Wealth creation isn’t PR and profiling
The most important item, over time, in valuation is interest rates.
Said Warren Buffet: “Any investment is worth all the cash you’re going to get out between now and judgement day discounted back.” In other words, if you were to deposit $1,000,000 in the bank and get a 4 per cent interest rate on your money, you would get $40,000 every year. However, if you were to leave it there for 25 years, while collecting the interest annually, you would receive a cash return of $1,000,000 back on top of the principal investment.
Placing your money in the bank and leaving it is regarded as a risk-free investment. Clearly, if you choose to invest your money elsewhere in stocks, real estate, or a mutual fund, you would expect a higher rate of return than what the bank offers. But, in that case, the investment is neither risk-free nor is the rate of return guaranteed.
Therefore, the objective of investing is to achieve the highest rate of return on your initial capital. The fact is that the growth rate of capital is more important in wealth creation than the amount of capital you are starting with.
A simple example of how money can grow is this: If I gave you the choice of taking $100,000 today or a starting capital of one cent ($0.01) but promised to double it by a 100 per cent rate of return compounded daily for 31 days, which would you choose?
Without doing the maths, most people would instantaneously prefer the $100,000 now. It seems like a safe bet. But a 100 per cent compounded daily return on $0.01 equals $21,474,836 in just 31 days. However, in the real world, with a more realistic investment market rate of 15 per cent compounded per annum, your capital would double in five years.
People should always seek higher rates of return on their money because of inflation. Why? If inflation is at 5 per cent, and your money in the bank is earning only 4 per cent, it would decrease your purchasing power. Wealth is about creating a sustained positive rate of return on your capital investment.
Let me be clear, I am speaking to the young person who may have a little money to invest, not the seasoned investor with funds to risk. In an era of conspicuous consumption, social media optics, and VIP profiling all-inclusive/exclusive party lounges, I’ve learned that it is difficult for people to distinguish how best to invest their money for the greatest return.
I have seen and listened to many young people extol the virtues of individuals on Instagram that they believe are ‘killing the game’ and are so well off.
The talent or aim is how to determine how to evaluate the best rate of return. Well, I will start by what it is not.
First, the wealth of a company is not defined by the car driven by the CEO, how often they’re at the latest parties, the designer clothing they sport, or listening to them speak about how well their company is doing. Those physical symbols and lofty speeches don’t say what the company’s balance sheet looks like. As such, the best determinant for identifying whether to invest in a company is looking at the numbers for yourself.
Here are some red flags to look out for:
(1) Companies with an unproven track record that base their valuation primarily on future projections.
(2) Companies whose income is highly dependent on asset revaluation. Remember, asset values can go up or down significantly based on the date of the valuation and are directly reliant on short-term interest rates, market conditions, and the company’s short-term profitability.
(3) Companies that have a high concentration of ownership in a few shareholders with only a tiny percentage of their stock that trades may be subject to two problems: (a) the stock may be hard to sell when you want to, unless you do so at a steep discount; or (b) the stock is easily subject to price manipulation.
(4) Companies that require additional public offerings or must return to the market for new funds, especially for investing outside of their core area of expertise.
(5) Companies that have very little or no operating cash flow with significant increases in their receivables.
(6) Companies that have frequent delays in producing their interim and audited accounts.
(7) Management changes of key personnel
Here are some positive attributes you should look for in a company when you decide to invest your money by buying shares in them:
(1) The company has a strong and sustained cash flow and a record of paying dividends from the cash flow internally generated.
(2) The company has outstanding management with an established track record
(2) The company has whose business model is understandable.
(3) The company has invests in a great company at a reasonable price versus a fair company at a discounted price.
(4) Buy companies you intend to hold for a long time
(5) The company enjoys a competitive advantage in the marketplace with high barriers to entry.
If you’re a Gen Z or a Millennial and never did accounts in high school, take some time and learn to read a company’s accounting statements, including its balance sheet, profit and loss, and cash flow statements. This knowledge becomes vital if you intend to take personal responsibility for your wealth creation.
In May 2018 the Jamaica Stock Exchange (JSE) was rated as one of the best performing in the world. This year, it is among the worst performers, with trading values at approximately two-fifths of 2022 highs. (Jamaica Observer, June 9, 2023)
Over the past couple of months financial reporters have been highlighting several concerns in the Jamaican financial marketplace; for example, National Commercial Bank’s lack of dividend payments, the JSE suspension of Stocks and Securities Limited and iCreate, and the overall fall of the JSE Index.
The adage that a “rising tide lifts all boats” seemed applicable in 2018 as companies enjoyed riding the investors’ wave. However, Warren Buffet, considered the world’s most significant investor, always says: “It is only when the tide goes out that you see who is standing naked.”
Therefore, don’t watch the glamour and the glitter when deciding how to invest your future. Spend some time and research to ensure that what you see is what will still be there in five years.