theory

A great tug-of-war between resistance and support. When the market tops out and moves down, that previous peak defines a resistance area, because people who missed selling at the top will be eager to do so if given another opportunity.

In the relative-strength system, an investor buys and holds those stocks that are acting well, outperforming the general market; The stocks that are poor relative to the market should be avoided or, perhaps, even sold short.

Price-volume systems suggest that when a stock rises on large or increasing volume, there is an unsatisfied excess of buying interest and the stock can be expected to continue its rise; when a stock drops in large volume, the sell signal is given. The investor following such a system is likely to be disappointed in the results.

The past history of stock prices cannot be used to predict the future in any meaningful way. Technical strategies are usually amusing, often comforting, but of no real value. This is the weak form of the random-walk theory. The most common complaint about the weakness of the random-walk theory is based on a distrust of mathematics and a misconception of what the theory means.

Another major advantage according to Professor Malkiel to a buy-and-hold strategy, is when buying and holding enable you to postpone or avoid capital gains taxes. If this buying and holding is suited to your objectives, then it will enable you to save on investment expenses, brokerage charges, and taxes, and at the same time, achieve overall performance that at least as good as that obtainable using technical methods.

Chapter 7: Fundamental Analysis is getting closer to the truth but also sucks

In this chapter, Professor Malkiel mentions how good Fundamental Analysis is through his examples and explanations. He cites two extreme views about the efficacy of fundamental analysis. The view of many is that fundamental analysis is becoming more powerful and skill-based all the time; and, an opposite-extreme view which is taken by much of the academic community but Professor Malkiel points to his view by saying this is somewhat less extreme than that taken by many of the academic. This chapter will also recount the major battle between academics and market professionals.

Forecasting future earnings is the security analysts’ purpose. For professionals, expectation of future earnings is still the most important single factor affecting stock prices. This thinking fails in the academic world. According to them, calculations of past earnings growth are no help in predicting the future growth. If you had known the growth rates of all companies, this will not help you in predicting what growth they would achieve.

He points out that we should not take for granted the reliability and accuracy of any judge, no matter how expert they are. When one considers the low reliability of so many kinds of judgments, it does not seem too surprising that security analysts, with their particularly difficult forecasting job, should be no exception. There are four factors that Professor Malkiel mentions to help explain why security analysts have difficulty in predicting the future: The influence of random events; the creation of dubious reported earnings through creative accounting procedures; the basic incompetence of many of the analysts themselves and; the loss of the best analysts to the sales desk or to portfolio management roles.

Do Security Analysts pick winners? Professor Malkiel narrates that the real test of the analyst lies in the performance of the stocks he recommends. Analyze investment performance, not earnings forecasts.

Can any Fundamental System Pick Winners?

Research has been done on whether above-average returns can be earned by using trading systems based on press announcements of new fundamental information and the answer, according to Professor Malkiel, seems to be clearly “Nope.” Systems are the device in which a news event such as the announcement of an unexpectedly large increase in earnings or a stock split triggers a buy signal.

Many professional investors move money from cash to equities or long-term bonds based on their forecasts of fundamental economic conditions. Several institutional investors now sell their services as asset allocators or market timers. According to Professor Malkiel, trying to do market timing is likely, not only not to add value to your investment program, but to be counterproductive.

Professor Malkiel further explains in this chapter what semi-strong and strong forms of the Random-walk Theory. He says that semi-strong form says that no published information will help the analyst to select undervalued securities while strong form says that absolutely nothing that is known or even knowable about a company will benefit the fundamental analyst.

The random-walk theory does not state that stock prices move aimlessly and erratically and are insensitive to changes in fundamental information, but on the contrary, the point of it is just the opposite: The market is so efficient prices move so quickly when new information arises that no one can buy or sell quickly enough to benefit.

Chapter 8: Modern Portfolio Theory is the latest craze and does work for some

In this chapter, Professor Malkiel narrates that a new strategy is needed, that this is the part of the book that states all about the new investment technology created within the academic world. One insight he shares is the Modern Portfolio Theory (MPT) that is now widely followed on the Street since it is so basic. In this chapter, he further describes the origins and applications of Modern Portfolio theory.

Defining Risk: according to the American Heritage Dictionary, it is the possibility of suffering harm or loss. Academics have accepted the idea that risk for investors is related to the chance of disappointment in achieving expected security returns. Financial risk has generally been defined as the variance or standard deviation of returns. Professor Malkiel also specifies a simple example that will illustrate the concept of expected return and variance and how they are measured. One of the best-documented propositions in the field of finance is that, on average, investors have received higher rates of return for bearing greater risk.

Portfolio theory begins with the assumption that all investors are risk-averse. They want high returns and guaranteed outcomes. The theory tells investors how to combine stocks in their portfolios to give them the least risk possible, consistent with the return they seek. It also gives a definite mathematical justification for the investment that is a sensible strategy for individuals who like to reduce their risks.

The theory was invented in the 1950s by Harry Markowitz. He discovered that portfolios of risky stocks might be put together in such a way that the portfolio as a whole would actually be less risky than any one of the individual stocks in it. The mathematics of modern portfolio theory is challenging; it fills the journals and, incidentally, keeps a lot of academics busy.

From the example given by the author, he finds that negative correlation is not necessary to achieve the risk reduction benefits from diversification. This correlation coefficient is used to measure the extent to which different markets hit their peaks and valleys at different times. They are the key element in Markowitz’s analysis. A perfect positive correlation indicates that two markets are in lockstep, moving up and down at precisely the same time whereas a perfect negative correlation means that two markets always move in opposite direction. According to Markowitz’s great contribution to investors’ wallets is his demonstration that anything less than perfect positive correlation can potentially reduce risk.

Professor Malkiel includes some charts and figures to further explain the theory or to demonstrate the point about diversification and its benefits. He further says that movements in long-term bonds do not mirror those of other assets, and long-term bonds tend to provide relatively stable returns when held to maturity.  Moreover, exhibits shown in the book demonstrate that three-year correlations of real estate bonds with the market are sufficiently low to provide important diversification benefits and have shown no tendency to become less favourable over time. Professor Malkiel will further discuss portfolio theory to craft appropriate asset allocations in the succeeding chapters.

Chapter 9: How Modern Portfolio Theory works 

In this chapter, Professor Malkiel begins with a refinement to modern portfolio theory citing that diversification cannot eliminate all risk because all stocks tend to move up and down together. Thus, in practice, it reduces some but not all risk. The basic logic behind the capital-asset pricing model is that there is no premium for bearing risks that can be diversified away; thus, to get a higher average long-run rate of return, you need to increase the risk level that cannot be diversified away.

Systematic risk, also called market risk, captures the reaction of individual stocks to general market swings. This is part of the total risk or variability that arises from the basic variability of stock prices in general market. The remaining variability in a stock’s returns is called unsystematic risk. Some stocks and portfolios tend to be very sensitive to market movements. This relative volatility or sensitivity to market moves can be estimated on the basis of the past record, popularly known by the Greek letter beta. Beta is based on the past however….

Professor Malkiel says that what makes new investment technology different is the definition and measurement of risk. Before the capital-asset pricing model, it was believed that the return on each security was related to the total risk inherent in that security. It was believed that the return from a security varied with the instability of that security’s particular performance, with the variability or standard deviation of the returns it produced.

The basic logic behind the capital-asset pricing model states that stocks can be combined in portfolios to eliminate specific risk, only the systematic risk will command a risk premium. Investors will not get paid for bearing risks that can be diversified away. The proof of the capital-asset pricing model can be stated as follows: If investors did get an extra return for bearing unsystematic risk, it would turn out that diversified portfolios made up of stock with large amounts of unsystematic risk would give larger returns than equally risky portfolios of stocks with less unsystematic risk.

Serious cracks in the CAPM will not lead to an abandonment of mathematical tools in financial analysis and return to traditional security analysis. There are reasons to avoid a rush to judgment: First, it is important to remember that stable returns are preferable less risky than very volatile returns; Secondly, you must keep in mind that it is very difficult to measure beta with any degree of precision and; Finally, investors should be aware that even if the long-run relationship between beta and return is flat, it can still be a useful investment management tool.

If beta is badly damaged as an effective quantitative measure of risk, is there anything to take its place? Stephen Ross has developed a theory of pricing in the capital markets called arbitrage pricing theory (APT). It has a wide influence both in the academic community and in the practical world of portfolio management. To understand its logic, one must remember the correct insight underlying the CAPM.

The only risk that investors should be compensated for bearing is the risk that cannot be diversified away. Only systematic risk will command a risk premium in the market. It appears that several other systematic risk measures affect the valuation of securities.

Chapter 10: The Market is Efficient with Pockets of Inefficiency

This chapter will tackle the attempts to show that the market is not efficient and that there is no such thing as a profitable random walk through Wall Street. Professor Malkiel reviews all the recent research proclaiming the demise of the efficient-market theory; EMT after all implies that market prices are unpredictable but hyper efficient in correcting itself. He concludes that obituaries are greatly exaggerated and the extent to which the stock market is usefully predictable has been vastly overstated.

Recall that the weak form of the efficient-market hypothesis says simply that the technical analysis of past price patterns to forecast the future is useless because any information from such an analysis will already have been incorporated in current market prices.

A random walk would characterize a price series where all subsequent price changes represent random departures from previous prices. This model states that investment returns are serially independent of each-other and that their probability distributions are constant through time. More recent work, however, indicated that the random-walk model does not strictly hold. Some consistent patterns of correlations, inconsistent with the model, have been uncovered. It is less clear that violations exist of the weak form of the efficient-market hypothesis, which states only that unexploited trading opportunities should not persist in any efficient market. (1) Stocks do sometimes get on one-way streets; (2) But eventually stock prices do change direction and hence stockholder returns tend to reverse themselves; (3) Stocks are subject to seasonal moodiness, especially at the beginning of the year and the end of the week.

Academics and financial analysts in the semi-strong school of market efficiency believe that all public information about a company is always reflected in the stock’s price. They are skeptical about the ability of fundamental security analysts to pore over data concerning a company’s earnings and dividends in an effort to find undervalued stocks, which represent good value for investors. Professor Malkiel cites some qualifications of value techniques: look for securities that (1) are relatively small, smaller is often better; (2) sell at low multiples compared with their earnings; (3) have low prices relative to the value of their assets, and; (4) have high dividends compared with their market prices.

Dogs of the Dow strategy is an interesting strategy that became popular in the mid-1990s. This is to combine some of the value patterns with a general contrarian style of investing consistent with the idea that out-of-favor stocks eventually tend to reverse direction.

Concluding comment of Professor Malkiel: market valuations rest on both logical and psychological factors. The theory of valuation depends on the projection of a long-term stream of dividends whose growth rate is extraordinarily difficult to estimate. Thus, fundamental value is never a definite number. It is a band of possible values, and prices can move sharply within this band whenever there is increased uncertainty. The appropriate risk premiums for common equities are changeable and far from obvious either to investors or to economists. There is room for the hopes, fears, and favorite fashions of market participants to play a role in the valuation process.

Chapter 11: How to Walk down Wall Street now that you know it is random

Part four of the book explains how-to-do-it guide for your random walk down Wall Street. In this chapter, Professor Malkiel offers general investment advice that should be useful to all investors, even if they don’t believe that security markets are highly efficient. He also says that you can take your random walk only after you have made detailed and careful plans with regard to all your investments, including your cash reserves. Think of the advice that follows a set of warm-up exercises that will enable you to reduce your income taxes and risk, at the same time increase your returns.

Exercise 1: Cover Thyself with Protection

Patience is key element in investing; you can’t afford to pull your money out at the wrong time. You need staying power to increase your earning attractive long-run returns. That’s why it is important to have non-investment resources to draw on should any emergency strike you or your family.

Exercise 2: Know your Investment

Determining clear goals is a part of investment process with disastrous results. You must decide what degree of risk you are willing to assume and what kinds of investments are most suitable to your tax bracket.

Exercise 3: Dodge Uncle Sam Whenever You Can

One of the best ways to obtain extra investment funds is to avoid taxes legally. Professor Malkiel says that there are no income taxes on money invested in a retirement plan until you actually retire and use the money. Professor Malkiel cites some plans to give some examples.

Exercise 4: Be Competitive; Let the Yield on your Cash Reserve Keep Pace with Inflation

As Professor Malkiel mentions, some of the ready assets are necessary for pending expenses. There are four short-term investment instruments he points out that can at least help stand up to inflation. These are (1) money-market mutual funds; (2) money-market deposit accounts; (3) bank certificates; and (4) tax-exempt money-market funds.

Exercise 5: Investigate a Promenade through Bond Country

In this particular topic, Professor Malkiel mentions four kinds of bond purchases according to his view: (1) zero-coupon bonds, (2) bond mutual funds, (3) tax-exempt bonds and bond funds, and (4) U.S. Treasury inflation-protection securities.

Exercise 6: Begin Your Walk at Your Own Home; Renting Leads to Flabby Investment Muscles

The natural real estate investment for most people is the single-family home or the condominium.   They are encouraging home ownership and cites two important tax breaks: (1) Although rent is not deductible from income taxes, the two major expenses associated with homeownership-interest payments on your mortgage and property taxes are fully deductible; (2) realized gains in the value of your house that are tax exempt. In addition, ownership of a house is a good way to force yourself to save, and a house provides emotional satisfaction.

Estate agent shaking hands with customer after contract signature

Exercise 7: Beef Up with Real Estate Investment Trusts

The packaging of ownership interests in real property into trusts called Real Estate Investment. This REITs are like any other common stock and are actively traded on the major stock exchanges.

Professor Malkiel further cites additional Exercises which are: (8) Tiptoe through the investment fields of gold and collectibles; (9) Remember the investment fields of gold and collectibles; and (10) diversify your investment steps. These exercises have been subject to a final checkup that you should do.

Chapter 12: Macro-Economic considerations are important for investors

This chapter is where you will learn how to become a financial bookie, according to Professor Malkiel. This is an important chapter because the money you are betting is your own.

Very long-run returns from common stocks are driven by two critical factors: the dividend yield at the time of purchase, and the future growth rate of the dividends. In principle, for the buyer who holds his stocks forever is worth the present or discounted value of its stream of future dividends. The discounted value of the stream of dividends can be shown with a very simple formula for long-run total return for either an individual stock or the market as a whole: long-run equity return = initial dividend yield + growth rate of dividends.

There are three eras of financial market returns Professor Malkiel discusses: Era I, the age of comfort, which covers the years of growth after World War II. Stockholders made out extremely well after inflation, whereas the meager returns earned by bondholders were substantially below the average inflation rate. Era II, the Age of Angst: widespread rebellion by millions of teenagers produced during the baby boom, economic, and political instability created by the Vietnam War. No one was exempt: neither stocks nor bonds. Era III, the Age of Exuberance is when the boomers matured, peace reigned, and a non-inflationary prosperity set in. It was a golden age for stockholders and bondholders.

The Age of the Millennium

Although Professor Malkiel states that he remains convinced that no one can predict short-term movements in securities markets, he does believe it is possible to estimate the likely range of long-run rates of return investors can expect from financial assets. It seems very clear that it would be unrealistic to anticipate that the generous double-digit returns earned by stock and bond investors during the 1980s and 1990s can be expected to continue in the early decades of the twenty-first century. Looking first at the bond market, we can get a very good idea of the returns that will be gained by long-term holders. Holders of good quality corporate bonds will earn if the bonds are held to maturity. Holders of long-term zero-coupon Treasury bonds will earn until maturity and so on.

He even is skeptical that anyone can predict the course of short-term stock price movements, and perhaps better off for it. He even shares his one favorite episodes from I Love a Mystery wherein this is about a greedy stock-market investor who wished that just once he would be allowed to see the paper, with its stock price changes, twenty-four hours in advance.

We can employ the same methods used in Chapter Twelve for the market as a whole to project the long-run rates of return for individual stocks, where it is reasonable to project a modest rate of growth over an extended period. Again, he suggests to only use the first two determinants in the analysis. He estimates the rate of return on an individual stock by adding the initial dividend yield to the expected growth rate of earnings. Although P/E ratios are obviously very important in explaining returns in the short run, such valuation changes are less important over the very long run and are unpredictable in any event.

Chapter 13: You can eat well or sleep well, it’s up to you

This chapter tackles a life-cycle guide to investing. Professor Malkiel even cites that it is simple to say that a thirty-four-year-old and a sixty-four-year-old saving for retirement may cautiously use different financial instruments to accomplish their goals. The thirty-four-year-old just beginning to enter the peak years of salaried earnings that can use wages to cover any losses from increased risk and the sixty-four-year-old does not have the long-term luxury of relying on salary income and cannot afford to lose money that will be needed in the near future.

In essence, these strategic considerations have to do with a person’s capacity for risk. Most of the discussion about risk has dealt with one’s attitude toward risk. Although both of them may invest in a certificate of deposit, the younger will do so because of an attitudinal aversion to risk and the older because of the reduced capacity to accept the risk. The most important investment decision you will probably ever make concerns the balancing of asset categories at different stages of your life.

There are key principles to determine a rational basis for making asset-allocation decisions:

  1. History shows that risk and return are related.
  2. The risk of investing in common stocks and bonds depends on the length of time the investments are held. The longer an investor’s holding period, the lower the risk.
  3. Dollar-cost averaging can be a useful, though controversial, technique to reduce the risk of stock and bond investment.
  4. You must distinguish between your attitude toward and your capacity for risk.

The risks you can afford to take depend on your total financial situation, including the types and sources of your income exclusive of investment income.

In this section contains reviews of three broad guidelines that will help an investment plan to particular circumstances:

  1. Specific Needs Require Dedicated Specific Assets:

Always keep in mind – a specific need must be funded with specific assets dedicated to that need.

  1. Recognize Your Tolerance for Risk:

The biggest adjustment to the general guidelines concerns your own attitude toward risk. It is for this reason that successful financial planning is more of an art than a science. General guidelines can be extremely helpful in determining what proportion of a person’s funds should be deployed among different asset categories. Risk tolerance is an essential aspect of any financial plan and only you can evaluate your attitude toward risk.

And lastly:

  1. Persistent Savings in Regular Amounts, No Matter How Small, Pays Off.

Professor Malkiel shares an advice of Talmud Rabbi Isaac saying that one should always divide his wealth into three parts: a third in land, a third in merchandise or business, and a third ready-at-hand. Such an asset allocation is hardly unreasonable but can improve this advice because we have more refined instruments and a greater appreciation of the considerations that make different asset allocations appropriate for different people.

As investors age, they should start cutting back on riskier investments and start increasing the proportion of the portfolio committed to bonds and stocks that pay generous dividends such as REITs.

For most people, Professor Malkiel recommends funds rather than individual stocks for portfolio formation. He cites two reasons for this. First, most people do not have sufficient capital to diversify properly; and Secondly, he recognizes that most younger people will not have substantial assets and will be accumulating portfolios by monthly investments.

Chapter 14: Investing advice now that your get Malkiel’s book

This chapter offers rules for buying stocks and specific recommendations for the instruments you can use to follow the asset allocation guidelines presented in Chapter Thirteen. By now, you have made sensible decisions on taxes, housing, insurance, and how to get the most out of your cash reserves. You also have reviewed your objectives, your stage in the life cycle, and your attitude toward risk and decided how much of your assets to put into the stock market.

In the first case, you simply buy shares in various index funds designed to track the different classes of stocks that make up your portfolio. This method also has the virtue of being simple. Under the second system, you jog down Wall Street, picking your own stocks and getting in comparison with the yield obtained with index funds much higher or much lower rates of return; and third, you can sit on a curb and choose a professional investment manager to do the walking down Wall Street for you.

Index funds trade only when necessary, whereas active funds typically have a turnover rate close to 100 percent, and often even more. Index funds are also tax-friendly. It is also relatively predictable. It is fully invested. And finally, it is easier to evaluate. With index funds, you know exactly what you are getting, and investment process is made incredibly simple.

The indexing strategy is one that Professor Malkiel recommended even before index funds exist. It is clearly an idea whose time had come. Although he recommends indexing or so-called passive investing, there are valid criticisms of too narrow a definition of indexing.

One of the advantages of passive portfolio management is that such a strategy minimizes transactions costs as well as taxes. To a considerable extent, index mutual funds help solve the tax problem. The do not trade from security to security and, thus, they tend to avoid capital gains taxes.

The fund is able to defer capital gains by the following techniques: First, the portfolio is indexed to the S&P 500 so there is no active management that tends to realize gains; Second, when securities do have to be sold, the fund sells the highest-cost securities first; Third, the funds offsets unavoidable gains by judiciously selling other securities on which there is a loss. As a result, the fund may not perfectly track the benchmark index, but it should come very close.

In this chapter, Professor Malkiel further states four rules for successful stock selection:

  • Rule 1: Confine stock purchases to companies that appear able to sustain above-average earnings growth for at least five years.
  • Rule 2: Never pay more for a stock than can reasonably be justified by a firm foundation of value.
  • Rule 3: It helps to buy stocks with the kinds of stories of anticipated growth on which investors can build castles in the air.
  • Rule 4: Trade a little as possible.

Investing is a bit like lovemaking, according to Professor Malkiel. Ultimately, it is really an art requiring a certain talent and the presence of a mysterious force called luck. If you have the talent to recognize stocks that have good value, and the art to recognize a story that will catch the fancy of others, it’s a great feeling to see the market vindicate you. If you are not so lucky, limit your risks and avoid much of the pain that sometimes involved in the playing.


Poverty is Moving Downwards in Real Terms | David Henderson

[WARNING BIAS POSSIBLE: David Henderson is part of the Milton Friedman School of Economics.]

Who is More Wealthy? | A Royal Dog from the 17th Century OR a Working-Class Dog Today

When we talk about inequality we need to understand that economic growth and productivity is driven my commercial transactions that drive new innovation and wealth creation.  So if you hear someone say that inequality is worse now than ever before, you need to ask this this question is a royal puppy from the 17th century more wealthy than a working class dog today? {I guess the dogs on the street with their homeless owner would be an exception here but you get the point}….



One Of the Most Important Question

Does it matter how people acquire their wealth?

Two Stories

The Story of the Earner; he invented the chainsaw. The guy sold 100K chainsaws….There was producer surplus and consumer surplus. The producer surplus: only 2.2% of value is consumed by the innovator himself, the rest goes to the others in the company. The individual creates a lot of value and his customer’s get to spent less time cutting wood relative to pre-chain saw Axe usage. The issue is that the consumers got modestly more wealthy. The Taker: used political power to get wealth. LBJ made his money through a radio station through Ladybird Johnson. The Big Taker is Cuban dictator Fidel Castro but even there, you could argue that he brought about universal healthcare to a poor island and all the other benefits minus pains.

Understanding Income Inequality: Transparency

Income and wealth distribution. If you are concerned about income and wealth. Most people do not understand their own income and wealth distribution. Most people do not realize that they are rich for example. Has Income Inequality Increased?

Yes, however real team income has gone up for everyone. There is new inequality. If you are making $20K per year, you are in the top 3.65% of income earners globally. Wow, that’s an unequal world but how does the nation-state system help out with other countries. It doesn’t! What can you do about it.










Everyone is getting the benefits of new technology but some people are getting more benefit than others.

There are lots of ways that we are way better off than our grandparents. Society is insanely accelerate quality of life. It used to cost a full month of work to buy a bicycle that now takes 1 day.

Piketty’s Clerical Error

Piketty talks about the inequality in France in the 19th century but then pivots back to the idea that the working poor are “no better off today” then the poor in the 19th century. That doesn’t make sense if you consider that the quality of life of everyone has been improved so much in the last 125 years.

Take 80% from the rich is what Piketty concludes.

Marry Someone And You Are Unlikely to Be Poor










If you want to be in the top 55 you would be wise to have a partner in crime, mkay?

Joe Stiglitz Doesn’t Ask How Crusoe or Friday Get Their Oranges…Mistake

You need to look not just at what money each person has but also HOW they acquired their wealth. You can have justified and ill gotten gains.

Henderson’s Idea: When You Focus on Inequality Over All Other Priorities We Get Strange Outcomes

Would you rather have everyone have the same income and have slow economic growth OR would you rather have lots of income inequality but have fast economic growth? As if this is a zero sum gain:  it depends on your priorities of course. If you are obsessed with what your neighbour has; then you would want equality.

The following is a disturbing extension of equality rights. Now, imagine you want equality in life length. Currently, women live up to 89 years old while men live up to 84 years old. If you are obsessed with inequality, you might want women to be executed at that average age so that it would be more fair for the males in society. Would you agree to that? Hard to imagine.

David Henderson is Obsessed with Something Else : Economic Freedom

Frequently, folks basically ignore the ills of commercial.



Business Management Relies on Financial Sciences | Ratios in Finance

Challenges of finding a Pure Play: it’s not easy to find a firm that is exactly like the other firms you are comparing. Loblaws & Metro: Outlets like No Frill (Loblaws). But what is days o inventory different at Metro: their days of inventory is shorter.

  • Loblaws
  • Joe Fresh
  • Shoppers (long shelf life)

Product Mix is different for Loblaws than Metro.

Risk and Profitability Analysis

  • Analyze Firm’s operating profitability and risk
  • Compare performance over time (Time Series Analysis)
  • Compare performance across firms (Cross-Sectional Analysis)
  • Look at the components of profitability
  • Look at different kinds of risk.

Principles of Ratio Analysis

  • Focus on the inputs
  • Importance of prior analyses
  • Be aware of events that can affect comparability –M&A, accounting changes, changes in strategy (e.g., Loblawsvs. Metro)
  • Consistency in approach
  • Use Ending Balance Sheets
  • Most common, fits the data availability in most cases
  • Use Average Balance Sheets
  • Most economically meaningful as Balance sheets are snapshots
  • Use Beginning Balance Sheets
  • Beginning assets/liabilities used to drive the operations
  • Useful for forecasting and valuation
  • Do not rely on 3rdparty ratios
  • Calculate all ratios yourself

Measures of Short-Term Risk

  • Working Capital = Current Assets –Current Liabilities
  • Would we prefer a positive or negative amount of working capital? A.) Positive B.) Negative

Working Capital = Current Assets minus Current Liabilities.

Positive working capital: CA – CL > 0 is the ideal.

Ratio #1: Current Ratio

  • Current assets / Current liabilities
  • Current Ratio = Current Assets/Current Liabilities
  • Measure of ability of the firm to pay short-term liabilities on time

Ratio #2: Quick Ratio

  • Current highly liquid assets / Current liabilities
  • Current highly liquid assets (i.e., cash, marketable, account receivable) – no inventory or prepaid expenses.

Prepaid expenses = the rent. Which firm might have a current and quit ratio that differ dramatically?

  1. A big 4 auditing firm: very little prepaid, no inventory
  2. Airline: no inventory, provide services with a fixed asset.
  3. Dell: eRetailer movement inventory trying to be just in time. Small amount of inventory.
  4. Loblaws: it has a problem where inventory is in fact liquid: they have a high turnover.

Ratio #3 Inventory Turnover

  • Inventory Turnover = COGS/ Average Inventory
  • Days Inventory = (Average Inventory / COGS) x 365

Indicated how fast firms sell merchandise. If inventory turn over twice a year, then they average one-half of a year in inventory (and a days inventory of 182.5). Why do we typically want a higher inventory turnover?

For what sort of firm might a higher days inventory be preferred.

  • Wine Makers you want a higher days inventory
  • Grocers for fruit you want it to be shorter.
  • Fashion retailer there is the potential for fashion obsolescence.
  • Apple Inc: technology obsolescence. (you don’t want the iPhone to be in your inventory).

Raw Materials

RW                                                      Work in Progress

|_____________|________________________________|______________________| Finished Goods

Picked                  Grape Juice

CA/CL (4) C+ A/R+M/S < .19

CL                                         highly illiquid assets

You don’t sell in a pinch, not very liquid. You might have some short-term obligations to the bank.

Ratio #4 Accounts Receivable Turnover

  • Accounts Receivable Turnover = Sales

Average Accounts Receivable

  • Days Accounts Receivable = (Average Accounts Receivable/Sales) x 365

Measures how quickly a firm collects cash. If A/R turns over twice a year, then days accounts receivable is 182.5 or on average one-half of a year to collect receivables. High turnover and fewer days to collect A/R is generally preferred.

For what sort of firms might it be normal to have higher days accounts receivable:

  1. Lemonade Stand no extension
  2. Consumer goods companies that allow customers to pay in instalments
  3. Companies that only accept cash or VISA
  4. Companies whose suppliers do not extend them credit.

If you are extending credit: you would need a line of credit if your suppliers have no extension of credit.

In 2011, Apple $108 Billion in sales

(Average Accounts Receivable/Sales) x 365

5.36B + 5.5B =


108 billion x 365 = 18.38. Apple has perfect just in time inventory

Ratio #4.5: Turnovers to “Days”

Payables turnover = Purchases / Accounts Payable.

Where purchases = COGS + Change in Inventory

  • Accounts Payable
  • where purchases = COGS + change INV
  • Turnover tells us how many “cycles” there were in a year.
  • If Inventory Turnover = 3, that means over 365 days, I “churn” my inventory completely 3 times.
  • Hence at any time, I have 365/3 =121.7 days of inventory

In general

  • Days Inventory = 365/(Inventory t/o)
  • Days Receivable = 365/(Receivables t/o)
  • Days Payable = 365/(Payables t/o)
  • Cash Cycle = Days Inventory + Days Receivable – Days Payable
  • The smaller this is, the less the need for working capital
  • Other people’s money

Days Inventory + Days Receivable – Days Payable

Days Inventory + Days



Days Inventory + Days Receivable


35 Days                               45 Days

Example of Dell

Dell has a negative cash cycle. Dell always have cash and don’t need financing. General contractors get paid by customers and then collect interest. If this is negative, this mean you do not have external financing opportunities.

Example of Bug in a Rug

Shipping from France means you will need a line of credit. Example Rug Canada Inc. Bug in a Rug toys.

Days Inventory + Days Receivable – Days Payable

Days Inventory + Days Receivable


  • Days 45 Days

Days Payable

60 Days

You need a line of credit because you are shipping from France. And you have to make payments to France BEFORE you even get paid from customers.

Ratio #5 Fixed Asset Turnover

Only include tangible assets (no goodwill).

Fixed Asset Turnover = Sales

Average Fixed Assets

  • Measures the relation between investment in long-term or fixed assets (such as property, plant, equipment) and sales. Note fixed assets refer to tangible assets (i.e., no goodwill or patents).
  • Efficient use of fixed assets would be associated with high sales.
  • If fixed assets turn over every four years, then each dollar invested in fixed assets is generating a quarter of a dollar in sales per year.
  • A high turnover is preferred to a low one.

For what type of company might a high fixed asset turnover ratio simply be a function of the industry the firm is in, as opposed to efficient use of capital assets on management’s part?

  • McKinsey fixed assets are low Sales high
  • Air Canada High Fixed Assets
  • A Construction Company: high fixed asset, fixed assets, maybe it’s customer assets. Intangible impacts performance. Have stars, better reputation
  • A Supermarket: fixed asset tells you about performance

Ratio #6: Total Assets Turnover

  • Total assets turnover = Sales

Average total assets

1.) its accounts receivable turnover, inventory turnover, and fixed asset turnover have increased.

2.) The beginning and ending balance for all assets in year 1 were the same.

3.) Sales and COGS were the same in year 1 and year 2,

Year 1                                  Year 2

Sales                     =             Sales

COGS                    =             COGS

Sales  Sales

A/R                       >             A/R (down)

What must be true.


INV                       <             INV (down)

Sales  Sales

FA                          <             FA (down)


What are some possible explanations as to why total asset turnover decreased year-over-year?

  1. A) accounts receivable has increased year-over-year
  2. B) Cash has increased year-over-year
  3. C) inventory has increased year-over-year
  4. D) Goodwill decreased year-over-year
  5. E) Prepaid expenses have decreased year-over-year

Total Asset Turnover

  • What transaction might account for an decrease in total asset turnover without being inconsistent with the other ratio changes from the previous page?

Has the firm:

  • Sold some land for its value on the balance sheet
  • Collected more cash this year than last year from customers who bought products on credit
  • Declared but did not pay a dividend
  • Took out a loan
  • Depreciated some equipment

You will need to do this with your group projects. No more debt lead to higher interest

Leverage and Risk

Should firms with volatile operating profitability finance their operations with debt as opposed to equity? A.) Yes B.) No

No, more debt leads to higher interest

Given the points above, which firm should be most likely to finance with debt as opposed to equity?

  • A utilities company
  • An airline: has sticky wages, operating leases, lots of fixed costs. Air Canada debt is large.
  • A tech start-up: no debt on capital, all financed.
  • A junior mining company: financed by Equity = stock exchanges. Not with Debt.
  • A utilities company: inelastic demand, cost +5% profitability is regulated.

Ratio #7: Debt-to-Equity Ratio

  • Debt (long term, short term, cap. Leases)

Total Equities

  • Percentage of total financing provided by creditors (debt) as opposed to owners (stock)

Manchester United: net income $137million

$160 million why?

It look like a massive interest expense.



Op II                     160

Interest               -279

Net Income        -137

Ronaldo was sold. Measures of Long-Term Risk

Ratio #8: Interest Coverage Ratio

  • Earnings Before Interest and Income tax /interest expense
  • This is the number of times interest is covered by income
  • Indicates the relative protection that operating profitability provides to debtors
  • Really should be higher than 1, if not much higher than 1

Which of the following transactions or outcomes do not ultimately increase the D/E ratio?

  1. A firm issuing a bond
  2. Issuing dividends: Debt/Equity DOWN
  3. A net loss for the period
  4. A firm repurchasing its share
  5. All of the above increase the D/E ratio.

Imagine a firm has a strict debt convenant that forbids the D/E ratio from going above a certain point. How would this effect the transactions listed in A – E?

Debt convents shift to existing debt holders.


Ratio #9: Return on Assets

  • ROA disaggregates into the product of two ratios:
  • ROA = Profit margin ratio x Total assets turnover

ROA = Net Income x Sales

Sales                                    Assets

ROA tells us something about the firm’s operating strategy.

Profit margin ratio = Net Income


Total assets turnover = Sales

Average total assets.

ROA = NI/Sales x Sales/Assets


  • Operating Strategy
  • Profit Margin Ratio = NI/Sales
  • (Tell us about the market monopoly higher rates)
  • Total Asset Turnover = Sales/Total Assets
  1. Costco NI/Sales (DOWN ALL) x Sales/Assets (UP ALL)
  2. GM NI/Sales (DOWN ALL) x Sales/Assets (DOWN ALL) so they improved cost structure
  3. SPACEx NI/Sales (UP ALL) x Sales/Assets (DOWN ALL)
  4. Microsoft NI/Sales (UP ALL) x Sales/Assets (UP ALL)


  • ROE = NI/Sales x Sales/Assets x Assets/Equity
  • ROE = ROA x Leverage Ratio

The leverage ratio tells us something about the firm’s financing strategy

ROE = L (Up) + E


  • Causes the numerator to go up: it depends on what happens to equity.
  • Leverage ratio = Ata/AE
  • Financial Strategy is revealed.

Example HOME

H                           EQ                         ROA                      ROE

1M                        1M         1.1M      100k/1m = 10%

1M                        0             1.1M      100k/1m = 10%

900K      -10%                     -10%

1M                                                      infinity – 0%


ROA is negative amplified it to negative infinity.


Ratio #10: Return on Equity (ROE)

ROE can be disaggregated into 3 ratios:

ROE = profit margin X total asset turnover X Leverage Ratio

ROE = ROA X leverage ratio

The leverage ratio tells us something about the firm’s financing strategy

As a firm’s debt increases, what happens to its ROE?

A.) it increases

B.) it decreases

C.) it depends

Walmart and their Robot Bee Patent

Reading the Walmart Patent, it seems like this is something that can and should be contested. The diagrams a literally what bees do + bluetooth and UAV prior art. What is the patent really? Seems unfair and worth attacking as a legal expert should (I am not one by the way).

Can you patent a docking station? Not sure. We know that China has a problem as the bubble bee population is in a state of collapse. Full grown adult Chinese citizens are pollinating flowers manually……so drone bees is a market.

This is the HoneyDrone (trademark) 

Lessons from Peter Munk – Canadian Entrepreneur

Start A Company In An Emerging Industry You Are Familiar With (Some What)

(November 8, 1927 – March 28, 2018) Hungarian-Canadian Peter Munk moved to Canada 1941. He was of Jewish decent and Studied Engineering in the 1950s at UofT. There were no women in engineering in the 1950s….Peter Munk was interested a radio technology and his uncle was in that space. He was interested in radio tubes; with $3000 dollars he establish Clairtone: it was a Canadian success company. Largely, due to innovating in the cooling of the cathode tubes needed to project images on the TV. It was the BlackBerry (another Canadian startup) of the late 1950s – 1960s. Canada was mostly resources, so people didn’t believe that something that sold at $500 from Canada(?) could be sold at Bloomingdales.

Create Your Product in a Jurisdiction That Protects The Rare and Cool

The Canadian government was very interested in protecting industry and Clairtone became a natural darling of Canadian federal governments and consumers generally. The company scaled across the Canadian market. Most Canadians will remember the Clairtone product line. It was the first company to use transistors in the television.

It was a Canadian Watch this commercial from over 50 years ago. “Smart people won’t settle for something new.”

Do Not Get Sucked Into Relocating Via a Government:

The Clairtone company transitioned to Nova Scotia thanks to incredible government grants. Munk wanted to help Nova Scotia’s shipping industry. Premier Stanfield successfully attracted Peter Munk’s business into moving to New Glasgow in Nova Scotia. Why? Job creation + the Nova Scotia shipping industry skill set could be transferred to technology. However there were bond payment defaults, workers in Nova Scotia went on strike. As a result, the Government of Nova Scotia bought the TV company in 1970. Peter Munk walked away with a lot of capital.

Re-Invent Yourself Where Necessary (Too Much Knowledge is Bad)

Munk built a television set prototype with transistors rather than vacuum tubes in hi sbasement. Munk thought that too much knowledge can be dangerous: he was driven to be number one. He didn’t know transistors because he hadn’t taken that class yet. Peter Munk had to re-invent himself but reallocating his capital into hotels. Created South Pacific Hotel organization in Fiji etc. Munk sold that and then started in Natural Oil in 1979, he lost a lot of money and had a good board. So he pivoted to mining. Munk worked with Joseph Rotman and had a few lucky breaks. He founded Barrick Mining company. Barrick Gold is now the largest gold mining company. They bought CanFlo: they had diversified by they moved to coal, oil, therma all of that collapsed; the Bank wanted Munk to rescue the company and then merge CanFlo with Barrick. They had amazing management miners; outstanding in geotechnology, metallurgy.

Acquisitions: Bought Texaco mining; double the production, half the overhead. Bought GoldStrike, BlackMinerals. As the stock improved they exercised their magic and into all the mines. Mining is about evening out the cycle. Barrick Gold would use it’s shares to buy companies.

Why Does Canada Struggle at Business? And How Can We Get It Back?

Munk wonders out load: Why there are so few global leader companies from Canada. For example, a tiny country like Denmark has 6 major success stories: Phillips, Shell etc. Even BlackBerry, Nortel. Canadians are the best but we screw-up; Seagrams, the Wrightman brother owned Canary Wharf, Cadillac Fairview.

If I could provide an answer. 1) it’s easier to move to the US and test your idea in that market and then stay there, even if the standard of living etc is not as great as Canada’s. 2) tyranny of distance: doing business across a vast underpopulated country is costly, 3) government is selectively protectionist; helping certain companies who support the various political party leadership a) get re-elected, b) fundraise etc etc. The answer to getting it back is a billion dollar question.

Peter Munk: Give Back to Your Country

Peter Munk is extremely patriotic of Canada. The immigrants to Canad were given security, free healthcare, etc etc. He believe that where you come from matters, but it’s where you are going too. Money is a token to recognize success, do not hand that money over to your kids, it’s better giving them education, values, and tell them how to live a life. As a result Munk believes in redistributing the funds. Money should go back to the society: Canada in Peter Munk’s case.

A Successful and Happy Life

Money is a token of success. It is not the success itself. Money is a measure. George Soros who is also from Hungary broke the Bank of England and caused the pound to collapse. It led to John Major’s failed leadership. That is one way to make money by Munk believes these speculators are not the ones to aspire to. After you did get that money, it’s what you do with the Money. You need to look at the second side, you should not horde it. If you do the achievement part + the second part. You can’t do much better than that.

How Finance Is Used In Business Operations | Appreciating Depreciation!

Dollarama: Looking at their Industry leadership in Canada and Earnings Management 101

  1. competing on price
  2. cost leadership
  3. cheap product retailer

Dollarama IPOed in 2009 and become a Canadian darling trading as TSX:DOL. Then in June 2014 which is the first quarter of their 2015 financial year (fillings standard), they changed the useful life of all their stores & additional fixed assets from 10 years to 15 years. So what? Well, this spreads the rate of depreciation over a longer life time. Assets stay on the balance sheet longer and that means that Dollarama has a lower amount of depreciation expense per year. Since depreciation expense take away net income, the effect is that: in Dollarama’s case:

  • they gained $0.04 per share increase by in effect tweaking the depreciation rates of their stores.
  • David Milstead of the Globe and Mail said the reasoning behind this is that “Dollarama needed to keep the P/E at 21 versus 16.”

What Milstead is arguing is that Dollarama had to hit analyst expectations. Gross margin was down in the first quarter so how was that going happen?

You can imagine the C-suite discussion: “We wanted to maintain a premium valuation.” What’s a bit shocking is that adjustments on the depreciation rate of their stores made up for exactly the short-fall. Weird right? Although Dollarama could legitimately set depreciation for their stores at 15 years; it is plausible deniability. The kind of activity that draws similar behaviour in both corporate and political decision-making. Only through a premium valuation can Dollarama maintain its $21 Price over Earnings ratio. However in the long term, this C-suite decision would have a future impact on CAPEX. Cost leadership by gross margins were down and trending lower. They can’t increase prices; they have nothing to divest. They have few receivables (i.e. beyond gift cards). They could delay paying suppliers? Or they could only fiddle with depreciation. What’s the future impact on depreciation? The net income goes down in future years!

Depreciation as Form of Earnings Management

Recall that Depreciation is used to explain how much of an Asset’s value is used up. And then it is matched the expenses of an asset against the income that asset earns. Depreciation is used for income tax purposes to degrade assets thus reducing the tax burden on a business.

A straight-line depreciation would have a tangible asset worth $500K with a 5-year useful life. Every accounting year, the firm expenses $100K which is matched with the money that the tangible asset creates each year. Therefore, when you change the Depreciation from $500K over 5 years to 10 years, that means you would expense $50K per year rather than $100K which means the asset stays on the books for longer.

Depreciation sits on the balance sheet as a reduction from the total gross amount of a company’s long-term Property, Plant and Equipment PP&E. In other words, if you keep the PP&E longer on the balance sheet, it will benefit the earnings / net income. When an asset is retired or sold, the total amount of the accumulate depreciation associated with that asset is reversed, completely removing all record of the asset from a company’s books.

Depreciation expense is a non-cash expense because the monthly charge on a company’s income statement is made by a monthly recurring depreciation entry. A depreciation expense on a company’s income statement is debited and a company’s accumulate depreciation expense is credited on its balance sheet. If you reduce the depreciation expense over a specific period, it is the depreciation expense itself that reduces the earnings as a non-cash charge on a company’s income statement.

Off-Balance Sheet Assets: Leasing – Capital vs Operating

Operating lease is off the balance sheet only appearing in the Income Statement.

A true lease

Capital Leases: the lessor transfers ownership of the asset to the lessee who gets the depreciation for the asset. The lessee has to list the capital lease and gets the depreciation from that asset.

Operating Leases: are where the lessor owns the asset and all the costs and benefits (depreciation) associated with it. The lessee merely rents out the asset and pays a lease fee. The tangible asset is off the balance sheet.

Knife-edge criteria e.g. – under US GAAP, a lease is a capital lease if any one of these four hold:

  • Length of Lease extends to >= 75% of Useful Life
  • Ownership is transferred of title at end of the lease
  • Bargain Basement clause at the end of the lease
  • PV(Payments) @ “appropriate” discount rate >= 90% of Fair Value

Firms will often structure leases to ‘just’ avoid capital lease. i.e. Many Operating Leases be a Capital Lease in disguise.

Operating Lease:

Debit                    Rent Expense

Credit                   Cash

You have no application on the balance sheet:

Capital Lease:

Debit                    Asset

Credit                   Liability

Plausible deniability: you have a plausible justification that masks (convincingly!) another objective. Create your own schedule, flexibility, aim for the highest support, money. The true economic reality of a firm and what is presented in the financial statements: The role of financial statements in valuation does not rely solely on reported profit.

Operating Lease versus Capitalized Lease

Operating lease: the transaction appears on the Income Statement. >= 75% of it’s useful life. Ratios are better: Return on Assets (sales are not in Operating Lease). Fewer journal entries. ROA is Return on Assets = Net Income / Average Total Assets. Capitalized Lease is BS + IS

  • Debit Rent Expense
  • Capitalized Lease; the transaction appears on the Balance Sheet and Income Statement.
  • Debit into Expenses
  • Debit Liability
  • Credit Cash

Who is Fooled?

Banks can observe this activity as well. They are not fooled.

Off Balance Sheet Finance

Debit Covenant: when a company is given a target performance range by investors that they must follow.


Off Balance Sheet Finance



Moody’s Agencies: {Not Fooled Either} Air Canada – standard metrics + Moody’s standard adjustments. 8.3 billion adjust to long term debt. Balance Sheet: -> present value of Capital Lease

Air Canada Case

You need to get the present value of capital leases. Air Canada added Cap Leases. Investors trade on heuristics: so yes, Investors can be FOOLED. Take Operating Lease for the next 5 years. Cost of Debt 7.32% You can almost double the debt load. If you capitalize your Operating Leases the firm looks totally screwed. Take all the debt to the end of 2004

Intangible Asset (Off the Balance Sheet)

  • Intangible assets include intellectual property, brand equity and goodwill.
  • Intangible assets are categorized into two categories;

1) those that appear on the financial statement and;

2) those that do not appear on the financial statement.

R&D Expenses are almost always expensed. There are some expections; software firms where accounting standard allow for the capitalization of development expenses after product feasibility has been demonstrated. This rule applies for internally generated intangibles.

If the pharmaceutical firm develops a patent, that patent is not recognized on the balance sheet.

If the pharmaceutical firm purchases patents form other: the value of the patent appears on the balance sheet. It is difficult to determine the value of intangibles. Spending money on R&D or advertising does not guarantee a benefit to the firm. However, when assets are acquired there is an explicit or implicit valuation for the acquired intangible asset.

Is R&D an Asset?

In the US all R&D is expensed. On the balance sheet; there is a liability. There matching entry is on the shareholders’ equity and deferred taxes.

What about Advertising: Energizer Bunny didn’t improve Duracell’s sale

Goodwill              |                            <- Intangible


Net Assets           |


Valeant Case R&D is expensed in the US but R&D is Goodwill and Intangibles.

What are the future benefits of its assets?

Goodwill: I can’t sell that much.

Intangible assets are massive: you can put the intangibles in the Goodwill and not in Net Assets. ROA (return on assets) was low 1.2% organically

The telltale signs of distortion on in the ROE, firms with intangible industries will have ROEs much higher than firms in other industries and also much higher than their costs of equity.

ROE =                   Net Income / Total Shareholder’s Equity

ROA =                   Net Income / Total Assets

You have R&D of $10 billion as Intel. But your balance sheet shows under $5 billion of identifiable intangible assets. Intel R&D using a three year straight line amortization period; what this means is that you don’t expense R&D as incurred but capitalize it and amortize it over a three year period.

Intel is close to steady state which means the impact is more muted.

You only grow Goodwill by acquisition.

  • 13 Billion Down
  • 2 Billion
  • ROA 8.4%

ROA inflates if the most important assets isn’t in the denominator. You are growing by acquisition. Synergies: not tangible, you can’t give to another firm. 11 Billion out 13 billion means you have negative equity.

On Balance Sheet – Intangible Assets

Why On Balance Sheet distorted?

In this case, the intangible assets are overstated on the balance sheet.

Two types of intangible assets:

  • Amortization period not appropriate (for finite lived intangibles): these are patents which expire after a set duration. Finite lived intangible assets are amortized over their useful life.
  • Impairment not taken (indefinite life intangibles): these are goodwill or trademarks. Indefinite duration assets are typically evaluated periodically for impairment.

Where Crucial

In addition to I.P. intensive industries, also M&A intensive firms/industries. HP and CGI for example.

Telltale Signs
Others taking impairments, especially for goodwill while this firm is not taking impairments.

Firms hate to take goodwill impairments as these are a tacit admission that the acquisition was a failure: goodwill will reflect overpayment.

Remember that Goodwill impairments are not tax deductible while fixed asset impairments are! Therefore with Goodwill impairments, the impact will be felt in Net Income and Correspondlu in Shareholder’s equity.

Hewlett Packard | Autonomy

The HP acquisition of Autonomy: ‘Get Rid of Goodwill?

You need to do an Impairment Test (for your information) there are 4 steps.

PV = FCF/(r-g)

The g will massively impact your PV, so in terms of financials you can massively miscalculated the PV.

Valeant doesn’t tell you about the inputs into the Goodwill impairment and we get wildly different results. HP had a 9 billion 2012 impacted due to the Autonomy situation.

Autonomy $9 billion, they paid a premium of 65% over the target’s trading price. HP recorded a $6.9 billion goodwill and $4.3 billion of other intangible assets. HP overpaid and they had to write down $8.8 billion. $5.7 billion was written off goodwill, while $3.1 billion was written off the intangible assets.

On the Income Statement you see charges for both these impairments; The balance sheet, impairments of $8.8 billion totally towards goodwill and other intangibles and an entire impact of $8.8 billion on equity as these impairments are non-deductible.

  1. flexibility of write downs


  1. Poor profitability

Therefore, it’s possible that there was a Big Bath: Autonomy founder suggests as much: it’s a write off quickly. Write off over 10 years versus write it all down now.

They choose to write it down NOW, indicating a Big Bath.

HP’s Big Bath

Liability Distortions

RRSP and 401K are Defined Contribution Plans:

Remember: Conservative Accounting Versus Aggressive Accounting

  • Being conservative is Asset DOWN Income DOWN
  • Being aggressive Assets UP and Income UP

Deferred Revenue

Why do deferred revenues get distorted? Deferred revenues can get distorted when firms manipulate the criteria for revenue recognition. If a firm is aggressive, it may choose to recognize revenue prematurely, increasing revenue and thereby income, and lowering the deferred revenue liability.

Where it matters?

Deferred revenues are important in businesses where the operating cycles are long; where project often span multiple years and where there is a mismatch between the receipts of payments from customers and provision of goods/services.

Example, Microstrategy was accused of aggressive revenue recognition. Essentially, had multi-period contracts for software service Instead of deferring the revenue and recognixing it over the life of the contract. For the year 1999, Microstrategy admitted to overstating approxiametaly $50 million in revenue.

Deferred Revenue

  • Instead they should treat it as deferred revenue
  • When firms get paid, before they provide a good/service, they should not treat it as revenue.
  • In the future year, they recognize revenue (cr.) and remove the deferred revenue (dr.)
  • Often firms are aggressive and prematurely recognize revenue
  • Adjustments are similar to channel stuffing with an increase in liability (deferred revenue) instead of decrease in an asset (accounts receivable).
  • Micro-strategy example – prematurely recognized 50 million of revenue (and 2 million of associated cost)


When you recognize the impact of the expenditures before the expenditures actually occur.

  • Warranty Expenses Debt $5 million
  • Warranty Reserves Credit $5 million

Reserves can be distorted at both times either at origination or at the time when then the expense is incurred. You can have expenses diverted to reserves instead of the income statement.

Where Might This Be Crucial?

In industries where warranties are crucial. Restructuring reserves are crucial as often the ‘turnaround that has been shown by the new management can be a fiction of the accounting treatments.

Telltale Signs:

Unexpected improvement in cost ratios on the income statement, along with a corresponding decline in reservices.


Defined Contribution Plans:

  • You have Assets and Liabilities which are equal to each other.
  • These plans tie you to a given company for example:
  • GM: $50 BILLION liability because they had a contribution plan.
  • Car company: $2500 per car went to cover Post Retirement Healthcare costs.
  • The risk is with the employee.
  • Contribution Plans are portable?

Defined Benefit Plans:

  • Risk is to the employer.
  • The present value of the future payments to be made to the pension plan is the PBO (projected benefit obligation). If the Net Assets of a pension exceed the PBO, the pension plan is adequately funded.
  • If the Net Asses are lower than the PBO, then the pension is underfunded.
  • This is a portable plan which you can take with you anywhere you like.

Pension Plan sits under the COGS, SG&A or some other expense category. Pension Expense has three components: a) service cost, b) interest cost and c) return on plan.

Distortion in Pension Accounting:

Some because of the complexity of the standard and some because of the manipulation.

Where might this be crucial? Pension related issues are important in labour intensive and unionized industries, usually more so in older legacy companies.

How old are my fixed assets: accumulated breakdown: Apple outsources to Foxconn. Apple has Operating leases for their Apple Stores.

Discontinued Operation

When firms discontinue a line of business, the results are then restated for past periods: usuall past 3 income statements and last 2 balance sheets….

They want to prevent firms from disposing of entire lines of businesses in order to improve net income. Amy gains and losses will be reported separately. The Net Assets from discontinued operations: this represents the assets less liabilities of the discontinue operations.

Changed in Accounting Principles

You could change accounting principles regularly in order to confuse Equity Researchers.

Cumulative Effect of Accounting with Pro-Forma Disclosure

  • Say a company changes from one method of depreciation to another.

Governments love depreciating assets;

  • New assets get depreciated well before new investment.
  • Citizens hate to see reinvestment in older infrastructure.
  • The government only wants to invest in older infrastructure when it really really needs to be fixed.
  • They have to issue debt or raise taxes to get more revenue.

Grss PP&E                                                        Acc Dep

_______________                          _____________________

11billion                                                                           Credit 4billion

10.7bilion                                                                        Credit .700billion

Net PP&E

7 |

BA versus Luftansa:

  • BA’s long-haul planes depreciate at a lower rate because they have fewer take offs and landings.
  • Luft has less turnaround times, smaller planes therefore higher rates of depreciation.

British Airways

Gross PP&E                                      Depreciation                                     Assets

Layer useful left                              high

18 to 25 years for their assets


  • When you balance those two together you get
  • 12 years for their assets.

Lufthansa has smaller planed, depreciation is much fast, more takes and landings. Gross PP&E/Useful Life = Depreciation Expense. 12 years depreciation with a 15% salvage value.

Average Gross PP&E

  • Useful Life

BA          .60                        .61

Luft        .63                        .64

Gross PP&E                                       Acc Dept

Dr.          |                                                          | Cr.

$23.2B    |                                                          |$12.6B

Net PP&E

Dr.          |

19.6B      |

So if you were to use the same depreciation. Equity increases when you depreciate faster…

How Mainstream Publications Overlook Their Own Weirdness and Just Blame Facebook…

[Disclaimer this is a non-partisan publication]
And I am no Facebook apologist, but I thought it was worth raising awareness about the following:

[Transcript] Hey, I had to talk about this because I noticed, this morning, something really interesting, and I mean, more interesting than your standard cat video while you’re scrolling through Instagram. I was on Twitter and I clicked on a link to a really cool story called “Watch a Robot ‘Hen,’ Robot Chicken, with some chicks, flock of chicks.” And when you scroll to the bottom of this article, you’ll notice some moderately spooky or weird links from Outbrain and I think we need to look at Outbrain, but let me just show you on my phone what it looks like.

So, on my phone, I don’t know if you can see here, but the link at the bottom… Where’s my… Yeah, there’s my finger. The link at the bottom, one of them says, “Justin Trudeau about to legalize something controversial.” You click on that link, it takes you to this web page, which I will provide a link to in the video. You can see it right now probably. So I’m just voicing over what I see. Now, isn’t it kind of interesting this content is basically false or low-quality news? It’s not from the CNN website. If you look at the top URL, it’s not from CNN. It’s from something called, and Outbrain is promoting it. At the bottom of the page, you can see what it’s really about. It’s about bingo. Fair play. I know that Wired is a reputable publisher and I know that Outbrain is really reputable as well, and so they post this in order to draw traffic to commercial interest.

Now, imagine if this was actually not true (which it obviously is not true): Justin Trudeau has legalized gambling to cover costs. It’s, basically an attack on the current liberal government in Canada. So this is Outbrain directly on Wired magazine, a reputable technology publication, which has probably seen hard times. Why are they seeing hard times? Facebook is eroding their revenue. YouTube is eroding their revenue. PewDiePie is getting 2 million hits per video and “The Washington Post” is only getting 1 million hits. This isn’t fair. So, what do we need to do? We should be attacking Facebook as publications. We should be criticizing them in particular and there’s some legitimate arguments. There are very legitimate arguments regarding Facebook, but what’s being overlooked is this hilarious Outbrain and Taboola redirection network.

So what they do is, as you can see at the bottom of the article, there are sponsored stories from third parties. You click on it and it’s about driving traffic from Wired, as reputable site, to, you know, whatever you wanna sell these folks on the internet. Now, why would Wired work with them? Because ad revenue, they need the money. They’re desperate actually in many cases because people don’t wanna pay for what they feel is free even though 10 years ago, 20 years ago you’d have to buy Wired Magazine to read these great articles. So you’ve got Outbrain, they are reputable, they look at the content, they tie the articles to that content and boom, it’s great.

They have to vet their publishers, but it’s a chicken in the end. They need the publishers and at the same time, they need the suppliers, the actual companies that will publish articles to drive traffic. And it’s this weird situation where they might not necessarily vet and approve of every story and say, “Oh, valid. This is a legitimate story.” They’re happy to take the money and run, and Wired magazine is complicit in this. Now, another company that is even more famous for ingenuity for sure, for having that ability to create a click worthy the article is Taboola, and they’re based in Europe, Israel, in the US and they publish articles on places like “Huffington Post.”

So, when you scroll down to what appears to be, you know, a reputable website, “HuffPost,” sure, you read this article about Cambridge Classica or Analytica, whatever it’s called, and then you scroll at the bottom and you have “You May Like” a bunch of ads for things that are like. Some of them are pretty dubious. You click on “Forget Lithoium. We’re advocating You Buy Electric Cars.” Fine, I suppose. It’s not pretending to be CNN, the website, but it’s interesting what’s going on here. So the media isn’t actually going after these two publications and the other publishers that redirect people from these websites to often questionable, sometimes questionable, not all I’d say, you know. Let’s just pretend it’s 20% ballpark, a number I made up, but it’s clearly some of these publishers are dubious and are not legitimate. But let’s look at “Wired Magazine’s” business model, let’s look at “Huffpost” business model and analyze what’s really going on here.

These companies are under duress, you know. What, with me, you could say, but they’re going after Facebook and no publisher, mainstream publisher, will go after what’s directly on their own web pages, again, because that’s how they make money. And this speaks to the broader problem of what I call $ad Revenue. So that’s ad revenue that is clickbait driven, that is about intensity of the viewership, about entertainment over factual information, the goal of which is to drive traffic to their sites, CNN or Wired or whoever other…Fox News, whatever.

They’re all in the game of eyeball collection and then redistributing those eyeballs or selling those people off to various business commercial interests, which is fair play. But they’re not auditing the quality and the veracity of the claims on these click-worthy, little, crazy articles on the bottom because they need the money. And these content redistributors don’t have the time to vet everything themselves, so we all point at Facebook. Facebook this and that because Facebook’s a multi-billion dollar company. It should be able to solve this, but we don’t look at the Taboola and Outbrain. So, I guess, even the reputable publishers are saying things like, “Donald Trump is about to cause World War III. Click on this link. Find out more about his evil and crazy actions, and while you’re at it, look at the bottom. Take a look at this weird article and try some bingo.” So thank you very much. I thought that’d be kind of a cool thing to share.

Weapons of Math Destruction an Important Insight

Math is Logic, Math is Beautify, Math is Abuse-able:

Math is logic and it should be ported to social discussions. O’Neil worked with Larry Summers and O’Neil says that the trick of the economic downturn in 2008 was that everyone trusted the math nerds who were actually lying and engaging in mathematical abuse. But there is more to this story….

Data Science determines who are the Winners and Losers:

The algorithms are opinions embedded in code. It takes past data and builds a predictive model of what your goal as a company is in the future. You impose your algorithmic goals, we train our algorithms for success. There is no objective algorithm. We were marketing these things as if it is being mathematical but they are corrupted as well. Three areas of concern for Kathy O’Neil are:

  • Widespread: where the less well off get a loan, scoring systems are not appropriate for real people.
  • Mysterious: these algorithms are like secret laws that are not held accountable for anything.
  • Destructive: they ruin people’s lives, opportunities are getting taken away from people; there is a negative feedback loop; just thinking about university grades as a feedback loop itself.

Teach Assessment Problem:

Standardized test performance in order weed out bad teachers has failed according to O’Neil. If you have a test system the statistical scores it is hard to know how the kids did well. The error sample of their students (the hot and cold room) is significant. O’Neil said she was not allowed to understand how these people were evaluated. They shamed the teachers, but they couldn’t get the testing model. It wasn’t meaningful analysis. Teachers were punished for the previous year’s students if the teacher’s from the previous year were cheating on the tests for those kids: in essence passing the problem forward. I remember teaching swimming to a kid that had extreme ADHD, I failed her and their parents wanted the kid to progress to the next level  anyway so they tried to pressure me; their argument was that they had spent the money….I didn’t pass that kid up the chain. But if my job was at stake, I might have….










Personality Tests for Jobs:

They do systematically discriminate for jobs using an algorithm. Algorithm’s basically codify the past practices, therefore, they basically want more males in power. So one kid’s dad was suing 7 companies for creating personality tests that filter out mentally challenged people. Human resources is also a huge problem, these folks think they are filtering appropriately but they are biased towards certain attributes.

Algorithms are Value Laden Decision Making Processes: Predicting health outcomes: doctors having it is great, but insurance companies and companies discriminate against people who have high health risks. 


  1. Hippocratic Oath for Data Scientists.
  2. Mathematical Models need to be Improved because We are Hiding Behind Data to Perpetuate Past Patterns of behaviour.
  3. Anonymity doesn’t help this problem because you can categorize people using other markers to determine their race extra.
  4. Learn more….


Jeff Bezos | The Early Ages

Remember that analogies do not reflect your own reality. There are many types of CEOs out there. Here is one that is hilarious. Jeff Bezos and in 1999. Bezos was always nerdy. You should be a domain expert AND fresh thinking. Jeff Bezos has a Regret Minimization Framework that helps him to decide to get going with Amazon. That’s a useful framework for deciding if you should pursue what you are passionate about versus what will pay the bills for sure: will you regret that choice at aged 100; looking back?