How to Think Like Benjamin Graham and Invest Like Warren Buffett
by Lawrence A. Cunningham
Chapter 6 - Apple Trees and Experience
If market price is the last thing an investor or manager should look
at in determining the value of a business or an ownership interest
in it, the first thing to consider is its fundamental economic characteristics.
There are so many approaches to appraising those fundamentals
that many people use the relatively lazy metric of market
price as a guideline in valuation, but that is a mistake. Of all the
approaches to appraising business value, just a few do virtually all
the hardwork, and those are the ones you need. A parable will
illustrate the basics, and the rest of this part will fill in the details.
Story of an Old man and his tree
Once there was a wise old man who owned an apple tree. It was a
fine tree, and with little care it produced a crop of apples each year
which he sold or $100. The man wanted to retire to a new climate,
and he decided to sell the tree.He placed an advertisement in the business
opportunities section of The Wall Street Journal to sell the tree for “the best offer.”
The first person to respond to the ad offered to pay $50, which, he
said, was what he could get for selling the apple tree for firewood
after he cut it down. “You don’t know what you are talking about,”
the old man chastised. “You are offering to pay only the salvage value
of this tree.You can’t see that my tree is worth far more than 50 bucks.
The next person who visited the old man offered to pay $100 for
the tree. “For that,” she opined, “is what I would be able to get for
selling this year’s crop of fruit, which is about to mature.” “You are
not as out of your depth as the first one,” responded the old man.
“At least you see that this tree has more value as a producer of apples
than it would as a source of firewood. But $100 is not the right price.
You are not considering the value of next year’s crop of apples or
that of the years after. Please take your $100 and go elsewhere.”
The third person to come along was a young man who had just
dropped out of business school. “I am going to sell apples on the
Internet,” he said. “I figure that the tree should live for at least
another 15 years. If I sell the apples for $100 a year, that will total
$1,500. I offer you $1,500 for your tree.” “Oh, no, dot-commer,” lamented the
man, “you’re even more ill informed about reality than
the others I’ve spoken with.” “Surely the $100 you would earn by selling the apples from the
tree 15 years from now cannot be worth $100 to you today. In fact,
if you placed$41.73 today in a bank account paying 6% interest,
compounded annually, that small sum would grow to $100 at the end
of 15 years. So the present value of $100 worth of apples 15 years
from now, assuming an interest rate of 6%, is only $41.73 not $100.
Pray,” advised the beneficent old man, “take your $1,500 and invest
it safely in high-grade corporate bonds and go back to business
school and learn something about finance.”
Before long there came a wealthy physician who said, “I don’t
know much about apple trees, but I know what I like. I’ll pay the
market price for it. The last fellow was willing to pay you $1,500 for
the tree, and so it must be worth that.” “Doctor,” advisedthe oldman, “you should get yourself a knowledgeable investment adviser. If there were truly a market in which
apple trees were traded with some regularity, the prices at which
they were sold might tell you something about their value. But not
only is there no such market, even if there were, taking its price as
the value is just mimicking the stupidity of that last knucklehead or
the others before him. Please take your money and buy a vacation
home.”
The next would-be buyer was an accounting student. When the
old man asked, “What price are you willing to give me?” the student
first demanded to see the old man’s books. The old man had kept
careful records and gladly brought them out.
After examining them, the accounting student said, “Your books
show that you paid$75 for this tree ten years ago. Furthermore, you
have made no deductions for depreciation. I do not know if that
conforms with generally accepted accounting principles, but assuming
that it does, the book value of your tree is $75. I will pay that.”
“Ah, you students know so much and yet so little,” chided the
old man. “It is true that the book value of my tree is $75, but any
fool can see that it is worth far more than that. You had best go back
to school and see if you can find a book that shows you how to use
your numbers to better effect.”
The final prospect to visit the old man was a young stockbroker who
had recently graduated from business school. Eager to test her new
skills, she too asked to examine the books. After several hours she
came back to the old man and said she was prepared to make an
offer that valued the tree on the basis of the capitalization of its
earnings. For the first time the old man’s interest was piqued, and
he asked her to go on.
The young woman explained that while the apples were sold for
$100 last year, that figure did not represent the profits realized from
the tree. There were expenses attendant to the tree, such as the cost
of fertilizer, pruning, tools, picking apples, and carting them to town
and selling them. Somebody had to do those things, and a portion of the salaries
paid to those persons ought to be charged against the revenues from
the tree. Moreover, the purchase price, or cost, of the tree was an
expense. A portion of the cost is taken into account each year of the
tree’s useful life. Finally, there were taxes. She concluded that the
profit from the tree was $50 last year.
“Wow!” The old man blushed. “I thought I made $100 off that
tree.”
“That’s because you failed to match expenses with revenues, in
accordance with generally accepted accounting principles,” she explained.
“You don’t actually have to write a check to be charged with
what accountants consider to be your expenses. For example, you
bought a station wagon some time ago and used it part of the time
to cart apples to market. The wagon will last a while, and each year
some of the original cost has to be matched against revenues. A
portion of the amount has to be spread out over the next several
years even though you expended it all at one time. Accountants call
that depreciation. I’ll bet you never figured that in your calculation
of profits.”
“I’ll bet you’re right,” he replied. “Tell me more.”
“I also went back into the books for a few years and saw that in
some years the tree produced fewer apples than it did in other years,
the prices varied, and the costs were not exactly the same each year.
Taking an average of only the last three years, I came up with a
figure of $45 as a fair sample of the tree’s earnings. But that is only
half of what we have to do to figure the value.”
“What’s the other half?” he asked.
“The tricky part,” she told him. “We now have to figure the value
to me of owning a tree that will produce average annual earnings of
$45 a year. If I believed that the tree was a ‘one-year wonder,’ I would
say 100% of its value—as a going business—was represented by one
year’s earnings.”
“But if we agree that the tree is more like a corporation in that
it will continue to produce earnings year after year, the key is to
figure out an appropriate rate of return. In other words, I will be
investing my capital in the tree, and I need to compute the value to
me of an investment that will produce $45 a year in income. We can
call that amount the capitalized value of the tree.”
“Do you have something in mind?” he asked.
“I’m getting there. If this tree produced entirely steady and predictable
earnings each year, it would be like a U.S. Treasury bond.
But its earnings are not guaranteed, so we have to take into account
risks and uncertainty . If the risk of its ruin was high, I would insist
that a single year’s earnings represent a higher percentage of the
value of the tree. After all, apples could become a glut on the market
one day and you would have to cut the price, thus increasing the
costs of selling them.”
“Or,” she continued, “some doctor could discover a link between
eating an apple a day and heart disease. A drought could cut the
yield of the tree. Or the tree could become diseased and die. These
are all risks. And we don’t even know whether the costs we are sure
to incur will be worth incurring.”
“You are a gloomy one,” reflected the old man. “There could also
be a shortage of apples on the market, and the price of apples could
rise. If you think about it, it is even possible that I have been selling
the apples at prices below what people would be willing to pay and
that you could raise the price without reducing your sales. Also,
there are treatments, you know, that could be applied to increase
the yield of the tree. This tree could help spawn a whole orchard.
Any of these would increase earnings.”
“The earnings also could be increased by lowering costs of the
sort you mentioned,” the old man continued. “Costs can be reduced
by speeding the time from fruition to sale, managing extensions of
credit better, and minimizing losses from bad apples. Cutting costs
boosts the relationship between overall sales and net earnings or, as
the financial types say, the tree’s profit margin. And that in turn
would boost the return on your investment.”
“I am aware of all that,” she assured him. “The fact is, we are
talking about risk. And investment analysis is a cold business. We
don’t know with certainty what’s going to happen. You want your
money now, and I’m supposed to live with the risk.
“That’s fine with me, but then I have to look through a cloudy
crystal ball, and not with 20/20 hindsight. And my resources are
limited. I have to choose between your tree and the strawberry patch
down the road. I cannot buy both, and the purchase of your tree
will deprive me of alternative investments. That means I have to
compare the opportunities and the risks.
“To determine a proper rate of return,” she continued, “I looked
at investment opportunities comparable to the apple tree, particularly
in the agribusiness industry, where these factors have been
taken into account. I then adjusted my findings based on how the
things we discussed worked out with your tree. Based on those judgments,
I figure that 20% is an appropriate rate of return for the tree.
“In other words,” she concluded, “assuming that the average
earnings from the tree over the last three years (which seems to be
a representative period) are indicative of the return I will receive, I
am prepared to pay a price for the tree that will give me a 20% return
on my investment. I am not willing to accept any lower rate of return
because I don’t have to; I can always buy the strawberry patch instead.
Now, to figure the price, we simply divide $45 of earnings per
year by the 20% return I am insisting on.”
“Long division was never my strong suit. Is there a simpler way
of doing the figuring?” he asked hopefully.
“There is,” she assured him. “We can use an approach we Wall
Street types prefer, called the price-earnings (or P/E) ratio. To compute
the ratio, just divide 100 by the rate of return we are seeking.
If I were willing to settle for an 8% return, that would be 100 divided
by 8, which equals 12.5. So we’d use a P/E ratio of 12.5 to 1. But
since I want to earn 20% on my investment, I divided 100 by 20 and
came up with a P/E ratio of 5:1. In other words, I am willing to pay
five times the tree’s estimated annual earnings. Multiplying $45 by
5, I get a value of $225. That’s my offer.”
The old man sat back and said he greatly appreciated the lesson.
He would have to think about her offer, and he asked if she could
come by the next day.
When the young woman returned, she found the old man emerging
from behind a sea of work sheets, small print columns of numbers,
and a calculator. “Delighted to see you,” he said, enthralled. “I think
we can do business.
“It’s easy to see how you Wall Street smarts make so much
money, buying people’s property for less than its true value. I think
I can get you to agree that my tree is worth more than you figured.”
“I’m open-minded,” she assured him.
“The $45 number you came up with yesterday was something
you called profits, or earnings that I earned in the past. I’m not so
sure it tells you anything that important.”
“Of course it does,” she protested. “Profits measure efficiency
and economic utility.”
“Fair enough,” he mused, “but it sure doesn’t tell you how much
money you’re getting. I looked in my safe yesterday after you left
and saw some stock certificates I own that never paid a dividend to
me. And I kept getting reports each year telling me how great the
earnings were. Now I know that the earnings increased the value of
my stocks, but without any dividends I couldn’t spend them. It’s just
the opposite with the tree. “You figured the earnings were lower because of some amounts
I’ll never have to spend, like depreciation on my station wagon,” the
old man went on. “It seems to me these earnings are an idea worked
up by the accountants.”
Intrigued, she asked, “What is important, then?”
“Cash,” he answered. “I’m talking about dollars you can spend,
save, or give to your children. This tree will go on for years yielding
revenues after costs. And it is the future, not the past, we need to
reckon with.”
“Don’t forget the risks,” she reminded him. “And the uncertainties.”
“Quite right,” he observed. “If we can agree on the possible range
of future revenues and costs and that earnings averaged around $45
the last few years, we can make some fair estimates of cash flow
over the coming five years: How about that there is a 25% chance
that cash flow will be $40, a 50% chance it will be $50, and a 25%
chance it will be $60? “That makes $50 our best guess if you average it out,” the old
man figured. “Then let’s just say that for ten years after that the
average will be $40. And that’s it. The tree doctor tells me it can’t
produce any longer than that.
“Now all we have to do,” he finished up, “is figure out what you
pay today to get $50 a year from now, two years from now, and so
on for the first five years until we figure what you would pay to get
$40 a year for each of the ten years after that. Then, throw in the
20 bucks we can get for firewood.
“Simple,” she confessed. “You want to discount to the present
value of future receipts including salvage value. Of course you need
to determine the rate at which you discount.”
“Precisely,” he concurred. “That’s what my charts and the calculator
are for.” She nodded as he showed her discount tables that
revealed what a dollar received at a later time is worth today under
different assumptions about the discount rate. It showed, for example,
that at an 8% discount rate, a dollar delivered a year from
now is worth $.93 today, simply because $.93 today, invested at 8%,
will produce $1 a year from now.
“You could put your money in a savings account that is insured
and receive 5% interest. But you could also buy U.S. Treasury obligations
with it and earn, say, 8% interest, depending on prevailing
interest rates. That looks like the risk-free rate of interest to me.
Anywhere else you put your money deprives you of the opportunity
to earn 8% risk-free. Discounting by 8% will only compensate you
for the time value of the money you invest in the tree rather than
in Treasuries. But the cash flow from the apple tree is not risk less,
sad to say, so we need to use a higher discount rate to compensate
you for the risk in your investment.
“Let’s agree to discount the receipt of $50 a year from now by
15%, and so on with the other deferred receipts. That is about the
rate that is applied to investments with this magnitude of risk. You
can check that out with my neighbor, who just sold his strawberry
patch yesterday. According to my figures, the present value of the
expected yearly profit is $268.05, and tod ay’s value of the firewood
is $2.44, for a grand total of $270.49. I’ll take $270 even. You can
see how much I’m allowing for risk because if I discounted the
stream at 8%, it would come to $388.60.”
After a few minutes of reflection, the young woman said to the
old man, “It was a bit foxy of you yesterday to let me appear to be
teaching you something. Where did you learn so much about finance
as an apple grower?” The old man smiled. “Wisdom comes from experience in many
fields.”
Computation
First Five years
50 50 50 50 50
At 3% Inflation Adjusted 50(.97) 50(.97)(.97) 50(.97)(.97)(.97) etc.
48 47 46 44 43
Inflation adjusted price when Discounted at 15% 48(1/1.15) 47(1/1.15)(1/1.15) etc
42 36 30 25 21
Next Ten Years (Don't take inflation just take discounted value of 15%)
40 40 ......40 for the tenth year it is actually worth $10
So roughly $100 for all these years
Roughly the total Value of cash-flows is 42+36+30+25+21+100 = $254
“Nice try, you crafty old devil,” she rejoined. “You know there is
plenty of room for mistakes in your calculations too. It’s easy to
discount cash flows when they are nice and steady, but that doesn’t
help you when you’ve got some lumpy expenses that do not recur.
For example, several years from now that tree will need serious pruning
and spraying that don’t show up in your flow. The labor and
chemicals for that once-only occasion throw off the evenness of your
calculations.”
“But I’ll tell you what,” she bellied up. “I’ll offer you $250. My
cold analysis tells me I’m overpaying, but I really like that tree. I
think the delight of sitting in its glorious shade must be worth something.”
“It’s a deal,” agreed the old man. “I never said I was looking for
the highest offer but only the best offer.”
Monday, December 17, 2007
Tuesday, December 11, 2007
Introduction to Statistics
Introduction to Statistics - Fall 2006.
09:30-11:00 AM | Auditorium Wheeler
Instructor Fletcher Ibser
Tue 10/10 Probability I
Venn Diagram = Rectangle and the probability of the whole is 1
P(B/A) = Probability of B Happening Given that A has Happened.
e.g. Chance that a die rolls a 6 given that it has rolled an even number = 1/3
Multiplication Rule
Generic Case
P(A and B) = P(A) . P(B/A)
e.g. A red die rolls a 6 and a blue die also rolls a 6.
Think of it as a proportion. A large number of people do this so 6 will happen to 1/6th number of people.
Then a 6 will happen to 1/6th of that 1/6th group.
Special Case
If A and B are independent then
P(A and B) = P(A) . P(B)
Addition Rule
P(A or B) = P(A) + P(B) - P(A and B)
Venn Diagram makes it clear
This of two circles A and B overlapping so you will have to remove the overlapping portion which is what subtracting the P(A and B) does.
09:30-11:00 AM | Auditorium Wheeler
Instructor Fletcher Ibser
Tue 10/10 Probability I
Venn Diagram = Rectangle and the probability of the whole is 1
P(B/A) = Probability of B Happening Given that A has Happened.
e.g. Chance that a die rolls a 6 given that it has rolled an even number = 1/3
Multiplication Rule
Generic Case
P(A and B) = P(A) . P(B/A)
e.g. A red die rolls a 6 and a blue die also rolls a 6.
Think of it as a proportion. A large number of people do this so 6 will happen to 1/6th number of people.
Then a 6 will happen to 1/6th of that 1/6th group.
Special Case
If A and B are independent then
P(A and B) = P(A) . P(B)
Addition Rule
P(A or B) = P(A) + P(B) - P(A and B)
Venn Diagram makes it clear
This of two circles A and B overlapping so you will have to remove the overlapping portion which is what subtracting the P(A and B) does.
Monday, December 10, 2007
Words of Wisdom - Quotes
"The Unexamined Life is Not Worth Living" - Socrates
"Give a man a fish; you have fed him for today. Teach a man to fish; and you have fed him for a lifetime" —Author unknown
I hear...I forget
I see...and I remember
I do...and I understand
Ancient Chinese Proverb
Pilani :- Gyanam Parmam Balam - Knowledge is Power
Berkeley :- Let there be Light
Stanford :- Die Luft der Freiheit weht - "Winds of Freedom are in the Air"
MIT :- Mens et manus - "Mind and hand"
By Bernard Baruch
You have to lose money in order to better yourself
most people view the market as the place where the miracle of great and quick riches can be performed with little effort
a man who observes the future and acts before it occurs
if you get all the facts, your judgment can be right; if you don't get all the facts, it can't be right
Even being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he is wrong.
Market speculation is "no different than trying to be a successful doctor or lawyer....you simply must devote yourself full time to the study of your craft."
Self-reliance and "doing one's own thinking" is a must.
Most of the successful people I've known are the ones who do more listening than talking."
the stock market does not determine the health of the economy but "rather reflects it."
Having flexibility should not be underestimated.
"what we can try to do perhaps is to come to a better understanding of how to reduce the element of risk in whatever we undertake."
"better to have a few stocks and to watch them carefully."
good supply of cash on hand at all times in reserve is important
He liked to focus on "one thing at a time, perfect it, and do it well."
Same mistakes most investors make which are: 1) "they know too little about the company's management, earnings, prospects, and possibility for future growth," and 2) "they tend to trade beyond their financial capital capacity."
"Successful speculation requires staying on top of changes in industries and companies that either create new industries or improve on existing industries. The majority of your profits will come from these two.....
"Without control over your emotions, there is very little chance for profitable success in the stock market."
"Don't try to buy at the bottom and sell at the top. It can't be done except by liars."
"I made my money by selling too soon."
"Do not blame anybody for your mistakes and failures."
"Whatever failures I have known, whatever errors I have committed, whatever follies I have witnessed in private and public life have been the consequence of action without thought."
"follow what the market is currently doing as opposed to following what one might personally think the market should do."
Know your own failings, passions, and prejudices so you can separate them from what you see."
"The main purpose of the stock market is to make fools of as many men as possible."
He devoted lots of hours and effort to examining past trades to find out why he lost money.
"At times it is folly to hasten at other times, to delay. The wise do everything in its proper time." - Ovid
The market can stay irrational longer than you can stay solvent.
Successful investing is anticipating the anticipations of others.
It is better to be roughly right than precisely wrong.
When the facts change, I change my mind. What do you do, sir?
The difficulty lies, not in the new ideas, but in escaping from the old ones
You are neither right nor wrong because the crowd disagrees with you.You are right because your data and reasoning are right
Individuals who cannot master their emotions are ill-suited to profit from the investment process
Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble...to give way to hope, fear and greed
Warren Buffett, story from Benjamin Graham:
A story that was passed down from Ben Graham illustrates the lemminglike behavior of the crowd: "Let me tell you the story of the oil prospector who met St. Peter at the Pearly Gates. When told his occupation, St. Peter said, “Oh, I’m really sorry. You seem to meet all the tests to get into heaven. But we’ve got a terrible problem. See that pen over there? That’s where we keep the oil prospectors waiting to get into heaven. And it’s filled—we haven’t got room for even one more.” The oil prospector thought for a minute and said, “Would you mind if I just said four words to those folks?” “I can’t see any harm in that,” said St. Pete. So the old-timer cupped his hands and yelled out, “Oil discovered in hell!” Immediately, the oil prospectors wrenched the lock off the door of the pen and out they flew, flapping their wings as hard as they could for the lower regions. “You know, that’s a pretty good trick,” St. Pete said. “Move in. The place is yours. You’ve got plenty of room.” The old fellow scratched his head and said, “No. If you don’t mind, I think I’ll go along with the rest of ’em. There may be some truth to that rumor after all."
"Give a man a fish; you have fed him for today. Teach a man to fish; and you have fed him for a lifetime" —Author unknown
I hear...I forget
I see...and I remember
I do...and I understand
Ancient Chinese Proverb
Pilani :- Gyanam Parmam Balam - Knowledge is Power
Berkeley :- Let there be Light
Stanford :- Die Luft der Freiheit weht - "Winds of Freedom are in the Air"
MIT :- Mens et manus - "Mind and hand"
By Bernard Baruch
You have to lose money in order to better yourself
most people view the market as the place where the miracle of great and quick riches can be performed with little effort
a man who observes the future and acts before it occurs
if you get all the facts, your judgment can be right; if you don't get all the facts, it can't be right
Even being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he is wrong.
Market speculation is "no different than trying to be a successful doctor or lawyer....you simply must devote yourself full time to the study of your craft."
Self-reliance and "doing one's own thinking" is a must.
Most of the successful people I've known are the ones who do more listening than talking."
the stock market does not determine the health of the economy but "rather reflects it."
Having flexibility should not be underestimated.
"what we can try to do perhaps is to come to a better understanding of how to reduce the element of risk in whatever we undertake."
"better to have a few stocks and to watch them carefully."
good supply of cash on hand at all times in reserve is important
He liked to focus on "one thing at a time, perfect it, and do it well."
Same mistakes most investors make which are: 1) "they know too little about the company's management, earnings, prospects, and possibility for future growth," and 2) "they tend to trade beyond their financial capital capacity."
"Successful speculation requires staying on top of changes in industries and companies that either create new industries or improve on existing industries. The majority of your profits will come from these two.....
"Without control over your emotions, there is very little chance for profitable success in the stock market."
"Don't try to buy at the bottom and sell at the top. It can't be done except by liars."
"I made my money by selling too soon."
"Do not blame anybody for your mistakes and failures."
"Whatever failures I have known, whatever errors I have committed, whatever follies I have witnessed in private and public life have been the consequence of action without thought."
"follow what the market is currently doing as opposed to following what one might personally think the market should do."
Know your own failings, passions, and prejudices so you can separate them from what you see."
"The main purpose of the stock market is to make fools of as many men as possible."
He devoted lots of hours and effort to examining past trades to find out why he lost money.
"At times it is folly to hasten at other times, to delay. The wise do everything in its proper time." - Ovid
The market can stay irrational longer than you can stay solvent.
Successful investing is anticipating the anticipations of others.
It is better to be roughly right than precisely wrong.
When the facts change, I change my mind. What do you do, sir?
The difficulty lies, not in the new ideas, but in escaping from the old ones
You are neither right nor wrong because the crowd disagrees with you.You are right because your data and reasoning are right
Individuals who cannot master their emotions are ill-suited to profit from the investment process
Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble...to give way to hope, fear and greed
Warren Buffett, story from Benjamin Graham:
A story that was passed down from Ben Graham illustrates the lemminglike behavior of the crowd: "Let me tell you the story of the oil prospector who met St. Peter at the Pearly Gates. When told his occupation, St. Peter said, “Oh, I’m really sorry. You seem to meet all the tests to get into heaven. But we’ve got a terrible problem. See that pen over there? That’s where we keep the oil prospectors waiting to get into heaven. And it’s filled—we haven’t got room for even one more.” The oil prospector thought for a minute and said, “Would you mind if I just said four words to those folks?” “I can’t see any harm in that,” said St. Pete. So the old-timer cupped his hands and yelled out, “Oil discovered in hell!” Immediately, the oil prospectors wrenched the lock off the door of the pen and out they flew, flapping their wings as hard as they could for the lower regions. “You know, that’s a pretty good trick,” St. Pete said. “Move in. The place is yours. You’ve got plenty of room.” The old fellow scratched his head and said, “No. If you don’t mind, I think I’ll go along with the rest of ’em. There may be some truth to that rumor after all."
Tuesday, December 4, 2007
Nokia World 2007
Nokia Corp. said Tuesday it expects the global market for mobile devices to grow 10 percent next year
The markets had expected higher growth
It said worldwide sales for all companies should total more than 1.2 billion units in 2008.
Nokia said the worldwide market for Internet services would reach $145 billion by 2010.
The highest growth in the global mobile market next year -- more than 15 percent -- will be in the Asia-Pacific region, China, the Middle East and Africa, Nokia said. The lowest growth -- less than 10 percent -- will be in North America, Europe and Latin America.
Nokia said that globally there will be 4 billion mobile subscribers by 2009, a milestone that would come a year earlier than the company had earlier predicted.
The Finnish company -- which said in October that its global market share had grown to 39 percent, from 36 percent in the third quarter of 2006 -- said it aims to further increase market share in 2008. Its long-stated goal has been 40 percent, although Chief Executive Olli-Pekka Kallasvuo has said the company might raise that target.
Mary McDowell, from Nokia's enterprise solutions division, said Nokia handset owners will be able to use Avvenu's "digital locker," a file access and sharing technology to search, access and share PC files remotely even if a PC is turned off or not connected to the Internet.
Nokia also previously announced major deals with other recording labels, as well as with Vodafone, the world's largest mobile phone company, to provide Internet access "at the click of a button" to handset users. Nokia launched its own Web services on a new site, called "Ovi," that includes an online music store.
Link
The markets had expected higher growth
It said worldwide sales for all companies should total more than 1.2 billion units in 2008.
Nokia said the worldwide market for Internet services would reach $145 billion by 2010.
The highest growth in the global mobile market next year -- more than 15 percent -- will be in the Asia-Pacific region, China, the Middle East and Africa, Nokia said. The lowest growth -- less than 10 percent -- will be in North America, Europe and Latin America.
Nokia said that globally there will be 4 billion mobile subscribers by 2009, a milestone that would come a year earlier than the company had earlier predicted.
The Finnish company -- which said in October that its global market share had grown to 39 percent, from 36 percent in the third quarter of 2006 -- said it aims to further increase market share in 2008. Its long-stated goal has been 40 percent, although Chief Executive Olli-Pekka Kallasvuo has said the company might raise that target.
Mary McDowell, from Nokia's enterprise solutions division, said Nokia handset owners will be able to use Avvenu's "digital locker," a file access and sharing technology to search, access and share PC files remotely even if a PC is turned off or not connected to the Internet.
Nokia also previously announced major deals with other recording labels, as well as with Vodafone, the world's largest mobile phone company, to provide Internet access "at the click of a button" to handset users. Nokia launched its own Web services on a new site, called "Ovi," that includes an online music store.
Link
ETFC and Citadel Deal
At first blush, Citadel’s rescue plan Thursday looked like a pretty good deal. But now, many investors are beginning to wonder if E*Trade is burning the village to save it.
Here’s why: Lost in the excitement of the deal was the fact that E*Trade wrote down about $2.6 billion on its balance sheet — $2.2 billion of asset backed securities and $400 million in home equity loans. Citadel will invest roughly the same amount in E*Trade by buying the ABS portfolio for $800 million and taking on $1.75 billion in E*Trade debt.
But E*Trade will pay 12.5% interest on that debt, a hefty premium. (It’s also worth remembering that E*Trade lost about 15% of its deposits for which it paid a much lower interest rate than it will be paying Citadel.)
In addition, Citadel is getting 84 million shares, valued at about $405 million at yesterday’s closing share price, thrown in the pot for free.
Castle
E*Trade has effectively given away 20% of the company and borrowed $1.75 billion at a rate that could impair earnings by one analyst’s reckoning by more than 50 cents a share.
And what happens if further writedowns are necessary? E*Trade wrote down 3% of its $12 billion home-equity loan portfolio. By one rough comparison, Wells Fargo set aside reserves equal to 12% of its own $12 billion portfolio of home equity loans.
Maybe E*Trade’s loans are more sound. Maybe not.
We’ll find out in March when more adjustable rate mortgages reset. In the meantime, E*Trade might want to think about improving its fortifications.
Courtesy WSJ Blog
Here’s why: Lost in the excitement of the deal was the fact that E*Trade wrote down about $2.6 billion on its balance sheet — $2.2 billion of asset backed securities and $400 million in home equity loans. Citadel will invest roughly the same amount in E*Trade by buying the ABS portfolio for $800 million and taking on $1.75 billion in E*Trade debt.
But E*Trade will pay 12.5% interest on that debt, a hefty premium. (It’s also worth remembering that E*Trade lost about 15% of its deposits for which it paid a much lower interest rate than it will be paying Citadel.)
In addition, Citadel is getting 84 million shares, valued at about $405 million at yesterday’s closing share price, thrown in the pot for free.
Castle
E*Trade has effectively given away 20% of the company and borrowed $1.75 billion at a rate that could impair earnings by one analyst’s reckoning by more than 50 cents a share.
And what happens if further writedowns are necessary? E*Trade wrote down 3% of its $12 billion home-equity loan portfolio. By one rough comparison, Wells Fargo set aside reserves equal to 12% of its own $12 billion portfolio of home equity loans.
Maybe E*Trade’s loans are more sound. Maybe not.
We’ll find out in March when more adjustable rate mortgages reset. In the meantime, E*Trade might want to think about improving its fortifications.
Courtesy WSJ Blog
DRIP Plan
There's no need to do all that heavy accounting and itemizing. The IRS has at least a little common sense, and allows you to state "various" for the dates of acquisition, and report the sum total of the acquisition cost "basis" (although you still have to distinguish long term vs. short term holdings). See page 65 of Publication 550 ( http://www.irs.gov/pub/irs-pdf/p550.pdf) and the accompanying example.
So for anything held more than a year, all you have to come up with is the total of your purchase price (plus any reinvested dividends), which should be much easier to establish than all the individual purchases and dates. The reinvested dividends might be more painful to locate, but if you don't mind making an extra contribution to Uncle Sam, you can even choose to ignore those records -- you've presumably already paid taxes on the dividends; reporting them adds to your basis, lowering your current tax bill, so if you ignore them, you essentially pay taxes on the dividends twice -- but depending on the amount of the dividends and your situation, it might be less hassle.
Once upon a time it was expensive to buy stocks. Brokers charged retail commissions of several percent (really!) and charged extra fees on top of these for odd lots (less than 100 shares).
In the 70's there was a revolution wherein a new class of brokers called "discount brokers" appeared. These guys evolved and took over a huge chunk of the brokerage business.
DRIPs were created to get around the big broker commission problem -- a problem that no longer exists. Maybe in the 80's they were still useful to a significant fraction of the public. But now?
The discount brokers have lowered commissions until the commissions are so close to zero that they are hard to measure. Much smaller investors can now just buy stocks without resorting to DRIPs.
So for anything held more than a year, all you have to come up with is the total of your purchase price (plus any reinvested dividends), which should be much easier to establish than all the individual purchases and dates. The reinvested dividends might be more painful to locate, but if you don't mind making an extra contribution to Uncle Sam, you can even choose to ignore those records -- you've presumably already paid taxes on the dividends; reporting them adds to your basis, lowering your current tax bill, so if you ignore them, you essentially pay taxes on the dividends twice -- but depending on the amount of the dividends and your situation, it might be less hassle.
Once upon a time it was expensive to buy stocks. Brokers charged retail commissions of several percent (really!) and charged extra fees on top of these for odd lots (less than 100 shares).
In the 70's there was a revolution wherein a new class of brokers called "discount brokers" appeared. These guys evolved and took over a huge chunk of the brokerage business.
DRIPs were created to get around the big broker commission problem -- a problem that no longer exists. Maybe in the 80's they were still useful to a significant fraction of the public. But now?
The discount brokers have lowered commissions until the commissions are so close to zero that they are hard to measure. Much smaller investors can now just buy stocks without resorting to DRIPs.
Saturday, December 1, 2007
Stephen Hawking's Take on Black Holes
He gave us the big bang theory, he then realized that the birth of the star was Big Bang, so if we can look at the death of the star (black hole) we could get answers. Thus came the information paradox and Event Horizon
The Hawking Paradox
Part 2
Part 3
Part 4
Part 5
Susskind vs Hawking
The Hawking Paradox
Part 2
Part 3
Part 4
Part 5
Susskind vs Hawking
Newton’s Laws of Stock Market Trading
Dr. Leonard Susskind's Course on Quantum Mechanics
Newton's First Law of Trading
“A Stock at rest tends to stay at rest and a Trending Stock tends to stay in trend unless acted upon by an equal and opposite reaction or an unbalanced force.”
If a stock is trending sideways, it tends to stay sideways until a powerful enough market force takes it out of its trend. If a stock is trending up or downwards, it will tend to stay moving up or downwards until drastic changes happen to the company or the market at large creating an “equal and opposite reaction”. We should therefore always trade in the direction of a trend and always be vigilant for signs of an ”equal and opposite reaction” or the “unbalanced force”.
Newton’s Second Law of Trading
“The acceleration of a stock as produced by a market consensus is directly proportional to the magnitude of that consensus, in the same direction as the consensus, and inversely proportional to the mass of the stock.”
This law teaches us that a stock moves up or down into a trend due to a force created by market consensus. How much a stock moves up or down that trend is determined by the magnitude of the market consensus and how “massive” a stock is. By “massive” we are talking about the price of a stock. The more expensive a stock is, the more well established the company has been and the lesser in percentage you will make out of the same move in absolute dollar versus a smaller, less massive stock.
Newton’s Third Law of Trading
"For every action, there is an equal and opposite reaction."
For every buying or selling, there must be an equal amount of buyers or sellers on the other side. The stock market is a zero sum game. For every buyer, there must be a seller and for every seller, there must be a buyer. The real question is, who is profiting from each of their buying and selling.
Links
Newton's First Law of Trading
“A Stock at rest tends to stay at rest and a Trending Stock tends to stay in trend unless acted upon by an equal and opposite reaction or an unbalanced force.”
If a stock is trending sideways, it tends to stay sideways until a powerful enough market force takes it out of its trend. If a stock is trending up or downwards, it will tend to stay moving up or downwards until drastic changes happen to the company or the market at large creating an “equal and opposite reaction”. We should therefore always trade in the direction of a trend and always be vigilant for signs of an ”equal and opposite reaction” or the “unbalanced force”.
Newton’s Second Law of Trading
“The acceleration of a stock as produced by a market consensus is directly proportional to the magnitude of that consensus, in the same direction as the consensus, and inversely proportional to the mass of the stock.”
This law teaches us that a stock moves up or down into a trend due to a force created by market consensus. How much a stock moves up or down that trend is determined by the magnitude of the market consensus and how “massive” a stock is. By “massive” we are talking about the price of a stock. The more expensive a stock is, the more well established the company has been and the lesser in percentage you will make out of the same move in absolute dollar versus a smaller, less massive stock.
Newton’s Third Law of Trading
"For every action, there is an equal and opposite reaction."
For every buying or selling, there must be an equal amount of buyers or sellers on the other side. The stock market is a zero sum game. For every buyer, there must be a seller and for every seller, there must be a buyer. The real question is, who is profiting from each of their buying and selling.
Links
Tuesday, November 27, 2007
Stock Dilution in a Startup
Let's say, for example, that you signed up to be COO of a startup company and the CEO founder offered you 5% of the company. The CEO says there's no funding in the bank yet, so you'll have to sign up for a low salary -- $50,000 per year.
But he assures you that he's had conversations with venture capitalists and there's a sense that if things go right, the company might one day sell for $100 million.
Hmmm, you think. 5% -- not bad. If we sell this thing for $100 million, I will walk away with $5 million.
WRONG!
Your math failed to take into account stock dilution. That's the effect the issuance of new equity shares has on the existing shareholders.
Let's go back to our example and see how stock dilution works in action.
You take the job and get 5% of the company.
Odds are you don't get it all at once -- it's probably subject to a vesting schedule and it might only be stock options -- but that's not really relevant to our equity dilution lesson.
How much is 5% of your pre-funding company worth?
Not much. In fact, until there's a funding round you don't really know what it's worth.
A funding round is important to entrepreneurs and their employees because it's a milestone that values the underlying stock of the company.
So, let's say that a year after you've been working as the COO of the company, you and the CEO are finally able to land a funding round.
The funders says they will give you $700,000 in capital for 35% of the company.
What exactly does that mean?
It means that the total valuation of the company after they put their money in will be equal to $700,000/.35, or $2,000,000.
In VC terminology, that's the post-money valuation. The pre-money valuation is therefore $1,300,000. That's the post-money valuation minus the value of the cash that is coming into the business as part of the funding round.
So, after the funding round, the valuation is $2,000,000 and you had 5% equity in the company, so now you're equity stake is worth $100,000, right?
WRONG!
Equity dilution knocks down your percentage stake in the business.
Here's how equity dilution works in this scenario.
Let's say there were 1,000,000 issued shares prior to the funding round. In order for the new investors to get a 35% equity stake, they need to be issued new shares.
How many shares?
It's a simple algebra problem. Let x be the number of new shares that need to be issued. The equation becomes:
x / (1,000,000 + x) = .35
Solving for x implies that 538,462 new shares must be issued to the investors.
The math says that it should be 538,461.5 but there's no such thing as half a share so we round up. Believe me, investors won't round down. If there's something on the table to be taken, they will likely grab it.
So, now the total number of shares in the company is 1,538,462. What your percentage equity stake in the company?
Well, you were allocated 5% of the 1,000,000 shares so you had 50,000 equity shares before the funding round.
After the funding round, you still have 50,000 shares.
So, now, your diluted equity stake in the company is 50,000/1,538,462, or 3.25%.
How much is it worth?
The answer is simply .0325 x $2,000,000. That's your percentage equity stake times the post-money valuation. As it turns out, your stake is worth $65,000, not $100,000 as you might have thought.
If the company were to sell for $100 million now, after the first round of venture funding is in the bank, you 3.25% stake would be worth $3.25 million, not the $5 million you thought you'd get before you learned about equity dilution.
Notice that there was an easier way to figure out your post-dilution equity stake. You gave away 35% of the company in the financing round, so your 5% was knocked down by a .65 dilution factor -- that's what you got to keep, in effect. So, 5% times .065 gives you the 3.25%. It's the same answer, but it's a quick way of calculating the effect of dilution on your equity stake.
Mind you, this is just your first round of dilution. If the company has to do a second round and gives away 40% of the company to new investors, then you've got to knock your 3.25% equity stake down by a .60 dilution factor. After that second round, your ownership stake will be down to 1.95%.
Is that good or bad? It depends.
If the post-money valuation on the second financing round is $1 billion, your stake is only worth $19,500,000. Not bad!
If the post-money valuation on the second round is $2,500,000, then your equity stake is only worth $40,950. Given the salary cut you took to get in on the action for this startup, this is a pretty miserable scenario.
Adding insult to injury is the fact that your equity stake's valuation is not real -- it's just a paper value. In a startup company there's usually no liquidity unless there's an exit event of some kind -- for example, maybe the company goes public or the company is sold to an acquiring company. At that time, you finally get to know what your stock is really worth.
What's the moral of the story?
Well, for starters, you can see that somebody who doesn't understand equity dilution is going to be overly optimistic about their likely take in a startup. They may be more willing to take a lower salary than they should be, or more willing to take a lower equity stake than they should be.
Now that you understand equity dilution, you won't make that mistake. You'll properly evaluate potential outcomes and likely funding scenarios and their dilutionary effect on your stake.
Based on your equity dilution analysis, we hope you'll make smart decisions. Good luck!
CourtesyCitibank Dilutes the existing Shareholder stakes
Abu Dhabi Investment Authority said it will invest $7.5 billion in Citigroup Inc. Once the equity units Abu Dhabi bought are converted into stock in 2010 and 2011, Abu Dhabi will hold a 4.9 percent stake in Citi. Until those units get converted, Citi will pay Abu Dhabi a yield, or essentially an interest rate, of 11 percent. This is a hefty interest rate and also the analysts estimate earnings per share going forward will be diluted by about 3 to 4 percent by the sale. A very bad move for the investors more like the scenario 3 below.
What does all this mean to an average investor named Joe?
Stock dilution refers to when a company issues additional stock, for any purpose. Some of those purposes are bad for outside shareholders, some are neutral, and believe it or not, some are actually good. We examine all three scenarios to see how they can affect us as investors.
Example.
In 2005, Phaser(a hypothetical company) had 100,000 shares of common stock outstanding, a market cap of $1 million, and $100 of net profits.An individual investor Joe, on Dec. 31, 2006, bought 10,000 shares of Phaser stock. When the company reported its earnings, Joe was elated to learn that, by virtue of his stake, he vicariously earned $10 worth of Phaser's profits. Little did he know what 2007 held in store for him.
Dilution Scenario One
In 2007, Phaser decides to engage in the worst of the three main ways that companies dilute their shares: It issues 100,000 stock options to its CEO. For the time being, Phaser has a "basic share count" of 100,000 shares actually outstanding. But because its CEO will eventually exercise his or her stock options (i.e., tell the company to issue 100,000 shares to him or her and then sell them on the open market), Phaser now has a hypothetical, or "diluted," share count of 200,000.
That's bad news for Joe. While he will still own his 10,000 shares, his ownership stake will be diluted once the company issues that extra stock. What does that mean? Well, when Phaser's share count stood at 100,000, and it earned $100, Joe was entitled to 10% (10,000/100,000) worth of those profits, or $10.
But when Phaser issues those 100,000 extra shares, Joe's shares will not equal 10% but just 5% (10,000/200,000) of all shares outstanding. If Phaser earns $100 again the next year, Joe's take from that haul is just $5. Poor Joe.
The CEO, on the other hand, gets 100,000/200,000 worth of the profits, or $50. Lucky CEO!
Thus, the primary reason Fools dislike stock dilution is that it often represents a transfer of wealth from outside shareholders -- you and me -- to insiders.
Dilution Scenario Two
Stock dilution, however, isn't always bad. But before we look at when it can be good, let's consider the iffy situation of a company that acquires another one and pays for the purchase in stock. Say Phaser wants to expand its business. Phaser's solution is to buy out a rival.Since Phaser hasn't sold anything and doesn't have any actual, er, cash, it wants to issue its own stock to target company shareholders in exchange for their shares.
Now, if the target company has a market cap of roughly $32 billion. With Phaser shares trading for $10 a stub, our intrepid company will have to issue 3.2 billion new shares to acquire its heart's desire. Doing that will dilute Joe and Phaser's other shareholders thousands of times over. In what universe could that much dilution possibly be a good deal for Phaser shareholders?
The answer requires another question: Is Phaser overpaying for its purchase? If Phaser pays a price equal to target company's intrinsic value as a business, then the dilution created by the purchase does not really hurt Joe. Yes, Joe's slice of the merged Phaser pie looks much smaller than his slice of Phaser alone does. But the new pie is much bigger. Picture this: Joe is receiving a much thinner but also much longer slice of the (Phaser+Target) pie, in return for his original wide but stubby slice of Phaser.
And there's another possibility to consider. Alone, Phaser may not be objectively "worth" the $1 million market cap that the market accords it. If Phaser's stock is overvalued, then paying for an acquisition in inflated-value stock may be a smarter move than paying in cash.
Issuing More Stock through public offering or Convertible Bonds
When Phaser gives 100,000 shares to its CEO for a nominal "exercise" price, that's bad for outside shareholders. But what if, before Phaser decides to go that route, the message-board rumor mill gets going and anoints Phaser as the next moon-rocket stock? As Phaser's stock price doubles, triples, and then jumps 10 times more, company management reconsiders, decides not to issue options, and instead sells the 100,000 shares on the open market -- at $600 a pop.
If the company's intrinsic value hasn't changed, and if only its stock price has increased, then this is great news for Joe. After the secondary offering is completed, he again owns 10,000 shares out of 200,000, or 5% -- down from his original 10%. However, Phaser itself is now worth more -- not just from the rumor-bubble pricing of its stock but also intrinsically, because the company has traded 100,000 shares for $60 million in cash. That cash now sits in the company's bank account, and Joe owns 5% of it, or $3 million.
So to sum up, whenever a company issues shares at a price higher than the shares' intrinsic value -- whether it does so to buy another company or to sell the shares and raise cash on the market -- an outside shareholder benefits, despite his or her percentage of ownership being diluted.
The above article is courtesy MF
What does all this mean to an average investor named Joe?
Stock dilution refers to when a company issues additional stock, for any purpose. Some of those purposes are bad for outside shareholders, some are neutral, and believe it or not, some are actually good. We examine all three scenarios to see how they can affect us as investors.
Example.
In 2005, Phaser(a hypothetical company) had 100,000 shares of common stock outstanding, a market cap of $1 million, and $100 of net profits.An individual investor Joe, on Dec. 31, 2006, bought 10,000 shares of Phaser stock. When the company reported its earnings, Joe was elated to learn that, by virtue of his stake, he vicariously earned $10 worth of Phaser's profits. Little did he know what 2007 held in store for him.
Dilution Scenario One
In 2007, Phaser decides to engage in the worst of the three main ways that companies dilute their shares: It issues 100,000 stock options to its CEO. For the time being, Phaser has a "basic share count" of 100,000 shares actually outstanding. But because its CEO will eventually exercise his or her stock options (i.e., tell the company to issue 100,000 shares to him or her and then sell them on the open market), Phaser now has a hypothetical, or "diluted," share count of 200,000.
That's bad news for Joe. While he will still own his 10,000 shares, his ownership stake will be diluted once the company issues that extra stock. What does that mean? Well, when Phaser's share count stood at 100,000, and it earned $100, Joe was entitled to 10% (10,000/100,000) worth of those profits, or $10.
But when Phaser issues those 100,000 extra shares, Joe's shares will not equal 10% but just 5% (10,000/200,000) of all shares outstanding. If Phaser earns $100 again the next year, Joe's take from that haul is just $5. Poor Joe.
The CEO, on the other hand, gets 100,000/200,000 worth of the profits, or $50. Lucky CEO!
Thus, the primary reason Fools dislike stock dilution is that it often represents a transfer of wealth from outside shareholders -- you and me -- to insiders.
Dilution Scenario Two
Stock dilution, however, isn't always bad. But before we look at when it can be good, let's consider the iffy situation of a company that acquires another one and pays for the purchase in stock. Say Phaser wants to expand its business. Phaser's solution is to buy out a rival.Since Phaser hasn't sold anything and doesn't have any actual, er, cash, it wants to issue its own stock to target company shareholders in exchange for their shares.
Now, if the target company has a market cap of roughly $32 billion. With Phaser shares trading for $10 a stub, our intrepid company will have to issue 3.2 billion new shares to acquire its heart's desire. Doing that will dilute Joe and Phaser's other shareholders thousands of times over. In what universe could that much dilution possibly be a good deal for Phaser shareholders?
The answer requires another question: Is Phaser overpaying for its purchase? If Phaser pays a price equal to target company's intrinsic value as a business, then the dilution created by the purchase does not really hurt Joe. Yes, Joe's slice of the merged Phaser pie looks much smaller than his slice of Phaser alone does. But the new pie is much bigger. Picture this: Joe is receiving a much thinner but also much longer slice of the (Phaser+Target) pie, in return for his original wide but stubby slice of Phaser.
And there's another possibility to consider. Alone, Phaser may not be objectively "worth" the $1 million market cap that the market accords it. If Phaser's stock is overvalued, then paying for an acquisition in inflated-value stock may be a smarter move than paying in cash.
Issuing More Stock through public offering or Convertible Bonds
When Phaser gives 100,000 shares to its CEO for a nominal "exercise" price, that's bad for outside shareholders. But what if, before Phaser decides to go that route, the message-board rumor mill gets going and anoints Phaser as the next moon-rocket stock? As Phaser's stock price doubles, triples, and then jumps 10 times more, company management reconsiders, decides not to issue options, and instead sells the 100,000 shares on the open market -- at $600 a pop.
If the company's intrinsic value hasn't changed, and if only its stock price has increased, then this is great news for Joe. After the secondary offering is completed, he again owns 10,000 shares out of 200,000, or 5% -- down from his original 10%. However, Phaser itself is now worth more -- not just from the rumor-bubble pricing of its stock but also intrinsically, because the company has traded 100,000 shares for $60 million in cash. That cash now sits in the company's bank account, and Joe owns 5% of it, or $3 million.
So to sum up, whenever a company issues shares at a price higher than the shares' intrinsic value -- whether it does so to buy another company or to sell the shares and raise cash on the market -- an outside shareholder benefits, despite his or her percentage of ownership being diluted.
The above article is courtesy MF
Monday, November 26, 2007
Living in a Southern California Bubble
24 Shady Lane, Irvine, CA 92603, was purchased in January 2005 for $1,157,000. The combined first and second mortgages totalled $1,156,730 leaving a downpayment of $270.
By April 2007, they had multiple refinances on it finally with a first mortgage for $999,999, and a HELOC for $491,000. These owners pulled $333,000 in HELOC money.
Assuming they spent the entire HELOC, and assuming the negative amortization on the first mortgage has increased the loan balance, the total debt on the property exceeds $1,500,000. The asking price of $1,249,000 does not look like a rollback, but if the property actually sells at this price, the lender on the HELOC will lose over $300,000.
This is the story of a lot of households in California.
The Winner - The owners (may be...)
The Loser - The bank (lack of due diligence and loan standards)
This information is courtesy IHB
By April 2007, they had multiple refinances on it finally with a first mortgage for $999,999, and a HELOC for $491,000. These owners pulled $333,000 in HELOC money.
Assuming they spent the entire HELOC, and assuming the negative amortization on the first mortgage has increased the loan balance, the total debt on the property exceeds $1,500,000. The asking price of $1,249,000 does not look like a rollback, but if the property actually sells at this price, the lender on the HELOC will lose over $300,000.
This is the story of a lot of households in California.
The Winner - The owners (may be...)
The Loser - The bank (lack of due diligence and loan standards)
This information is courtesy IHB
What are SIVs?
Background...
SIV (Structured Investment Vehicle) has high net worth investors like hedge funds or wealthy individuals who invest say $1 Billion in the SIV (the equity). Then the SIV issues commercial paper (CP) and medium-term notes (MTN) that pay slightly higher rates than similar duration paper. The typical SIV, according to Fitch, uses 14 times leverage, so in our example the SIV would sell CP and MTN for $14 Billion.
Now the SIV invests this $15 Billion ($1 Billion equity and $14 Billion borrowed) in longer term notes. The idea is simple: borrow short, lend long, hedge the interest rate and credit risks - and the profits flow to the investors in the SIV.
Usually the bank sets up the SIV, attracts the investors, manages the SIV for a fee - and there was always the appearance that the SIV CP was backed by the bank - perhaps allowing the CP and MTN to pay lower interest rates.
Now the problem....and how HSBC plans to solve it
Some SIVs invested in asset backed paper, backed by home mortgages. Even though the SIVs almost always invested in the highest tranches (with no losses to date), the market value of these assets has fallen recently.This means that the investors in the SIV (the equity) have taken paper losses on their $1 Billion investment.In fact many of the SIV NAVs have fallen substantially.A NAV of 71% means the $1 Billion equity in the example is now worth $710 million.
Once the value of the equity falls enough (usually 50%) there is usually a trigger event forcing the SIV to liquidate the longer term investments. A forced liquidation might not only wipe out all the remaining SIV equity, but the holders of the CP and MTN might take some losses too.
This has made potential investors in CP and MTN (not to be confused with the investors in the equity of the SIV) to refuse to buy any more CP. Since there is a duration mismatch - the investments are in longer term notes, CP is less than 9 months - the SIV is stuck with a liquidity problem when the CP comes due.
To solve this problem, a bank like HSBC could explicity guarantee the CP and MTN, and this would attract investors in CP and MTN again. But under accounting rules, this guarantee means the SIV belongs on the bank's balance sheet. The structure stays the same - the SIV equity investors still take the losses - but there is no liquidation event. If the losses exceed the equity investment ($1 Billion in our example), then the bank would start taking losses.
The balance sheet lists the assets and liabilities of the company. Moving the SIV to the balance sheet simply means adding the $15 Billion in assets (those longer term notes) to the Asset portion of the balance sheet, and moving the $15 Billion in CP, MTN and SIV equity to Liabilities. The new assets balance with the new liabilities, and there is no income or loss for the bank. Since the equity will take the losses first, any mark down in the $15 Billion in assets will be matched by a mark down in the liabilities - up to $1 Billion.
Problem for the bank?
There is an impact on the ratios of the bank - the reason the SIVs were off the balance sheet in the first place - and this limits other lending activities of the bank, contributing to the credit contraction.
The above information is Courtesy CR
SIV (Structured Investment Vehicle) has high net worth investors like hedge funds or wealthy individuals who invest say $1 Billion in the SIV (the equity). Then the SIV issues commercial paper (CP) and medium-term notes (MTN) that pay slightly higher rates than similar duration paper. The typical SIV, according to Fitch, uses 14 times leverage, so in our example the SIV would sell CP and MTN for $14 Billion.
Now the SIV invests this $15 Billion ($1 Billion equity and $14 Billion borrowed) in longer term notes. The idea is simple: borrow short, lend long, hedge the interest rate and credit risks - and the profits flow to the investors in the SIV.
Usually the bank sets up the SIV, attracts the investors, manages the SIV for a fee - and there was always the appearance that the SIV CP was backed by the bank - perhaps allowing the CP and MTN to pay lower interest rates.
Now the problem....and how HSBC plans to solve it
Some SIVs invested in asset backed paper, backed by home mortgages. Even though the SIVs almost always invested in the highest tranches (with no losses to date), the market value of these assets has fallen recently.This means that the investors in the SIV (the equity) have taken paper losses on their $1 Billion investment.In fact many of the SIV NAVs have fallen substantially.A NAV of 71% means the $1 Billion equity in the example is now worth $710 million.
Once the value of the equity falls enough (usually 50%) there is usually a trigger event forcing the SIV to liquidate the longer term investments. A forced liquidation might not only wipe out all the remaining SIV equity, but the holders of the CP and MTN might take some losses too.
This has made potential investors in CP and MTN (not to be confused with the investors in the equity of the SIV) to refuse to buy any more CP. Since there is a duration mismatch - the investments are in longer term notes, CP is less than 9 months - the SIV is stuck with a liquidity problem when the CP comes due.
To solve this problem, a bank like HSBC could explicity guarantee the CP and MTN, and this would attract investors in CP and MTN again. But under accounting rules, this guarantee means the SIV belongs on the bank's balance sheet. The structure stays the same - the SIV equity investors still take the losses - but there is no liquidation event. If the losses exceed the equity investment ($1 Billion in our example), then the bank would start taking losses.
The balance sheet lists the assets and liabilities of the company. Moving the SIV to the balance sheet simply means adding the $15 Billion in assets (those longer term notes) to the Asset portion of the balance sheet, and moving the $15 Billion in CP, MTN and SIV equity to Liabilities. The new assets balance with the new liabilities, and there is no income or loss for the bank. Since the equity will take the losses first, any mark down in the $15 Billion in assets will be matched by a mark down in the liabilities - up to $1 Billion.
Problem for the bank?
There is an impact on the ratios of the bank - the reason the SIVs were off the balance sheet in the first place - and this limits other lending activities of the bank, contributing to the credit contraction.
The above information is Courtesy CR
Saturday, November 24, 2007
Is this a confirmation to Sell?
Maybe.....
1. DJIA and DJTA must undergo a significant correction from joint new highs.(July 2007)
2. In their subsequent rally attempt following that correction, either one or both of the averages fail to rise above their precorrection highs. (Sep 2007)
3. Both averages must then drop below their respective correction lows. (Nov 2007)
For those who care, 12,846 is the number to watch..........
1. DJIA and DJTA must undergo a significant correction from joint new highs.(July 2007)
2. In their subsequent rally attempt following that correction, either one or both of the averages fail to rise above their precorrection highs. (Sep 2007)
3. Both averages must then drop below their respective correction lows. (Nov 2007)
For those who care, 12,846 is the number to watch..........
Tuesday, November 20, 2007
What is Lua?
Lua, an extension programming language (a language for extending applications). It supports procedural languages by using powerful data description facilities.
What does extension programming language mean?
There is increasing demand for customizable applications. As applications became more complex, customization with simple parameters became impossible: users now want to make configuration decisions at execution time; users also want to write macros and scripts to increase productivity. In response to these needs, there is an important trend nowadays to split complex systems in two parts: kernel and configuration.
The kernel implements the basic classes and objects of the system, and is usually written in a compiled, statically typed language, like C. The configuration part, usually written in an interpreted, flexible language, connects these classes and objects to give the final shape to the application.
Configuration languages come in several flavors, ranging from
a. simple languages for selecting preferences usually implemented as parameter lists in command lines or
b. as variable-value pairs read from configuration files (Windows .ini files, X11 resource files) or
c. as embedded languages, for extending applications with user defined functions based on primitives provided by the applications. Embedded languages can be quite powerful, being sometimes simplified variants of mainstream programming languages such as C.
Such configuration languages are also called extension languages, since they allow the extension of the basic kernel semantics with new, user defined capabilities. Lua is such a language.
What does powerful data description facilities mean?
Associative arrays are a powerful language construct for describing data used in an application.
Many algorithms are simplified to the point of triviality because the required data structures and algorithms for searching them are implicitly provided by the language.
Lua uses tabled for data description. Most typical data containers, like ordinary arrays, sets, bags, and symbol tables, can be directly implemented by tables.
Tables can also simulate records by simply using field names as indices. Lua supports this representation by providing
What makes extension languages different?
They only work embedded in a host client, called the host program. Moreover, the host program can usually provide domain-specific extensions to customize the embedded language for its own purposes, typically by providing higher level abstractions. For this, an embedded language has both a syntax for its own programs and an application program interface (API) for communicating with hosts. Unlike simpler configuration languages, which are used to supply parameter values and sequences of actions to hosts, there is a two-way communication between embedded languages and host programs.
What are the requirements of extension languages?
In its design, the addition of many different features has been replaced by the creation of a few meta mechanisms that allow programmers to implement those features themselves. These meta mechanisms are: dynamic associative arrays, reflexive facilities, and fallbacks.
Currently, Lua is being extensively used in production for several tasks, including user configuration, general-purpose data-entry, description of user interfaces, storage of structured graphical metafiles, and generic attribute configuration for finite element meshes.
It took me 1 Hour and 10 mins to write this up on Nov 20th 2007 (9:30 am - 10:40 am). Just after bi-weekly HDK meeting.
More Information
What does extension programming language mean?
There is increasing demand for customizable applications. As applications became more complex, customization with simple parameters became impossible: users now want to make configuration decisions at execution time; users also want to write macros and scripts to increase productivity. In response to these needs, there is an important trend nowadays to split complex systems in two parts: kernel and configuration.
The kernel implements the basic classes and objects of the system, and is usually written in a compiled, statically typed language, like C. The configuration part, usually written in an interpreted, flexible language, connects these classes and objects to give the final shape to the application.
Configuration languages come in several flavors, ranging from
a. simple languages for selecting preferences usually implemented as parameter lists in command lines or
b. as variable-value pairs read from configuration files (Windows .ini files, X11 resource files) or
c. as embedded languages, for extending applications with user defined functions based on primitives provided by the applications. Embedded languages can be quite powerful, being sometimes simplified variants of mainstream programming languages such as C.
Such configuration languages are also called extension languages, since they allow the extension of the basic kernel semantics with new, user defined capabilities. Lua is such a language.
What does powerful data description facilities mean?
Associative arrays are a powerful language construct for describing data used in an application.
Many algorithms are simplified to the point of triviality because the required data structures and algorithms for searching them are implicitly provided by the language.
Lua uses tabled for data description. Most typical data containers, like ordinary arrays, sets, bags, and symbol tables, can be directly implemented by tables.
Tables can also simulate records by simply using field names as indices. Lua supports this representation by providing
a.name as syntactic sugar for a["name"].Lua provides a number of interesting ways for creating a table. The simplest form is the expression {}, which returns a new empty table. A more descriptive way, which creates a table and initializes some fields, is shown below; the syntax is somewhat inspired in the BibTeX [13] database format:
window1 = {x = 200, y = 300, foreground = "blue"}
This command creates a table, initializes its fields x, y, and foreground, and assigns it to the variable window1. Note that tables need not be homogeneous; they can simultaneously store values of all types. A similar syntax can be used to create lists:
colors = {"blue", "yellow", "red", "green", "black"}
This statement is equivalent to: colors = {}
colors[1] = "blue"; colors[2] = "yellow"; colors[3] = "red"
colors[4] = "green"; colors[5] = "black"
Sometimes, more powerful construction facilities are needed. Instead of trying to provide everything, Lua provides a simple constructor mechanism. Constructors are written name{...}, which is just syntactic sugar for name({...}). Thus, with a constructor, a table is created, initialized, and passed as parameter to a function. This function can do whatever initialization is needed, such as (dynamic) type checking, initialization of absent fields, and auxiliary data structures update, even in the host program. Typically, the constructor function is pre-defined, in C or in Lua, and often configuration users are not aware that the constructor is a function; they simply write something like:
window1 = Window{ x = 200, y = 300, foreground = "blue" }
and think about ``windows'' and other high level abstractions. Thus, although Lua is dynamically typed, it provides user controlled type constructors. Because constructors are expressions, they can be nested to describe more complex structures in a declarative style, as in the code below:
d = dialog{
hbox{
button{ label = "ok" },
button{ label = "cancel" }
}
}
What makes extension languages different?
They only work embedded in a host client, called the host program. Moreover, the host program can usually provide domain-specific extensions to customize the embedded language for its own purposes, typically by providing higher level abstractions. For this, an embedded language has both a syntax for its own programs and an application program interface (API) for communicating with hosts. Unlike simpler configuration languages, which are used to supply parameter values and sequences of actions to hosts, there is a two-way communication between embedded languages and host programs.
What are the requirements of extension languages?
- extension languages need good data description facilities, since they are frequently used as configuration languages;
- extension languages should have a clear and simple syntax, because their main users are not professional programmers;
- extension languages should be small, and have a small implementation. Otherwise, the cost of adding the library to an application may be too high;
- extension languages are not for writing large pieces of software, with hundreds of thousands lines. Therefore, mechanisms for supporting programming-in-the large, like static type checking, information hiding, and exception handling, are not essential;
- finally, extension languages should also be extensible. Unlike conventional languages, extension languages are used in a very high abstraction level, adequate for interfacing with users in quite diverse domains.
In its design, the addition of many different features has been replaced by the creation of a few meta mechanisms that allow programmers to implement those features themselves. These meta mechanisms are: dynamic associative arrays, reflexive facilities, and fallbacks.
Dynamic associative arrays directly implement a multitude of data types, like ordinary arrays, records, sets, and bags. They also lever the data description power of the language, by means of constructors.
Reflexive facilities allow the creation of highly polymorphic parts. Persistence and multiple name spaces are examples of features not directly present in Lua, but that can be easily implemented in Lua itself using reflexive facilities.
Finally, although Lua has a fixed syntax, fallbacks can extend the meaning of many syntactical constructions. For instance, fallbacks can be used to implement different kinds of inheritance, a feature not present in Lua.
Where can we use Lua?Currently, Lua is being extensively used in production for several tasks, including user configuration, general-purpose data-entry, description of user interfaces, storage of structured graphical metafiles, and generic attribute configuration for finite element meshes.
It took me 1 Hour and 10 mins to write this up on Nov 20th 2007 (9:30 am - 10:40 am). Just after bi-weekly HDK meeting.
More Information
Thursday, November 8, 2007
KPP Seminars Attended
March 2006 The sun should never set on your investments - A primer on International investing
July 19th 2006 What it takes to stay ahead of the market
Oct 11th 2006 Happy New Year! – Stocks and Sectors that should shine in 2007
Nov 2006 Politics and profits - The Presidential Cycle
March 21 2007 Tough times ahead? - Prospering in a shaky market
June 21 2007 Back to the Basics - Improving your analytical skills
July 19th 2006 What it takes to stay ahead of the market
Oct 11th 2006 Happy New Year! – Stocks and Sectors that should shine in 2007
Nov 2006 Politics and profits - The Presidential Cycle
March 21 2007 Tough times ahead? - Prospering in a shaky market
June 21 2007 Back to the Basics - Improving your analytical skills
Tuesday, October 30, 2007
Free Courses Online
#1 UC Berkeley
Ranked as the #1 public school in the United States, Berkeley offers podcasts and webcasts of amazing professors lecturing. Each course has an RSS feed so you can track each new lecture. For printable assignments and notes you can check the professors homepage, which is usually given in the first lecture or google his name. Even though the notes, homework and tests are not directly printed in the berkeley website, as they are in MIT and other courseware sites, it's not a problem to find them. I personally tried to use it for John Wawrzynek's machine structures class and the nutrition courses.
Visit: Berkeley WebcastsVisit: Berkeley RSS Feeds
Visit: UC Berkeley on Google Video
Getting The Most From Berkeley Webcasts
Berkeley Videos are in .rm format and real player can be a pain. It asks you to register real player, spawns on startup. Instead, download a free program called media player classic with the real alternative plugin. Media player classic is fully featured and much easier on the computers memory. The real alternative plugin download seems to come with an older version of media player classic, so updating media classic is optional.
Download: Real Alternative PluginDownload: Media Player Classic For Windows XP/2000
Download: Media Player Classic For Windows 98/ME
#2 MIT Open Courseware
The Massachusetts Institute of Technology is ranked 7th nationally in the United States. Many of the courses do not have video lectures. Instead, they have notes in PDF format along with tests and homework.
Visit: MIT OpenCourseware Course ListingsVisit: MIT OpenCourseware Online Textbooks
Visit: MIT Courses With Video Lectures
Visit: MITWorld Public Videos
Visit: MIT Pocast: ZigZag
Getting the Most Out of MIT OCW
Since MIT OCW is heavily based on opening PDF files it's recommended you download FoxIt Reader, a freeware PDF reader that's many times faster than the bulky and slow adobe acrobat. Also Ghost Script in combination with GSView is able to read pdfs, and post scripts files.
Download: Foxit Reader#3 Carnegie Mellon's Open Learning Initiative
Carnegie Mellon is a private research university ranked equal with Berkeley. Though registration is not required they have a registered user mode that allows you to keep track of your scores and progress. Currently 11 courses are offered. The courses are basically ebooks in a frame-based easy to use navigation system with an occasional powerful interactive Java Applet for practice and testing.
Visit: Carnegie Mellon OLI#4 Utah State OpenCourseWare
Utah State has a very familiar structure as MIT OCW with large available course listing.
Visit: Utah State Course Listings#5 Tufts OpenCourseWare
Tufts University in Massachusetts has a very familiar structure as MIT OCW with large available course listing.
Visit: Utah State Course Listings#6 Openlearn
European site called Open University's OpenLearn supported by The William and Flora Hewlett Foundation. Contains many online course and a different style content management system. I was unable to find anything interactive or any streaming media, though it does have forums for each course. Appears to function mostly as a large educational ebook library.
Visit: OpenLearn2 #7 JHSPH OCW
Johns Hopkins University Bloomberg School of Public Health offers health based lecture notes and assigments. You'll find the JHSPH OCW website uses the same familiar navigation structure as MIT OCW. The notes are formatted much more cleanly but I haven't seen exams, and their search bar seems to be broken.
Visit: JHSPH OCW Course ListingsVisit: Johns Hopkins University Podcasts
#8 Connexions
CNX.org is an open-content library of course materials developed by Rice University. It has a huge database of content which is very useful for people who know what they're looking for. It does have ebook style higher level courses courses you can choose from.
Visit: ConnexionsVisit: Connexions Course List
#9 Sophia
Initiative is led by Foothill College which contains 8 free courses.
Visit: Sofia#10 University of Washington Computer Science & Engineering
Contains posted lectures and classnotes. Some of the courses even contain video lectures.
http://www.cs.washington.edu/education/course-webs.htmlNotre Dame OpenCourseware
Just found out about this one.
http://ocw.nd.edu/Wikiversity
From the creators of wikipedia, Wikiversity describes itself as being a community seeking to create and use learning materials and activities. Wikibooks is also incredibly powerful already containing everything from a detailed guide to learning French to Organic Chemistry and Nanotechnology.
Visit: WikiversityVisit: Wikibooks
Archive.org Education
Contains 1354 educational resources at the time of posting.
Visit: Archive.org EducationHonorable Mention: Peoi.org
Visit: Peoi.orgBarnes and Nobles University
Free online courses given as long as you buy the required reading material. Unfortunately barnes and nobles university is now barnes and nobles book club.
More University Video Sites
http://globetrotter.berkeley.edu/conversations/http://graduateschool.paristech.org/?langue=EN
http://www.researchchannel.org/prog/
http://mitworld.mit.edu/
http://www.princeton.edu/WebMedia/lectures/
http://ci.columbia.edu/ci/
http://www.law.duke.edu/webcast/index.html
http://www.hno.harvard.edu/multimedia/video_mm.html
http://www.law.georgetown.edu/sci/sls.html#Presentations
http://athome.harvard.edu/archive/archive.asp
http://www.ksg.harvard.edu/multimedia/videoarchive.html
http://www.law.harvard.edu/news/webcasts/
http://webcast.oii.ox.ac.uk/?view=Default
http://www.princeton.edu/WebMedia/lectures/
http://www.gsb.stanford.edu/news/audiovideo.html
http://shc.stanford.edu/events/archive.htm
http://www.oid.ucla.edu/Webcast/
http://www.yale.edu/yale300/democracy/mediatranscripts.htm
http://yaleglobal.yale.edu/video.jsp
http://freescienceonline.blogspot.com/
Jimmy Ruska
http://freevideolectures.com/
Monday, October 29, 2007
How to issue Shares to Partners
Why Do You Need a Partner?
If you are very bright, very tenacious, and financially well endowed, then you can start a company which you own in its entirety and in which you can hire a bright, capable, highly motivated and well-paid management team. However, if you do not fit this description entirely (I might add that, if you do not possess at least one of these attributes, you might want to re-think starting your own business), then you will likely have to bring "partners" into your company by giving them equity, i.e. some share ownership. Obviously, investors who bring money to fuel the growth of your company deserve some ownership. Similarly, key people who join you on your team, or who start the company with you, will want some form of ownership if they are making a valuable contribution for which they are not being fully paid in cash. Others who contribute their skills, experience, ideas, or other assets (such as intellectual property) may be given shares in your company in lieu of being paid in cash.How do you deal in New Partners?
Valuation is the issue. What is the new partner's contribution worth in relation to the whole pie? At that moment in time, what is the company worth and how is that worth determined? Bringing in new shareholders always means "dilution" to the existing shareholders. If a new investor is to receive a 10% stake in the company, then a shareholder who previously held 40% of the equity, will now hold 36% (i.e. 90% of 40%). You never actually never give up your shares when new people are dealt in. You simply issue more shares (the same way governments print money). Issuing more shares is what causes the dilution. If you have 100 shares and you want to give someone 10%, you'd have to issue 11 new shares (11/111 x 100 = 10%, approximately).Unless you are greatly concerned about control issues, each time you dilute you should be increasing your economic value. If you dilute your ownership from 40% to 36%, you still hold the same number of shares, but the per-share value should have increased. For example, if you entice Terry Mathews (of Newbridge and Mitel fame) to your board by paying him 10%, it is quite likely that your shares will double or triple in value (i.e. market value for sure and hopefully also intrinsic value because of strengthened leadership). If your 40% was worth $1 million, your resulting 36% may now be worth $3 million!
If you bring in a new VP of Marketing and give her 5% as a signing bonus, how do you know that her contribution will be worth 5%? How do you measure someone's reputation? Unless the person is well known or has a proven record, it may not be so easy. That's why vesting (described later) may be appropriate.
There is only one way to bring in new partners: carefully and with deliberation. A partner may be with you for life. It may be more difficult to terminate a business partnership than it is to obtain a marital divorce. So think about it!
Who Should Get What?
What percentage of the company should each partner in a new venture receive? This is a tough question for which there is no easy answer. In terms of percentage points, what's an idea (or invention or patent) worth? What's 5 years of low salary, sweat and intense commitment worth? What is experience and know-how worth? What's a buck worth? "Who should get what" is best determined by considering who brings what to the table.Suppose Bill Gates said he'd serve on your Board or give you some help. What share of the company should he get? Just think about the value that his name would bring to your company! If a venture capitalist thought your company was worth $1 million without Gates, that value would increase several-fold with Gates' involvement. Yet, what has he "done" for you?
Often, company founders give little thought to this question. In many cases, the numbers are determined by what "feels good", i.e. gut-feeling. For example, in the case of a brand-new venture started from scratch by four engineers, the tendency might be to share equally in the new deal at 25% each. In the case of a single founder, that person may choose to keep 100% of the shares and build this venture through a "bootstrapping" process, in order to maintain total ownership and control by not dealing in other partners. It may be possible to defer dealing in new partners until some later time at which point the business has some inherent value thereby allowing the founder to maintain a substantial ownership position.
The answer to the question "who should get what" is, in principle, simple to answer: It depends on the relative contributions and commitments made to the company by the partners at that moment in time. Therefore, it is necessary to come up with a value for the company, expressed in either monetary terms or some other common denominator. It gets trickier when there are hard assets (cash, equipment) contributed by some parties and soft assets (intellectual property, know-how) contributed by others. Let's look at a some examples for illustration.
1. Professor Goldblum has developed a new product for decreasing the cost of automobile fuel consumption. He decides that in order to bring this innovation to market, he will need a business partner to help him with a business plan, and then manage and finance a new company formed to exploit this opportunity. He recruits Sam Brown, aged 45, who has a good record as a local entrepreneur. They agree that Sam will get 30% of the company for contributing his experience, contacts, and track record plus the fact that he will take a $50K/year salary instead of a "market" salary of $100K for the first two years. Furthermore, they agree that Sam will commit his full-time attention to the firm for 5 years and that should he leave, for whatever reason before the full term, he would forfeit 4% of the equity for each year under the 5 year term. The Professor takes 60% for contributing the intellectual property and for providing on-going technical advice and support. The Professor "gives" the University a token 10% because according to University policy, the University is entitled to "some share" of his intellectual property because of its contribution of facilities even though, under its policy, the intellectual property rights rest with the creator. Although these numbers are somewhat arbitrary, they are seen by the parties as being fair based on the relative contributions of the parties. As a taxpayer, one might suggest that the University got the short end of the deal, but that's a moot point.
2. Three freshly graduated software engineers decide to form a new software company which will develop and sell a suite of software development tools, bearing in mind the paucity of software talent plaguing the industry. They all start off with similar assets, i.e. knowledge of software, and comparable contributions of "sweat equity". Heidi takes on the role of CEO of the new venture and they divide the pie as to 40% for Heidi (because of her greater responsibilities) and 30% each for the other two. They are happy campers for now. Some time later, they decide to recruit a seasoned CEO with relevant experience and bring in a Venture Capital investor to fund the promotion of their then-developed and shipable suite of software products. They will then have to wrestle with the issue of what their company is now worth and how much ownership they will have to trade for these new resources. This will be determined by the venture capital suitor(s) in light of current market investment conditions and the attractiveness of this particular deal.
3. Four entrepreneurs who have recently enjoyed financial windfalls from their businesses, decide to get into the venture capital business. They decide to form a company with $10 million in investment capital. Harry provides $3 million, Bill provides $2 million, and the other two each provide $2.5 million. How much of the new company will each of them own? (This isn't a trick question.) For assets as basic as cash, it is easy to determine "fair" percentages.
In the case of the second example above, we have a situation in which a company is established and has some value by virtue of its products and potential sales in the market. The company's Board decides to bring in an experienced CEO (this also makes the venture capitalist happy) to develop the business to its next stage of growth. Although it may be possible to hire such a person and pay him/her an attractive salary, it probably makes more sense to bring in such a person as more of a partner than a hired hand. In this case a lower-than-market salary could be negotiated along with an equity stake. One way of doing this is to apply the difference between market rate and the actual salary over a period of time, say 5 years, to an equity position based on a company valuation acceptable to the founders. If a venture capital investment has been made or is being negotiated, this may set the stage for such a valuation. For example, Louise was earning $125,000 per year working as the CEO of an American company's Canadian operations. She agrees to work for $75,000 per year for 5 years. She is essentially contributing $250,000 up front (in the form of equity that does not have to be raised to hire her). If the company has been valued at $2 million, she ought to receive something in excess of 10% of the company. However, her shares would "vest" over 5 years meaning that each year she would receive one-fifth of the shares from "escrow". She would forfeit any shares not so released should she break her commitment or should her employment be terminated for cause. In this example, Louse's salary is really $125,000 per year but she is investing a portion of this in the company's equity (on a tax-advantaged basis, I might add!).
For more mature companies and especially for publicly-listed companies, it is possible to provide managers with incentive stock options as an additional incentive in the form of a reward if the company performs well and if the stock price reflects this performance. However, this is not the same as ownership and should be viewed as part of a salary package.
Important Point: Don't confuse equity (i.e. investment and ownership) with income (i.e. salary)!
Shares vs Percentage Points
Sometimes people will get hung up on percentage points. For example, if a new company is created which consists of many people, it may not be possible to divide that fixed 100% into 20 or 30 meaningful chunks of 10%. It just won't work. Some people may receive only 3% and may feel slighted by what appears to be an insignificant amount (although I sure would like to have had 1% of Microsoft when it got started). It's too bad that only 100 percentage points are available. However, there is no limit on the number of shares which can be issued. So, let's issue 10 million shares and give our 3% person 300,000 shares. We all know that someday these shares might be worth $5, $10, or $50! Work it out! It suddenly becomes more palatable.So, how many shares should be issued? Small public companies usually have between 5 and 15 million shares outstanding. Larger public companies may have 100 million or more shares issued. Private companies, large or small, have fewer shares issued - anywhere from 1 to perhaps a few million. The number is not really important for private companies because these shares do not trade in a public market. When companies go public, i.e. list their shares for trading, there are often stock splits such that 5 or 10 new shares are traded for each existing share in order to give a company a "normal" number of shares and a "normal" price range.
The number of shares which you will issue when you first start out should be determined by how many partners you wish to have. If only a handful, then you could simply issue 100 shares with the percentage points being equivalent to the number of shares. It might make you and your partners feel better to increase this number by a few orders of magnitude. That's OK, too. If you have many partners, it helps to have many shares - even if only for psychological reasons.
Novice entrepreneurs may think, "Gee, it would be nice to own 5 million shares in a company." True, but it may cause complications if you have too high a number. For example, if you start with 10 million shares and then deal others in so that you end up with 15 million shares and then you decide to go public, resulting in over 20 million shares, this may be too large a number and you may have to do a roll-back or consolidation (see next paragraph).
Stock Splits and Stock Rollbacks
You have probably heard of a "stock split". This happens often with publicly traded companies when their share prices become "too high". Microsoft, for example, has split many times. That's why Bill has 270 million shares. Microsoft does this when the share price appears too expensive for the average investor. After all, who wants to pay $500 for one share? If you split 2 for 1, then the price per share would be $250, but if you split 5 for 1, the price per share would now be $100. When companies split their shares, they do so simply by exchanging new shares for old shares with all the shareholders.Stock rollbacks or share consolidations as they are sometimes called are the reverse of stock splits - but with one notable difference. When a rollback is done, 1 new share is issued for 2 or 3 (or whatever the Board decides) old shares. However, the new shares are issued under a new corporate name meaning that the company must change its legal name. Often the change is minor, such as from Acme Corp to Acme Inc or from Acme Corp to Acme 2000 Corp. This is done so that the new shares are not as likely to be confused with old shares. This is not the case for splits, assuming that shareholders will want to trade in their old shares for new shares whereas in the case of consolidations shareholders will not be eager to trade their old for their new.
Why a rollback? If a share price is too low, the company may appear like a "penny stock" or nickle-and-dime outfit. So, if a stock is trading at $.10 per share a 1 for 10 rollback, will give the stock a more respectable dollar appearance. Also, if a smaller, more junior company has 500 million shares outstanding (which can happen), it may be better, for market reasons, to have a tigher "float" (i.e. number of issued shares trading on the market).
In terms of what is appropriate, here are some ballpark numbers to consider. Private companies, closely held (i.e. few shareholders) would have a small number of shares, regardless of their size. Private sompanies with a larger number of shareholders (say up to 50) could have a few thousand or even a few million shares issued. Small public companies (with annual sales below $10 million) such as those trading on a junior stock exchange, like Vancouver, would have between 5 and 10 million shares issued. Senior companies (with annual sales in excess of $100 million) such as those trading on Toronto, might have more than 50 million shares issued. The really mammoth corporations with sales in the billions of dollars will likely have more than 100 million shares issued. Microsoft has about 600 million shares issued as at March, 1997.
Implications of Ownership
Ownership means sharing risks and sharing rewards. It implies a certain degree of control (i.e. risk management) insofar as the shareholders appoint the management team and it implies a sharing in the value of the company - however measured (i.e. profits, the net worth, market value, etc). These are two distinctly different concepts. The astute entrepreneur might ask herself if she wants to be a wealthy, independent owner or if she wants to be a very busy manager! Most owners, especially founders appoint themselves as the senior managers. And, they have this right. But, I'd rather be rich than busy or poor. The most important aspect of share ownership is that as the value of the company increases, one's share of the value also increases. Bill Gates doesn't really have billions of dollars. What he has is a fraction (one-quarter, roughly) of a business worth many billions of dollars. Your risk is the investment you put in, other forgone opportunities, and possibly reputation (if the deal sours). But the reward may be unlimited. That's why equity is so attractive. It is not uncommon for a founder of a high tech venture to own a million shares (which cost him very little in the form of cash) and see these shares appreciate to a value of several million dollars in a relatively short time frame. There are literally thousands of examples of this - Gates being the most prominent one.Ownership does not imply any additional obligations nor liabilities. Once an equity stake is purchased, or "vested", it belongs to the owner forever. It also entitles the owner to vote for the company's board of directors, its governing body. Depending on the relative shareholding, a shareholder may have very little control as in the case of a large public company or very substantial control as in the case of a small company in which he has more than 50% of the votes or in which he may have less than 50% of the votes, but still have great influence by virtue of a shareholders' agreement.
A very successful founder once said, "I'm not really very smart, but I sure do have a lot of smart people working for me!". This person understood the difference between ownership and management.
What's a Company Worth? (and When?)
How is value added to a business over a period of time? All companies start off being worth only the incorporation expense. As soon as people, money and assets are added or developed, a company will appreciate in value. If the management team comes up with a breakthrough technology, that may be worth millions of dollars! The development of products and customers adds value. The management team itself is worth something by virtue of its aggregate experience, skill, contacts, etc. Value is best measured in terms of potential, not in terms of historical earnings or financial track record - but in terms of future performance possibilities. Value increases both through internal actions and growth as well as through external contributions (e.g. cash and people) which facilitate such growth.For founders and early investors, the upside potential is the greatest. In its early stages of development a company may be worth very little, especially to outsiders. All of the value may be dormant within the team - awaiting development. Those who contribute at this early stage deserve to enjoy enormous gains because they are the ones who are bold enough to take the initial risks. An "angel" investor who provides a University faculty member with a small amount of start-up funding, say $50,000 to prepare an invention for exploitation, may easily deserve 10 or 20% of that business. After a concept is more fully developed, this initial position may be viewed as a "steal", but then again, most such "steals" end up being worthless deals!
It is both unhealthy and unrealistic for an entrepreneur to begrudge the stake held by his or her early backers. Sometimes there is a tendency towards seller's remorse. For example, an entrepreneur who sells 20% of his firm for $50,000 may feel cheated one year hence when a serious investor is willing to pay $500,000 for 20%. This is flawed thinking. Without that intial $50,000, this company may never have survived its first year. In this illustration, the founder initially had 100%, then 80%, then ended up with 64%. The angel had 20%, then ended up with 16%. The rich investor ended up with 20% - at least until the next round at which time they will all again suffer a dilution. Ideally, as time marches on, the value of the company increases dramatically such that subsequent dilutions become less and less painful to existing stakeholders. Sometimes, when milestones are not achieved, the early investors and founders must swallow a bitter pill by enticing new investors with large equity positions with major dilutive consequences. But, that's business!
The value of a business is best ascertained by what an investor is willing to pay for it (i.e. its shares) or what a potential strategic acquisitor (i.e. an investor (or competitor) who wants to buy it for strategic business reasons) is willing to pay for it.
It is prudent management philosophy to always be thinking in terms of making a business attractive to such suitors by building a solid foundation and by nurturing and growing it. The business should always be in a condition to sell it.
Other Alternatives
Let's be creative. You don't always have to give up shares in your company if you can't pay cash. Also, it gets messy (from a corporate governance perspective) having too many, especially small, investors. You might be able to negotiate a deferred payment arrangement, possibly with interest. If you need to acquire a tangible asset, you can likely obtain bank or third-party financing. For soft assets like intellectual property, you could consider entering into a royalty arrangement, i.e. for every unit sold embodying said intellectual property, you pay a 5% royalty on sales to the provider of the asset. And remember, equity is expensive. Giving someone a 5% stake, means that that party owns 5% of your firm's net worth and profits forever! So, tread cautiously.Summary
Dividing the pie is not easy. In the end, or to put it more correctly - in the beginning, it is important that all equity partners accept the deal. Each shareholder would like to own a bigger percentage - that only makes sense. But, unfortunately, all the "percents" have to add up to 100. That's why it's nice to be able to issue 10 million shares. It sounds a lot better to own 100,000 shares in the next hot software deal, than to only own a mere one percent!At the time you sell some or all of your shares in the company, remember that it is dollars which you put into your bank account, not percentage points.
The Sensex Story
Imagine an investment fetching an average of 19% compounded annual returns for the next 17 years.
That is what the Indian Stock market has done since 1990
To keep things in perspective, if you invested 10,000($/EUR/Yen/Rs) in July 1990 it would have been 200,000($/EUR/Yen/Rs) in Oct 2007.
The journey....
1000, July 25, 1990
On July 25, 1990, the Sensex touched the magical four-digit figure for the first time and closed at 1,001 in the wake of a good monsoon and excellent corporate results.
2000, January 15, 1992
On January 15, 1992, the Sensex crossed the 2,000-mark and closed at 2,020 followed by the liberal economic policy initiatives undertaken by the then finance minister and current Prime Minister Dr Manmohan Singh.
3000, February 29, 1992
On February 29, 1992, the Sensex surged past the 3000 mark in the wake of the market-friendly Budget announced by the then Finance Minister, Dr Manmohan Singh.
4000, March 30, 1992
On March 30, 1992, the Sensex crossed the 4,000-mark and closed at 4,091 on the expectations of a liberal export-import policy. It was then that the Harshad Mehta scam hit the markets and Sensex witnessed unabated selling.
5000, October 8, 1999
On October 8, 1999, the Sensex crossed the 5,000-mark as the BJP-led coalition won the majority in the 13th Lok Sabha election.
6000, February 11, 2000
On February 11, 2000, the infotech boom helped the Sensex to cross the 6,000-mark and hit and all time high of 6,006.
7000, June 20, 2005
On June 20, 2005, the news of the settlement between the Ambani brothers boosted investor sentiments and the scrips of RIL, Reliance Energy [Get Quote], Reliance Capital [Get Quote], and IPCL [Get Quote] made huge gains. This helped the Sensex crossed 7,000 points for the first time.
8000, September 8, 2005
On September 8, 2005, the Bombay Stock Exchange's benchmark 30-share index -- the Sensex -- crossed the 8000 level following brisk buying by foreign and domestic funds in early trading.
9000, November 28, 2005
The Sensex on November 28, 2005 crossed the magical figure of 9000 to touch 9000.32 points during mid-session at the Bombay Stock Exchange on the back of frantic buying spree by foreign institutional investors and well supported by local operators as well as retail investors.
10,000, February 6, 2006
The Sensex on February 6, 2006 touched 10,003 points during mid-session. The Sensex finally closed above the 10K-mark on February 7, 2006.
11,000, March 21, 2006
The Sensex on March 21, 2006 crossed the magical figure of 11,000 and touched a life-time peak of 11,001 points during mid-session at the Bombay Stock Exchange for the first time. However, it was on March 27, 2006 that the Sensex first closed at over 11,000 points.
12,000, April 20, 2006
The Sensex on April 20, 2006 crossed the 12,000-mark and closed at a peak of 12,040 points for the first time.
13,000, October 30, 2006
The Sensex on October 30, 2006 crossed the magical figure of 13,000 and closed at 13,024.26 points, up 117.45 points or 0.9%. It took 135 days for the Sensex to move from 12,000 to 13,000 and 123 days to move from 12,500 to 13,000.
14,000, December 5, 2006
The Sensex on December 5, 2006 crossed the 14,000-mark to touch 14,028 points. It took 36 days for the Sensex to move from 13,000 to the 14,000 mark.
15,000, July 6, 2007
The Sensex on July 6, 2007 crossed the magical figure of 15,000 to touch 15,005 points in afternoon trade. It took seven months for the Sensex to move from 14,000 to 15,000 points.
16,000, September 19, 2007
The Sensex scaled yet another milestone during early morning trade on September 19, 2007. Within minutes after trading began, the Sensex crossed 16,000, rising by 450 points from the previous close. The 30-share Bombay Stock Exchange's sensitive index took 53 days to reach 16,000 from 15,000. Nifty also touched a new high at 4659, up 113 points.
The Sensex finally ended with its biggest-ever single day gain of 654 points at 16,323. The NSE Nifty gained 186 points to close at 4,732.
17,000, September 26, 2007
The Sensex scaled yet another height during early morning trade on September 26, 2007. Within minutes after trading began, the Sensex crossed the 17,000-mark . Some profit taking towards the end, saw the index slip into red to 16,887 - down 187 points from the day's high. The Sensex ended with a gain of 22 points at 16,921.
18,000, October 09, 2007
The BSE Sensex crossed the 18,000-mark on October 09, 2007. It took just 8 days to cross 18,000 points from the 17,000 mark. The index zoomed to a new all-time intra-day high of 18,327. It finally gained 789 points to close at an all-time high of 18,280. The market set several new records including the biggest single day gain of 789 points at close, as well as the largest intra-day gains of 993 points in absolute term backed by frenzied buying after the news of the UPA and Left meeting on October 22 put an end to the worries of an impending election.
19,000, October 15, 2007
The Sensex crossed the 19,000-mark backed by revival of funds-based buying in blue chip stocks in metal, capital goods and refinery sectors. The index gained the last 1,000 points in just four trading days. The index touched a fresh all-time intra-day high of 19,096, and finally ended with a smart gain of 640 points at 19,059.The Nifty gained 242 points to close at 5,670.
20,000, October 29, 2007
The Sensex crossed the 20,000 mark on the back of aggressive buying by funds ahead of the US Federal Reserve meeting. The index took only 10 trading days to gain 1,000 points after the index crossed the 19,000-mark on October 15. The major drivers of today's rally were index heavyweights Larsen and Toubro, Reliance Industries, ICICI Bank, HDFC Bank and SBI among others. The 30-share index spurted in the last five minutes of trade to fly-past the crucial level and scaled a new intra-day peak at 20,024.87 points before ending at its fresh closing high of 19,977.67, a gain of 734.50 points. The NSE Nifty rose to a record high 5,922.50 points before ending at 5,905.90, showing a hefty gain of 203.60 points.
That is what the Indian Stock market has done since 1990
To keep things in perspective, if you invested 10,000($/EUR/Yen/Rs) in July 1990 it would have been 200,000($/EUR/Yen/Rs) in Oct 2007.
The journey....
1000, July 25, 1990
On July 25, 1990, the Sensex touched the magical four-digit figure for the first time and closed at 1,001 in the wake of a good monsoon and excellent corporate results.
2000, January 15, 1992
On January 15, 1992, the Sensex crossed the 2,000-mark and closed at 2,020 followed by the liberal economic policy initiatives undertaken by the then finance minister and current Prime Minister Dr Manmohan Singh.
3000, February 29, 1992
On February 29, 1992, the Sensex surged past the 3000 mark in the wake of the market-friendly Budget announced by the then Finance Minister, Dr Manmohan Singh.
4000, March 30, 1992
On March 30, 1992, the Sensex crossed the 4,000-mark and closed at 4,091 on the expectations of a liberal export-import policy. It was then that the Harshad Mehta scam hit the markets and Sensex witnessed unabated selling.
5000, October 8, 1999
On October 8, 1999, the Sensex crossed the 5,000-mark as the BJP-led coalition won the majority in the 13th Lok Sabha election.
6000, February 11, 2000
On February 11, 2000, the infotech boom helped the Sensex to cross the 6,000-mark and hit and all time high of 6,006.
7000, June 20, 2005
On June 20, 2005, the news of the settlement between the Ambani brothers boosted investor sentiments and the scrips of RIL, Reliance Energy [Get Quote], Reliance Capital [Get Quote], and IPCL [Get Quote] made huge gains. This helped the Sensex crossed 7,000 points for the first time.
8000, September 8, 2005
On September 8, 2005, the Bombay Stock Exchange's benchmark 30-share index -- the Sensex -- crossed the 8000 level following brisk buying by foreign and domestic funds in early trading.
9000, November 28, 2005
The Sensex on November 28, 2005 crossed the magical figure of 9000 to touch 9000.32 points during mid-session at the Bombay Stock Exchange on the back of frantic buying spree by foreign institutional investors and well supported by local operators as well as retail investors.
10,000, February 6, 2006
The Sensex on February 6, 2006 touched 10,003 points during mid-session. The Sensex finally closed above the 10K-mark on February 7, 2006.
11,000, March 21, 2006
The Sensex on March 21, 2006 crossed the magical figure of 11,000 and touched a life-time peak of 11,001 points during mid-session at the Bombay Stock Exchange for the first time. However, it was on March 27, 2006 that the Sensex first closed at over 11,000 points.
12,000, April 20, 2006
The Sensex on April 20, 2006 crossed the 12,000-mark and closed at a peak of 12,040 points for the first time.
13,000, October 30, 2006
The Sensex on October 30, 2006 crossed the magical figure of 13,000 and closed at 13,024.26 points, up 117.45 points or 0.9%. It took 135 days for the Sensex to move from 12,000 to 13,000 and 123 days to move from 12,500 to 13,000.
14,000, December 5, 2006
The Sensex on December 5, 2006 crossed the 14,000-mark to touch 14,028 points. It took 36 days for the Sensex to move from 13,000 to the 14,000 mark.
15,000, July 6, 2007
The Sensex on July 6, 2007 crossed the magical figure of 15,000 to touch 15,005 points in afternoon trade. It took seven months for the Sensex to move from 14,000 to 15,000 points.
16,000, September 19, 2007
The Sensex scaled yet another milestone during early morning trade on September 19, 2007. Within minutes after trading began, the Sensex crossed 16,000, rising by 450 points from the previous close. The 30-share Bombay Stock Exchange's sensitive index took 53 days to reach 16,000 from 15,000. Nifty also touched a new high at 4659, up 113 points.
The Sensex finally ended with its biggest-ever single day gain of 654 points at 16,323. The NSE Nifty gained 186 points to close at 4,732.
17,000, September 26, 2007
The Sensex scaled yet another height during early morning trade on September 26, 2007. Within minutes after trading began, the Sensex crossed the 17,000-mark . Some profit taking towards the end, saw the index slip into red to 16,887 - down 187 points from the day's high. The Sensex ended with a gain of 22 points at 16,921.
18,000, October 09, 2007
The BSE Sensex crossed the 18,000-mark on October 09, 2007. It took just 8 days to cross 18,000 points from the 17,000 mark. The index zoomed to a new all-time intra-day high of 18,327. It finally gained 789 points to close at an all-time high of 18,280. The market set several new records including the biggest single day gain of 789 points at close, as well as the largest intra-day gains of 993 points in absolute term backed by frenzied buying after the news of the UPA and Left meeting on October 22 put an end to the worries of an impending election.
19,000, October 15, 2007
The Sensex crossed the 19,000-mark backed by revival of funds-based buying in blue chip stocks in metal, capital goods and refinery sectors. The index gained the last 1,000 points in just four trading days. The index touched a fresh all-time intra-day high of 19,096, and finally ended with a smart gain of 640 points at 19,059.The Nifty gained 242 points to close at 5,670.
20,000, October 29, 2007
The Sensex crossed the 20,000 mark on the back of aggressive buying by funds ahead of the US Federal Reserve meeting. The index took only 10 trading days to gain 1,000 points after the index crossed the 19,000-mark on October 15. The major drivers of today's rally were index heavyweights Larsen and Toubro, Reliance Industries, ICICI Bank, HDFC Bank and SBI among others. The 30-share index spurted in the last five minutes of trade to fly-past the crucial level and scaled a new intra-day peak at 20,024.87 points before ending at its fresh closing high of 19,977.67, a gain of 734.50 points. The NSE Nifty rose to a record high 5,922.50 points before ending at 5,905.90, showing a hefty gain of 203.60 points.
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