Deals: How George Lucas, Bill Gates, and Almost Every Other Rich Person Got Rich

“I guess the only other fair way to go about this would be that one of us deals with the body situation while the other one of us deal with the Krazy 8 situation.  In a scenario like this I don’t suppose it is bad form to just flip a coin. Heads or tails?” – Breaking Bad

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Who would have guessed that George Lucas would have his own Lego™?

Some small group of people become wealthy due to savings.  Some other small groups of people get wealthy by growing their business slowly over time.  Besides being born rich (which is the easiest and surest way to get rich), what do the majority do?

The Deal.

There are good Deals, and there are bad Deals, and I’ve been involved with both kinds.  So have you.  Anyone who has done a Deal (and, really, that’s everyone – two year olds start bargaining for candy and to stay up late as soon as they can speak) has likewise done good and bad Deals.

Let’s start with bad Deals.  One of the worst Deals I ever did was when I traded in my first car at a car dealership.  I traded for a pickup that was older than the car.  Six years older than the car.  Plus I gave them a big wad of cash to do the deal.  After that Deal was signed, the store manager played a recorded sound of a bomb dropping and exploding over the store intercom.

I innocently asked why they had played the explosion sound.  The car salesman said it was, “just a thing the manager does.”  Of course, it was in honor of the horrible Deal I’d just done.  I suppose it was fair.  Several years earlier I had sold them my used car.  After several hours of negotiation, they offered me a pretty good price.  I asked, “Do you need to know if there’s anything wrong with it mechanically?”

The salesman said, “Nah.  Just the body.  They can fix any mechanical problems.”

The car had a cracked engine block.  Hint:  seeing steam coming out of your tailpipe is never a good sign.

Well, I did ask.  Actually, several times.  I’m not sure they really liked that Deal . . . I guess I wish I had a little bomb sound that I could have made . . . “oh, no, that’s nothing.  Just something I like to do.”

But they got the last laugh with the pickup.  A year later it threw a rod (this is very bad) through the engine block and oil pan while I was driving seventy miles per hour.  Pretty impressive, actually.

What are some examples of other famous Deals/decisions?

  • George Lucas got the merchandise rights for a little film he did called “Star Wars®” for $20,000. I think that one little afterthought deal earned him over a billion dollars – and that’s after taxes.  Nerds who live in Mom’s basement can afford a LOT of Boba Fett® figurines, since they can avoid that whole “dating” money sink.
  • Bill Gates bought DOS® for $50,000. It formed the basis of MicroSoft™.  It became really valuable because IBM® said, “Who wants to own software, am I right, Brandon?  The money is in the hardware.  Let’s go get some martinis, cigarettes and blow dry our feathered hair, maybe play some Pac-Man™.”  Or whatever IBM© dudes said at lunch when Reagan was president.
  • Peter Thiel bought 10% of Facebook® for $500,000. He now only owns 2-3% of Facebook© due to dilution and share sales.  Don’t cry, he can still afford to buy lunch out once a week.
  • The Internet Bubble was probably the greatest mass insanity since the Dutch sold tulip bulbs for the price of a house (yes, this really happened, and I’ll talk about it in a post somewhere during the next week or two). I had a friend who got caught up in a website during the Bubble.  He ended up selling a company (he owned about 20% of it) to Alta-Vista©.  Who?  Alta-Vista™!  They were the Google™ before Google®.  How much did they sell the company for?  Fifty Million Dollars.  Immediately, my friend was worth Ten Million Dollars.  Unfortunately it was in Alta-Vista stock, which, by agreement he couldn’t sell for six months.  Six months later?  His Ten Million in stock was worth Two Million.  He got out, but he was a 36 year old with $2,000,000, which I guess is a pretty cool consolation prize.  Why did Alta-Vista™ want his company?  It had huge growth – heck, it made $2,000 a month!
  • AOL®-Time™ Warner©. Investors lost $8 billion on this merger.  Who could have predicted that dial up internet wasn’t the wave of the future?
  • Invading Russia or Afghanistan. Repeat after me:  no land wars in Asia.  Oh, we’re involved in two of them right now?  Yikes!
  • Nathan Rothschild had early information on the result of the Battle of Waterloo where Wellington defeated Napoleon in “Friday the Thirteenth Part 4: Napoleon Strikes Back.”  Even from the Rothschild archives we find:  “I am informed by Commissary White you have done well by the early information which you had of the victory gained at Waterloo.”  So, knowing the outcome of the battle, it seems certain that Rothschild made some money as the markets were agitated with the uncertainty of the war.  How much did Rothschild make that day?  History does not record, but Rothschild built a fortune that is estimated at $450 billion dollars in today’s money.  That’s five Mark Zuckerbergs.  Nathan didn’t make many bad Deals . . . .

What characterizes a Bad Deal?

  • Missing information: When I made my stupid truck deal, I had no idea how to get car value information.  This was pre-Internet.  Mismatched information leads to one-sided Deals.
  • Failure to understand potential: Star Wars® merchandise might have been a few posters and t-shirts.    Biggest movie merchandising Deal ever.  This is similar to what Bill Gates saw.  He figured that DOS® was worth much more than the owner did, and used it to leverage into everything MicroSoft™.
  • Taking advantage of circumstances. Thiel originally lent money to Facebook® that they needed badly.  He ended up with the 10% equity stake in the company.  Nice timing, good Deal.
  • Stoned-Level Euphoria: The Internet Bubble was characterized by wisdom of a mob all high on PEZ® and thinking that a website that was clearing $2,000 a month was worth $50,000,000.  Like toddlers with checkbooks making Deals.  Trade a Bugatti® for Cadbury Cream Eggs®?
  • Invading Russia or Afghanistan just shows that you have no ability to learn from either history or The Princess Bride®.
  • Rothschild bet on bad Deals made in a hurry under pressing circumstances. Never make a Deal under pressure, unless you have to.  Really have to.

Nature of the Deal

I’ve seen company take long, agonizing looks at acquisitions and mergers that amounted to far less than 1% of the company’s value.  I’ve also heard that Warren Buffett has bought many a company on a one page contract.  He says his lawyers make them longer now, but the Deals that made him rich (well, richer) could be written on a single page.  And nobody argues that Buffett does bad Deals.

But are there really Win-Win Deals?

Whenever I hear “win-win” I think of those zombie adult over-enthusiastic motivational speakers.  You know the ones I mean – the ones that are always insufferably happy?  Them.  They talk about win-win.  But win-win deals can be real, and here’s an example:

I was working at a multi-billion dollar company when a multi-billionaire decided he wanted to buy it.  He offered 30% above the current stock price, which was six times what I had gotten my shares for.  I took his offer (for my shares, not the company) in a second.  The billionaire then structured his payments from the profits so that his original purchase was paid off in about three years.  Plus he still owns the company.

So, I got more money out of the stock than I ever expected, the billionaire got more billions, and he still employs thousands of people daily to make products that millions of people use.

That’s a win-win-win-win.  Yay capitalism!

What was my personal best Deal?

When taking a job at a company, I requested as part of my offer that if they ever asked me to move, they’d pay me at least what I’d paid for my house.  Since house prices always go up, this was an easy calculation for the company, right?  Sure!  They agreed, and I said, “yes.”

Eleven months later when they asked me to move, the housing bust was in full swing.  Thankfully, they cut me a check for the difference between the appraised value of the house versus my original purchase price.  Had I not asked for that simple clause, I would have been out $45,000.  The upside?  The company also paid the mortgage, insurance, and property taxes until the house sold, a year and a half later.

Don’t feel bad for the company . . . they still got the better end of the deal.

They got me!

The Future of Employment, or, Almost All of Government is a Jobs Program

All right, listen closely.  I was at the unemployment office and I told them I was very close to getting a job with Vandelay Industries, and I gave them your phone number.  So now, when the phone rings you have to answer “Vandelay Industries.” – Seinfeld

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Notice it doesn’t say Texas Pain RELIEF Institute?

What are we going to do with everyone?

I’ve been (throughout my life) a proponent of the human race.  I like it.  I may not like certain individuals, but I’ve got a great degree of hope when it comes down to humanity.  And up to now, the equation has been that more people equals more Einsteins, more Isaac Newtons, more Nikola Teslas, and more Stephen Hawkings.  These are shining examples of humanity – folks who helped the human race achieve much more than we would have or could have without their knowledge.  I read an article recently (I am not making this up) about rising obesity rates in Ghana due to KFC® becoming the restaurant of status and choice.  And we know how much Einstein contributed to the secret government project that led to KFC™’s fried, greasy goodness.

There are seven billion of us, and 2.1 billion have the problem of being obese or overweight.  Less than 800 million are suffering from hunger or malnutrition.  This is a victory of the greatest magnitude.  Yes, obesity is bad, but I would much rather have people having heart attacks in their fifties after having a tasty chicken wing versus starvation at fifteen.  Everyone who has that choice would make the same choice, and raise their greasy hands up if asked.

In general, the world is getting better as we as a society create more wealth, as I talked about in previous posts (LINK).  But I’m really concerned as I look forward with simple questions:

How much does the future need us for continued prosperity?  How many people do we really need?  How many can be actively employed in productive work?

There are various reasons that I’m wondering:  Increasing Productivity, AI, Smart Machines, Robots to name a few, though there are other issues as well that we’ll skip today.

I’ve written before that trucking is a sure bet for replacement once self-driving trucks are approved by the Department of Transportation and the various states and a self-driving unit costs less than (about) $400,000 per unit.  After those conditions are met, at least a million jobs (and likely more) will be gone as fast as the autonomous trucks can be produced.  But it’s not just truckers.  It will be fast food workers.  It will be janitors.  It will be an increasing number of lower and mid-skilled jobs throughout industry.  If it can be described by an algorithm or computer program, it will be automated.  A large number of sports articles and financial news articles are now produced with no human intervention.  Journalists would worry, if there were enough of them left to worry.

And jobs that aren’t eliminated will be minimized.  An example:  a structural engineer nowadays runs calculations for a new bridge or skyscraper through a computer program that analyzes the stresses in the structure and optimizes the design for code and seismic conditions.  It then chooses the beams and columns and other structural members based on tens of thousands of calculations and three dimensional finite element analysis, and then pops out design drawings. Sproink.  (That’s the noise the drawings make when they come out of the machine.)

Fewer engineers are required, and the engineers don’t need to be as proficient since the engineering knowledge is built into the program.  Both the number of people and the quality of people goes down.

Another example:  I just bought (for $30) a device the will give me the data I need to order glasses online.  No prescription, no optometrist, no waiting.  Also, no glaucoma check, but I don’t have to take off time from work to visit the doctor.  And the glasses I ordered online cost less than I would pay, even at Wal-Mart®.  I may describe it in Friday’s blog.

Another example:  I had a cold that I was pretty worried was heading into my lungs and I was worried that I’d get pneumonia.   For $60 I got online from my basement (where I was in a cold sweat despite my 101˚F, got antibiotics, and got better.  Otherwise?  A $120 doctor visit where my copay would have been at least $100.  Yes, a real doctor was involved in the visit, but it was incredibly efficient for them – I’d imagine they make $300 an hour.  No office, no actual contact with icky sick people.  It was a great transaction for both of us.

But . . . it means we need fewer Doctors.  And fewer waiting rooms.  And fewer nurses.  Et cetera.

Efficiency is awesome.  It lowers costs, and does that while quality is increased, in most cases.

When economists study inflation, they study the price of the item.  I have a color TV in my house.  When my dad bought his first color TV, he spent (on an inflation adjusted basis) over $3,000 in today’s dollars.  With that kind of money today?  You could buy a 75” Sony® Ultra HD that also has a popcorn maker and margarita blender built in.  So, economists measure how much better a thing has gotten as well as what the thing costs.  They call this measurement “hedonics” because it’s way more confusing than “measuring how stuff got better.”

So, we live in a world where getting sufficient food to eat is easier than at any point in history.  We also live in a world where getting information is easier than at any time?  Want to listen to a song?  Unless it’s the Beatles™, it’s pretty much on YouTube®.  And we can make more things, better, faster and cheaper, than at any time in history.

But why hasn’t efficiency hit, oh, say the Department of Motor Vehicles?  Or the local County office where I go to get license plates?  At both places, you have to stand in line.  At both places, hours are limited, and you’d better get done before quitting time, because they’re serious about closing up at 4:30pm.

In a typical business, the best parking spaces are reserved for the customers.  In government?  The best parking places are reserved for the employees.  And I think government is giving us a hint:  the most important consumers of government are its employees.  You and I are the product.

And why, in a world where I can apply for $100,000 credit at midnight can I only get my driver’s license between 9AM and 4:15PM (closed for lunch hour)?  Why is it harder each year to deal with government?  Why do their budgets keep going up, faster than inflation?

Because nothing the government does is intended to help you, the consumer.  The bright folks that are hired to make wonder weapons?  Jobs program.  We do NOT want people that smart on the street.  The people who work for NASA®?  Jobs program.  They don’t even have to make rockets anymore, and Elon Musk has clearly shown that if he had NASA’s budget he’d be building Burger Kings® on Mars, because he’s have a million people living there in the next decade.  NASA spent money putting together braille books on the solar eclipse in August.  That might explain why we have to piggy back a ride with the Russians to get to the International Space Station.  NASA is a jobs program.  Originally it had a job to get people to the moon.  Now?  It produces new classes of astronauts with no vehicle to fly.  Thankfully they have a budget for cardboard boxes to sit inside and make rocket noises.  There’s even a budget for markers to write “ROKET” and “USA” on the side of the boxes!

The Department of Education, which has taught no classes?  Jobs program.  The Department of Energy, which has never produced a Watt?  Jobs program.  The military?  Parts of it are a jobs program, but most if it is real.  But you better pay attention to what congressional district and state the new weapons will be built in . . .

Your liberal-arts college professor?  Given a job so that they wouldn’t agitate for revolution in the streets, rather, they can agitate for revolution to rich kids who would much rather play Playstation® and X-Box©.

Ever wonder why they rip up a section of street that looks pretty good, and then work it for months?  Yup.  Jobs program.  Not to say that the original Interstate Highway System wasn’t real.  It was.  But now what do we build?  What infrastructure is left?  Dams are awesome for hydroelectric power, but just try to build one nowadays . . . it’s easier to declare war on Ghana.

It really took me by surprises that this was the case – that most government spending is based on the concept of giving people money so that they don’t riot in the streets (dumb people) or so they won’t plot and plan a revolution (liberal arts professors) or build wonder-weapons in a James Bond worthy plot for foreign governments (government scientists)?

Why is government inefficient?  It’s not.  It’s a very efficient jobs machine.  You’re just the product, not the consumer.

But what about the jobs that are already out there?  A recent study says that the average worker works less than four hours a day.

Think of the creativity that creates!  How to look busy for eight or nine hours a day when you’re done working after four?  And how long will a business stand for this?  Eventually, in private business, all of the “four hour a day” jobs will be eliminated – the business has to pay taxes, remain competitive.

But government will respond.  New regulations will be created and enforced that require new employees to compile data and report it to the government.  This is done mainly so that the government has excuses to hire more employees, but has the side effect to requiring more private sector compliance workers.

I actually had a job once where, on my start date, my office wasn’t yet ready.  They told me . . . come back in two weeks from now.  Did they pay me for the two weeks?  Yes.  And, who did this?  Yup.  It was a government job.  And, although I saved them several million dollars, they were kinda disappointed.  They wanted to spend their full budget.

But there will be in the next decade millions of people becoming unemployed as their jobs are minimized or eliminated due to clever business disruption, probably faster than the government can create jobs (hint: the government is broke (LINK)).  I’d love to suggest a minimum basic income, but we can’t pay for it.  We can’t even afford PEZ®.

What do we do?

There are millions of people in the United States right now that would love to work.  And millions more in made-up jobs that produce nothing that would love to work in productive jobs.  Around the world, this number is surely in the hundreds of millions.

And we need fewer of them every day.

How about . . . we let someone smart pay them to work on something really important . . . like going to Mars?

Paging Elon Musk . . . .

Unless someone else has a better idea?  Raise your greasy hand and sing out!

Value Creation and Zombie Steve Jobs

“Lies are like children: they’re hard work, but it’s worth it because the future depends on them.” – House, M.D.

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Pugsley, prior to going for his midnight shift in the PEZ® mines.

I was talking to a friend yesterday when he mentioned that he had been transferred to manage a group of newly graduated college kids.  To be clear – this group of college graduates is in no way typical – I imagine that they’re making in range of $80,000-$90,000 a year.  Not Harvard Law money, but still pretty good for the small(ish) town my friend lives in.  So, as a new manager to the group (he’s been managing people for decades, and he’s a good one) he got the group together to explain what he was looking for from them, what his general expectations were of his employees.  In one line that has been standard for him for years, (I heard it from him when Bill Clinton was President) he indicated that he expected the group to put in, on average, fifty hours a week.

Chaos!

Pandemonium!

My friend had become Literally Hitler.

He eventually backed down to forty-five hours per week, and was demoted to just being Literally Saddam Hussein.

As he told the story, I laughed.

The irony is that these college grads that actually do put in the long hours that my friend suggested will soon be so far ahead of their colleagues that their colleagues will never be able to catch up with them:  the harder worker will have more knowledge, more skills, more credibility, and very soon, much bigger raises and promotions.  Their colleagues will call them, “lucky.”

90% of success is showing up on time.  At least 5% is working just a bit harder, so your skills build up faster, especially when you are young.  (The remaining 5% is turtles.  All the way down.)

What’s the point in all this hard work and achievement?  To be rich?  To stress yourself out to the point where you have a heart attack in your 30s and die?

No.

The point is Value Creation.

One of the coolest aspects of the capitalist system is that it allows you (really, forces you in a purely capitalist system) to be of value to your fellow man.  Capital flows to those that create and provide value.  So, in a truly capitalist system, you create wealth for yourself by creating value for someone you might not even know or ever meet.  Bill Gates made money when I bought my copy of MicroSoft® Word™, and yet he’s never invited me for dinner.  Nor will he, unless that restraining order lapses.  I’ve told him to stop calling me, but that man won’t listen.

Value creation is like magic.  You take an idea or concept to make someone else’s life better, and then you create a product or service out of wood, metal, plastic, or just plain computer code, or, like this blog, just out of pure ideas.  If your idea is good, people will buy it, eat it, or read it, but probably not all three, unless it’s breakfast cereal.

Capitalism is simple – you (should) make money only when you create value for someone else.  Value Creation is nearly alchemy.  Alchemy was (at least in part) focused on turning lead into gold.  Capitalism is better.  It can turn cow poop into gold – when sold as fertilizer.  In a capitalist system, we transmute lower valued items into higher valued items every day.

The flows of capital follow the paths cut by Value Creation.  Those people (and businesses) that are best at creating value get more money.  What do they do with that money?  Do they put it in a box?  No.  They use it to create more value.

And that’s what my friend’s newly graduated college students do not get.  The business isn’t there for them to have a great life.  It doesn’t exist to pay them a living wage.  It won’t pay more because housing is more expensive where the business is.  Companies pay based on the value the employees create.  Don’t create more value than somebody else would for minimum wage?  You’ll get minimum wage.  Don’t create enough value for a three bedroom house on two acres in San Francisco?  Your boss and company don’t care.

In the end, it’s Value Creation.  How do you do it?

There are lots of ways, but perhaps the best way to create value is to solve someone’s problem.  The bigger the problem and the greater the number of people, the greater the value creation, and, generally, the greater the wealth that the person or company can expect to get.  The cell phone is a great example – before it existed, people spent no money on it.  After it was invented, people would spend . . . some money on it.  After the phones got data, and the phones got smart?  Massive floodgates of money poured into a product that had never existed.  Apple© went from a value of $30 billion to a market cap of 30 times as much, nearly a trillion dollars after their innovation with the iPod® and with the iPhone™.  They created a new category, and brought value to people in ways that nobody (except Steve Jobs) anticipated.  I hear that their primary focus right now, however, is bringing Steve Jobs back to life, so they can have a new idea.

The effort that went into creating the new products that Apple® launched was legendary.

And it was more than forty hours per week . . . because changing the world takes more effort than that . . . .

Income, Happiness, and Bad AC/DC

“See, this is what we call an all you can eat buffet.  Here you can eat all you want for just $6.99.  That why everyone comes here on Tuesday nights, except for Kenny’s family because for them, $6.99 is two years’ income.” – South Park

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The purpose of having money is so you can afford to buy things like this. 

I remember having a negative net worth and still enjoying most parts of life.  I had my health, my youth, good friends, PEZ® and meaningful work.  I also remember sleepless nights worried about how I was going to pay this bill or that bill.  I clipped . . . coupons.  And used them.  I’m so ashamed.

Let me back up.

I was married before The Mrs., as I’ve mentioned before.  That relationship ended (which made both of us happy) but my previous spouse had been in charge of paying the bills.  On her last day in the house she handed me a bulging plastic grocery sack filled with bills.  She then handed me a checkbook in a blue plastic cover, the sides of the cover starting to crack at the point where the cover bended to open and close the checkbook.

“I have no idea how much money is in the account,” she said.

The answer was, “not much.”  The first bill I pulled off the top of the stack was a credit card that hadn’t been paid in several months.

Wow.

I got out a spreadsheet and started to add up bills.  I made a list of minimum payments.  I made a pretty ruthless budget ($4 a day for food for three?) and . . . went to work.  I took a loan against my 401K and paid all the back payments due on the accounts.  Lots of Hamburger Helper®.

But was I happy?  Well, yes.  My friends said that I hadn’t looked happier in years.  And I felt happy.

Now there has been no time in my life where I couldn’t afford to feed my family.  Were there times when I was a week of payments away from being at zero cash?  Certainly.  Did I have an emergency fund?  Not really.  I could have played the alternate-bill game, slowing payments for the electricity so I could pay the gas.  I could have maxed out my credit cards, sold family heirlooms, sold plasma, sold a kidney.  I could have averted bankruptcy for a few months.  Emergency fund?  No, a catastrophe spending plan.

Thankfully, it never came to that.  So, a negative net worth and a happy life?  Sure.  I was young:  the future was wide open.

But you don’t have to trust me.  Actual Nobel® Prize-winning economists (Angus Deaton and Daniel Kahnemann) did a study where they tried to measure the impact of income on happiness.  And, they found (in 2010 dollars, which were less plump and firm compared to today’s inflated dollars) that happiness was maximized at a household income of about $75,000 (that would be $85,000 in today’s dollars).  People’s perception of life increased with more money (they thought they were doing better) but they weren’t any happier.

I then began to wonder what factors might influence whether or not $85,000 is enough?

  • If you’re paying a huge proportion of your income on debt, it will prevent you from spending on other things.  In my personal example, I had debt, but I also had a plan:  work like the devil to pay it off.  Each retired credit card or past due bill was a little victory.  There are some forms of debt, though, that are worse than others.  The king of bad?  Student Loan debt.  While education is valuable, the only way to default on a student loan is to die, and I think that’s pretty extreme to get out of a bill.
  • Location, location, location. New Yorkians and San Franciscainites would scoff at $85,000 per year.  Their homeless rat-catchers make more than $85,000 on a bad year.  I tried to come up with a city that might be near the national average for cost of living:  I ended up with Reno, Nevada.  To replicate $85,000 in Reno would require $184,000 in Manhattan, and $143,000 in San Francisco.  I’m not sure that this really covers it, because the average house in San Francisco per this survey was $1,000,000, and the last time I looked, $1,000,000 buys you a house with 830 square feet in San Fran.  750 square feet in Manhattan.  My college apartment was larger.  No free range children there – you probably have to stack cages to keep more than one.
  • What does your future look like? This is going to impact your overall contentment.  Feel like it’s all over and the dark of winter of your life is at hand?  Or is it just dawn, and you’re looking at a warm spring day with a lifetime ahead?  Your perceptions of yourself, your potential, and your future influence your contentment.  Grumpy old men?  Yeah, they think that they’re at their winter and are angry that you’re limber enough to touch your toes.
  • Number of Kids/Parents to Support. Have you ever spent money to buy food for a seventeen year old defensive tackle/noseguard?  I have seen The Boy get up from a Sunday dinner and go directly to the fridge to see if there’s anything to eat.  How many ribeye steaks can you eat?  I’ve seen him eat three.  After three or four bratwurst.  These are not exaggerations.  I went shopping one Sunday with The Mrs.  We had a shopping cart filled with food.  She looks at me.  “This is just for The Boy’s lunch.  One week of his lunch.”  He has a little brother, Pugsley, who will soon enter Junior High and the high calorie consumption of testosterone and a teenager.  Then there’s college.  There are cars.  Spending money.  Have a dozen kids?  Yeah, $85,000 for the household seems a bit sparse – you might need to sell some for medical experimentation.
  • Medical Expenses. The Mrs. listens not to my entreaties that her insulin costs nearly as much as gold per shot.  She’s all, “Well, if I don’t take it I’ll die.”  The Mrs. has a really crappy pancreas.  But if you have medical expenses that are very high?  Forget insurance – it’s been awful for years – it’s like paint made for the government:  it’s expensive and covers nothing.  Have enough of these issues?  Jimmy Kimmel will cry for you, and $85,000 might seem woefully small.  Note:  substituting “homemade” insulin is not recommended.  The Mrs. did NOT think that was amusing.
  • Hobbies.  Sure, they’re optional, but we’re talking about being happy.  I like collecting 17th century glassware.  And then using it for practicing skeet shooting.
  • Spending Habits. Being on a budget sucks – the discipline it takes to plan and scrimp and save is rough, but it’s better than homelessness . . . .  Sometimes you don’t get to pick the Sam Adams® and have to just pretend Natty Lite© is awesome.  My previous post on the money philosophy of Mr. Money Mustache, Financial Samurai, and Early Retirement Extreme still applies (LINK).  Read it.

The Kinks understand that nobody likes being a cut-priced person in a low budget land . . .

So the $85,000 is above the median (half of the households above, half below) household income of ~$60,000.  As near as I can figure, $85,000 puts a household in the top 35% of income in 2017.  Again all of this research doesn’t prove you’re happy or unhappy at any income.  It just shows the sweet spot where additional income seems to stop adding additional contentment for most people.

I would (personally) guess a big predictor of long term happiness would be the amount of wealth that you had managed to save.  It would certainly add peace of mind, knowing that you had some long term money, and that would remove a lot of the day to day stress from unexpected events – job loss, sickness, needing to buy Cher concert tickets.

But can you have too much money buried in Mason Jars® behind your house?  Sure.  If it removes your incentive to work, does that remove meaning from your life?  I’ve seen more than one person retire and die a month later.  And you don’t have to be old to lose your purpose and give up, as Buzz Aldrin proves (LINK).  Not everyone will lose their purpose, and I really do recommend working until you’re sick and tired of it – that’ll get you in the right mindset to retire.

But higher income come with issues as well that might detract from the overall contentment that income earners get – don’t think that the $150,000 crowd has it easy.  Long hours.  Deadlines.  Job insecurity (average VP only lasts six years before being canned).  Travel.  Time away from the family.  Awful bosses (CEOs rank high on the range of socio-psychopath).  So, at some point, it’s probably better to live cheap rather than live a stressed out life.

Because the future is wide open . . . .

Some bonus content, since we’re thinking about cheap:

The following is almost nine years old, back at my old blog, Wilder by Far.  Here’s a link to the original post (LINK).

For your pleasure, I have transcribed an AC/DC™ tune Dirty Deeds Done Dirt Cheap, as written by William F. Buckley. Enjoy.

If you’re experiencing difficulty with the school principal
He’s making you quite sad
You wish to complete education without resorting to implied sexual intercourse
Here is a course of action
Grab a telecommunication device, I never leave my domicile
Contact me whenever it’s convenient
E-mail – Bonn.Scott73@acdc.com
I conduct my life through extralegal means

Hey

Nefarious acts, performed inexpensively
Nefarious acts, performed inexpensively
Nefarious acts, performed inexpensively
Nefarious acts and they’re performed inexpensively
Nefarious acts and they’re performed inexpensively

You are experiencing difficulty with your life partner
You have serious emotional depression over the relationship
He’s conducting a clandestine illicit possibly romantic relationship with someone with whom you share extremely strong interpersonal ties
You may feel so emotionally distraught that you cry
Grab a telecommunication device, I am currently not in the vicinity of other humans
Or come visit informally with no set purpose or agenda
Enter and remove thoughts about him from your mind
We will cooperatively either stage a fancy dancing party or partake of our own illicit romance

Hey

Nefarious acts, performed inexpensively
Nefarious acts, performed inexpensively
Nefarious acts, performed inexpensively
Nefarious acts and they’re performed inexpensively
Nefarious acts and they’re performed inexpensively

You have a female domestic partner whom you wish to no longer have contact with
But you lack courage to take action
Your domestic partner is continually argumentative and critical
Sufficiently so to make you question your mental competence
Grab a telecommunication device, leave your domestic partner without other human companionship
The proximate moment for you to exhibit some sort of courage is now
With reasonable financial remuneration, I would be glad to
a)perform a silent act of assassination while you pursue your own alibi or,
b)have an illicit romantic encounter with your female domestic partner
(the Internet is unclear here, I prefer version a since I see no reason version b would in any way bring the situation described to a favorable conclusion, but there is some scholarly debate)

Nefarious acts, performed inexpensively
Nefarious acts, performed inexpensively
Nefarious acts, performed inexpensively
Nefarious acts and they’re performed inexpensively, yeah
Nefarious acts and they’re performed inexpensively
Nefarious acts and they’re performed inexpensively
Nefarious acts and they’re performed inexpensively

Heavy quasi-stone masses intended to sink bodies when attached to the feet
Molecules containing triple-bonded carbon and nitrogen
Tri-nitro-toluene
Performed inexpensively

Ooo, common items used for the purpose of constricting the ability of a subject to breathe
Agreements to do wrong
Large differences in electrical potential
Performed inexpensively, eah

Nefarious acts, I will perform them without regard to what they are, performed inexpensively
Nefarious acts, nefarious acts, nefarious acts, performed inexpensively

Yaaargh

The Cold Equations, 1973, Alice Cooper, and Government Debt

“We’re doing him a huge favor!  And do you realize how extreme this is to go from no debt to good old fashioned American debt? That’s the way to do it. Plus, I’ve been envisioning someone else paying for this thing the entire time.” – It’s Always Sunny in Philadelphia

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This was before a hurricane in Houston, almost all the shelves were bare.  Not the last hurricane.  So, after the Apocalypse?  You can still get food from Weight Watchers®.

This is the first post . . . the second post in this series is here (LINK).

The Cold Equations is a short story (you can find it here and read for free (LINK) on .pdf so you should read it today) that I remember reading as a young lad up on Wilder Mountain.  I think I read it in an old, moldy paperback from the Junior High library on a long bus trip.

The story sets up a moral choice, and a tough one.  But don’t we face those every day?  Don’t we look at the short term, the now, and not realize there are vast implications for our future actions?  Like if I eat all the PEZ® now, there’ll be none left for later?

I’m guilty of not looking at the big picture, too.

When I think about personal finance, most of the time what I’m thinking about are smaller strategies:  what mix of bonds and stocks should I have?  Index funds or mutual funds?  Managed funds?  How much of my net worth in real estate?  How much car should I buy?  Do I really need the signed Battlestar Galactica helmet?  (Answer:  YES!!!!)

And these are meaningful questions, and really have been the most meaningful questions for essentially all of my life:  these were the right questions to ask.  And, even though the economy has had ups and downs, for the most part, we’re like ships in pretty calm water.  Storm from time to time?  Sure.  But we’ve never see a hurricane.

Outside of technology (which I’ve discussed here (LINK) and which I will likely revisit soon) probably the two biggest factors in determining your personal financial future are government debt, which we’ll discuss in this post, and future payments that governments must make, which we’ll discuss next Wednesday.  I was originally going to discuss it today, but like government debt, this post got bigger faster than I was expecting.

Government Debt and Why 1973 is Important:

I’m picking a start date for my look into government debt as 1973.  In my opinion 1973 was a pretty big year for debt.  Before 1971, if a country, say, France, had a $100,000,000 in dollars, they could back up the semi and trade those dollars for gold at $35 per ounce.

This really happened.  France decided that they had a lot of dollars, but they decided that they liked gold even more.  So, like a kid at the arcade with 5,000 Skee-Ball® tickets, they brought all of their dollars up to the counter and asked for gold.  And a gummy eraser.  And a set of the glasses with the nose and fake mustache.

Nixon decided he liked his gold more than he liked France, so put out an emergency order that the Skee-Ball© window was closed, and that France could keep their tickets.  This set in a chain of events that determined just how many dollars could even exist . . . .

In 1972, Nixon ordered that the dollar be devalued from $35 per ounce of gold to $38 per ounce of gold.  I’m not sure anyone listened because we’d stopped converting dollars to gold.  And, in 1973 the decision was made to allow normal American citizens to own gold, something that President Roosevelt had made illegal in 1933.  The gold/dollar link was severed, so the US could print as many dollars as they chose.

(Roosevelt had confiscated all of the gold coins and bullion in the hands of Americans in 1933 at the price of $20.67 per ounce and made it illegal for Americans to own gold.  After he had all the gold?  He said it was worth $35 per ounce.  Nifty way to make an instant 70% profit, if you’re the government.  If you or I did that, they would just compare us unfavorably to Bernie Madoff.  And that’s just the hair!)

So, I picked 1973, because that approximates the date when the US dollar was completely free of any constraints put on it by a gold standard.  And also, coincidently when Alice Cooper released his classic album Billion Dollar Babies.  Or is it really a coincidence?  Regardless, my choice of 1973 as a starting point isn’t arbitrary.

billion dollar babies

A fine album – you should buy six or so.  Album Picture via Wikimedia – © believed to be with Warner Music.

DANGER:  FALLING DOLLARS AND GRAPHS AHEAD

In the graph below, I’ve listed the Debt of the United States over the years since 1973.  I first converted the annual figures into 2017 dollars using magic the Bureau of Labor Statistics website, so we don’t have to worry about pesky inflation in this graph.  H/T to The Balance (LINK) for pointing to all the appropriate websites for the data.

basedebt

When I first started inputting the data, I was surprised at how familiar the shape of the curve of the debt was – and when I tried a fit of the data to an exponential curve it matched very nicely.  You can see it on the graph.  The exponential curve is a pretty standard formulation.  I’m not going to get all mathy, but the R2 =0.97 shows that a large amount of the variation you’d expect to see is explained by the curve that’s fit to it.  An R2 =1.0 is perfect.  Thanks, Excel®!  More on the curve fit later.

The dashed line represents the ratio of the national debt (how much the US owes as a country) divided by the Gross Domestic Product (how much the country produces in a year, both goods and services).  It uses the right side scale, so you can see that now the national debt is more money than all the goods and services the United States produces in a year are worth.

Hmm.  Oddly, Japan leads the list of countries that have a high debt to GDP ratio, primarily because no matter what the government does, the citizens just won’t take on debt, so government takes it on for them, in order to fund more comic books, vending machines, and seven-eyed fish.

Perennial economic basketcases Greece, Lebanon, and Italy have higher debt to GDP ratios than the US, but the United States is 12th out of 100 or so on a list where you really don’t want to be at the top.  Admittedly, most of the countries on the bottom of the list don’t actually use money, but rather trade goats for transistor radios and nine-volt batteries so they can listen to 1970’s disco music, which is all the rage now.

But let’s get back to the overall debt.  If it is a good fit for the past, I can try to use that same curve to project 10 or 20 years into the future, as I did in the graph below:

Debtintofuture

If the projection holds, in 2027 the debt will be above $30 Trillion dollars.  That’s $30,000,000,000,000.  Some people work a whole year and don’t make that much money!  And in 2037, the debt will be a little higher at $55 trillion dollars.  But those are 2017 dollars, and we live in world where inflation exists.  Here’s that graph:

debtplusinflation

This graph shows we’ll be facing a debt of $55 TRILLION dollars in ten years, and a tidy $135 TRILLION in twenty years.

For grins, I deleted the last 10 years of data, back to 2006, from the projection from the inflation adjusted numbers.  Result?  It projected the current level of US debt almost exactly.  That equation seems pretty accurate:  it’s good at predicting the future.

But when I deleted 10 years’ worth of data from the graph where inflation exists?  Yikes!  It would have projected a current debt of about $28 trillion versus the $20-ish trillion we’re at right now.

The last ten years have produced inflation that is very low, and interest rates that are at all time historic lows (like all of recorded history low).  Both the low inflation and low interest rates have acted to keep the debt much lower than it would normally be.  This tells me our debt is very sensitive to inflationary swings (as a first year economics student would figure out and give me a resounding “duh” after thwaping me in the forehead).  The ultimate rate of inflation will eventually determine the final shape of the debt’s growth, but we can get to the right range with these estimates.

The Cold Equations don’t lie.

I don’t know about you, but these numbers seem . . . impossibly large.  And large in such a fashion that I can’t really see how the system can work.  Ben Stein’s dad was famous for saying, “If something can’t continue forever, it won’t.”  Interest on that $55 trillion in ten years or so at 5% would be 70% of today’s entire federal budget, for just one year.

This is Ben Stein.  Anyone, anyone feel like getting me a beer?

The interesting thing to me is that everyone thinks that there is a choice involved, and that every aspect of the current system in the United States isn’t baked into that equation.  But I tested the equation with data from before the housing crash.  With data from before Obama.  Hate to tell everyone, but we could have elected John McCain or a bowl of quivering strawberry Jell-O® (but I repeat myself) as president for the last eight years and we would be in exactly the same place.  It’s not parties, it’s not individuals.  It’s the system.

And what are the consequences of trying to stop?

$1.1 trillion was added to the debt in the government fiscal year ending in 2016.  This amounted to around 5% of US GDP.  US GDP grew by less than 2% that year.  Remove the deficit?  The US economy shrinks by 3% in that year.

The “Great Recession” saw the economy contract 5.1%.

So, yes, addiction to government debt is bad.  The only thing keeping the country out of recession is adding more debt.  But the Cold Equations indicate that exponential growth can’t continue forever.

The Part Where Wilder Answers His Own Question

So, why does this continue now?  Why doesn’t somebody jump out in front of the speeding train and yell, “Stop!”  (I think I answered my own question there.)

It’s convenient.  The United States creates dollars out of either paper or electrons, and then ships them halfway across the world to buy something real, like a car, underwear for Johnny Depp, or a barrel of oil.  They take our made-up dollars as payment, and ship us the stuff.  Then they take the dollars and recycle them into our system and buy the debt through Treasury Notes and Bills.  If that’s not a tax, I’m not sure what is.  It’s really an awesome deal if you’re the United States.

Eventually someone will create a currency or mechanism to compete with the dollar.  China is desperately trying (LINK) having created a mechanism to trade oil not in terms of dollars, but in terms of gold.

Will that system take down the dollar?  Likely not.  The sheer size and psychological trust the dollar has accumulated over the past hundred and fifty years won’t go away with just one alternative Afghan (the people not the blanket) herdsmen trade actual dollar bills.  In Zimbabwe when they turned their currency into the equivalent of a mathematical joke, they traded US dollars to actually buy stuff.  And inertia plays a big part.  You don’t tear down Rome in one day, week, or month.  And, as the Romans showed (LINK) a strong army goes a long, long way to having whatever you say is money be accepted.

The second thing that keeps this system going:

It’s that the system has evolved to grow continually.  Jerry Pournelle (who may have been the architect that brought down the entire Soviet Union while writing entertaining science fiction), (1933-2017) described it well in his Iron Law:

Pournelle’s Iron Law of Bureaucracy states that in any bureaucratic organization there will be two kinds of people”:

First, there will be those who are devoted to the goals of the organization. Examples are dedicated classroom teachers in an educational bureaucracy, many of the engineers and launch technicians and scientists at NASA, even some agricultural scientists and advisors in the former Soviet Union collective farming administration.

Secondly, there will be those dedicated to the organization itself. Examples are many of the administrators in the education system, many professors of education, many teachers’ union officials, much of the NASA headquarters staff, etc.

The Iron Law states that in every case the second group will gain and keep control of the organization. It will write the rules, and control promotions within the organization.

This is why NASA can’t launch spaceships, the Department of Education doesn’t teach, and the Department of Energy doesn’t produce power.  It’s not that these bureaucrats are bad people, they’re simply focused on personal preservation – they want to have a job until they retire, and enough petty power to make them feel that they’re important.  The best way to ensure that is to surround themselves with a staff of fifty.  And all of this is in harmony with the equation.

If you notice, both sides pick things to fund, and both sides will defend the other side’s projects to the death.  Republicans complain about Obamacare, and then add more funding.  Democrats complain about the military, and then add more funding.  Each side is careful to preserve the one thing that Washington is good at . . . spending.

What’s the favorite baby in Washington?  Billion Dollar Babies!

But I feel that the Cold Equations will point to a place where this cannot last.  And when you violate the Equations?  Your choices dwindle . . . to zero.

Superpowers, Stress, Ben Franklin’s Nails

“I’m not stressed beyond the stress induced by telling you how stressed I am.” – House

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The Boy took this selfie.  Not sure what he was upset about.  Maybe it was the stock market? 

I think too much.  I know, I know, it hurts.  The Mrs. tells me I should just relax and not think so much.  But perhaps my superpower is that I think about the future, so to not think about the future would be like Superman® not flying or Aquaman™ not . . . talking to fish, or whatever it is that he does.

To me, the future is a set of probabilities, branching at intervals.  And what I can do is imagine branches from decisions in the past reaching into the future, starting at the single, solid limb of now, and moving forward, getting smaller, as larger probabilities stay thicker, but smaller possibilities branch out into tiny limbs.

The tiny limbs are real, though, and they represent things that can happen based upon both the choices made today as well as some element of chance (either random or not).

As we’ve discussed in the past, Taleb taught us that all probabilities and all risks aren’t equal (LINK).  And Seneca said it’s always easier for things to come crashing down than to hold them together (LINK).

 

But we are active in creating our future.  I can place myself (mentally) in that future to understand what that situation looks like.  I can imagine a future where I cooked a cherry pie.  I can then map it out and see what I can do now to make a better then.  Like buy whipped cream for the top.  And I can imagine a future where we’ve all forgotten about Warrant:

Is it wrong that sometimes I sing the lyrics “She’s a hairy guy?”  I swear this isn’t about Jenner.

My Superpower is a little like chess, but with more showering than the last chess tournament I was in.  Also, the variables are not as well-known as chess, but in most cases I’ve done really well with at work and at life with this ability, though I cannot yet hover or make adamantium claws spring out from my knuckles, which would be even better superpowers than fish-talking.

But when we finally get to a decision point, most of the time it’s like coming home to a place I’d already been on my imaginary branch so I’m generally not surprised.

One advantage to this power is that I look at the risks around me on a regular basis and try to figure out ways around them, measures that mitigate them, or better yet, insurance that I can get that allows someone else to take the risk (insurance is not always an Allstate® product, sometimes it’s a contract where somebody else owns a risk, which can often be gotten for asking).

Of the things I do at work (besides being snarky and obscure), this is probably the best one.  Way better than my coffee consumption skill, though I’ve been told that’s legendary.

And frankly, I like the pressure when the ball is in my hand and I have the ability to think, to perform and to achieve.  I like the odds on me performing well, because I think like this:

 Diz ſagent uns die wîſen, ein nagel behalt ein îſen, ein îſen ein ros, ein ros ein man, ein man ein burc, der ſtrîten kan.

-Freidank (Which is a dude’s name.) via Wikipedia

I know, a knee-slapper, right?

The English version of that is:

The wise tell us that a nail keeps a shoe, a shoe a horse, a horse a man, a man a castle, that can fight. – Now a translated Freidank, still via Wikipedia

And, know that Freidank lived in 1230 A.D., long before Ben Franklin collected a version in his book “The Way to Wealth” that most of us are more familiar with:

For the want of a nail the shoe was lost,
For the want of a shoe the horse was lost,
For the want of a horse the rider was lost,
For the want of a rider the battle was lost,
For the want of a battle the kingdom was lost,
And all for the want of a horseshoe-nail.

Thinking this way is stressful, but not the bad kind of stress, but rather the excitement, the exhilaration of having a real problem, a meaningful problem to be solved.  Are there exciting challenges?  Sure!  Are there horrible, frustrating setbacks?  Also, sure.  But when everything comes together and we light up the cigars to celebrate, it more than makes up for anything “stressful” along the way.

A Stanford® professor (LINK) has been doing research and agrees.  “Good” stress is . . . not bad for you, and, in fact, may help you perform at your peak.  It’s a challenge.

That same article noted that stress was bad mainly if you thought it was bad.  If you thought it was okay, exciting, just a challenge?  It tended to not have the bad long-term consequences we associated with stress: the heart attacks, the stress hormones, the late night peanut butter and tuna sandwiches, etc.

But for me, the downside of this thinking was still this thinking.

I can see bad things.

My job (in many cases) has been literally looking at the worst case and pulling back from there.  I once looked at tornado frequency in the Midwest, and made a half-hearted attempt to quantify the likelihood of civil war changing our government (this was only for about six months of my career, but it was an interesting six months).  Since that was my job and I got paid to do it, it tended to bleed over into home life, so I thought about worst case scenarios even when I was off the clock, and related them to myself and my family.  The upside?  The last time we needed duct tape, paracord, a socket set, and a knife on a family trip (this really happened) we had it in the emergency kit in the trunk.  I only wish I had packed the goatskin – we could have used that.

So I think.  It used to be worst at night when I was ready to go to sleep.  The possibilities would branch out and I would end up going down decision/probability trees (of my own personal life) and, being night and all, often end up in some dark places.  I’d start with, say, needing to pay the mortgage, and then end up penniless and panhandling to pay for new shingles after a storm that never happened.  Yeah.  Silly.  Now I play the radio so other people think and I can listen – it distracts me so I don’t end up on paranoid rabbit trails.

The downside of this is that thinking down chains of causation, I used to build up a big amount of worry in a hurry about personal stuff.  It’s not that I’m scared of the future, it’s that the future can be so uncertain – understanding that a risk exists doesn’t tell you very much about the risk.  For that, experience and mathematics are key, but we’ll have that on a Monday post some week.

One thing leads to another, and I ended up with?  Stress.

Not the good kind.  I’d worry about aspects of my future that were difficult to control.  Research indicates that the key to removal of stress in life is having control.  In psychological speak, believing that most outcomes depend on things that you can do and control is called an “internal locus of control” and is just a fancy way to show that you like having the ball in your hands on a 4th and five with 30 seconds left on the clock.  You believe you control your own outcomes.

So I turned parts of that into challenges.  I challenged myself to have enough money so that I didn’t have to worry about next week’s mortgage, or even next year’s mortgage.  I took my money stress and put it in my hands, and thankfully had the opportunities to make sufficient money that I’m not scared about tomorrow.  I did my best to take what was a (bad) stress and turn it into a good pressure to achieve.

Tough times along the way?  Yeah.  But way more wins than losses.

I think that’s why it’s exhilarating to quit a job – it’s the ultimate demonstration of control when you can move to a situation where you think you’ll be happier.

I think that (in part) is what Jordan Peterson means (LINK) when he says “clean your room” – take control of some facet of your own life so that you feel you’re able to fix your own situation before you burn out.

I’ve switched from being fixated at looking down long dark halls and now I see the light coming in from the side rooms.  And I like to think that I take some time to play there – because on a long enough timeline, all of our mortality rates are 1.0.

And I’m committed to taking control and ownership of my issues.  Like Mark Twain said, “Worrying is like paying a debt you don’t owe.”  And, as I noted on an earlier post, that’s at least part of what keeps me writing.  I’m taking control, taking the garbage out, and making sure I have enough nails.

Somebody might need that horse after all.  Better yet?

Let’s saddle up Ben.

For heaven’s sake, if you’re really stressed out, go see a doctor, not an Internet humorist!

Warren Buffett’s Investing Secrets, F-Troop, and Amazing Bigfoot Investments

“Well if there were no Gods then anyone can do anything and nothing will matter.  You could do as you like and nothing would be real.  Nothing would have meaning, or value.  So even if the Gods don’t exist, it still necessary to have them.” – Vikings

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Even Bigfoot appreciates the climate in Margaritaville.

It was reported (quite a while ago) that Jimmy Buffett of “Margaritaville” fame and Warren Buffett of “Having All the Money” fame were related.  However in 2007 they spit into a tube (well, separate tubes, one tube would be gross) and had their DNA tested.  The results showed that if they were related, it was more than 10,000 years in the past, as Warren Buffett was related to Scandinavians and either Iberians or Estonians.  Jimmy Buffett was related to the Dutch, sunscreen, tequila and salt.

I’ve always regretted that they weren’t related, since my ideal restaurant would be the Buffett Buffet™.  All you can eat cheeseburgers (from Jimmy) and Coca-Cola® from Warren (who owns a large chunk of the company Coca-Cola™).  The television screens would alternate between surfing, bartending shows, and a stock ticker.

But this post is all about Warren, and only slightly about Cheeseburgers in Paradise©.

Warren Buffett is smart.  You don’t start with (relatively) small amounts of money and end up with billions by luck, unless you’re Mark Cuban, who is the only person on planet Earth who sold a company with 330 employees for enough stock to make him a billionaire.  Thankfully he has a billion dollars, so he can hire people smarter than him.   (Yes, he has more money than me, but, really – aside from being so lucky?  He’d be a wonderful bartender.)

One data point in my favor in stating that Warren is smart would be that he graduated from the University of Nebraska at the age of 19, and then went off to Columbia (the college, not the country).  Why Columbia (the college, not the country)?  He knew that Benjamin Graham taught there.  Ben Graham is known as the “Father of Value Investing,” and Buffett wanted to learn from him, and took his class.  After finishing at Columbia, he wanted to go to work for Graham, but Graham said no.  Buffett went back to Nebraska to be a stockbroker.

One day, Graham called and said that Buffett could come to work for him – he was being called up to the big leagues.  The next day Buffett killed all of his customers (no witnesses that way) and went to New York to work for Graham.  Okay, Buffet didn’t kill anyone.  That we know of – this isn’t Game of Thrones.

So, when Buffett got the job with Graham, he learned a lot.  Eventually Graham had enough money and wanted to spend the rest of his life on, well, whatever he wanted to spend it on (PEZ®, pantyhose and elephant rides?), so he shut the company down.  Buffett was, by most standards, pretty well off, and decided he wanted to move back to Omaha and open his own value investing shop because he missed all of the corn and the corn smells.  Buffett’s various ventures were pretty small – in 1990, his company (Berkshire Hathaway) was worth $7175.  Per share.  Recently that same share would cost over $260,000, and Berkshire Hathaway’s total value is over $440 billion dollars.

Warren Buffett has done okay.

He’s also known for being pretty frugal.  I know you’re happy I added frugal to that last sentence, because otherwise you’d just think that I thought that Warren Buffet was pretty.

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I personally think that this picture is pretty, even if Game of Thrones® has made dragons the good guys.

Warren has lived in the same house since the 1950’s, (it is a nice house, but not that nice), drives a car for years at a time (rumor is he bought a hail damaged one because it was cheaper), and recycles Pringles© canisters into air conditioning ductwork for his house and saves the trays for TV dinners to use to microwave Oscar Meyer® hot dogs.

Me?  If I had as much money as he does, I’d probably buy a new car every time mine ran out of gas (I kid, I drive my cars forever (LINK)).

I was watching a video while exercising (I work out for only for you and I study for only for you, Internet!) and heard Warren state “ . . . if I could invest as a small investor today I think I could . . . I know I could make a 50% return.”

That was a pretty powerful statement, since I certainly count as a small investor by Mr. Buffett’s standards.

Why can’t he do that?  He’s got billions of dollars he has to invest, so he has to do big deals.  There are a lot of good deals you could do with a few million dollars, but very few good deals in the billion plus region.  Turning the company’s $440 billion into $660 billion in a year is hard.  He could turn $10 million in to $15 million in a heartbeat.  Small deals are easier since there are so many of them.

Warren’s advice to investors is simple:  buy a low overhead (low fees) index fund (an index fund is a fund that is created to match an index, like the Dow Jones Industrial Average or the S&P 500).  If you can’t do what he does and value invest, this is the best way to get a good return.  And that’s good advice (in my opinion) for any small investor that doesn’t have the time to do the required research.

Let’s repeat that:  Warren Buffett says you should buy an index fund.

But me?  I know Warren didn’t get all of those Pringles® cans by investing in an index fund.  What did Warren Buffett do to get really rich?

What research did Graham and Buffett (reminder:  not Jimmy Buffett, but Warren Buffett) do prior to investing?

  1. Good Leadership, Good Business – Graham and Buffett were looking for leaders that had experience, capability, and great integrity. Warren can call CEOs and talk to them and give them the sniff test.  You can’t, so this is harder for you.  The business also has to be a good one. (More on this later.)
  2. Low Price to Earnings Ratio – The price to earnings ratio (P/E ratio) is how much you have to spend to get a dollar of the company’s earnings.

Before the 1980’s, the rule was a company that had a price to earnings ratio of over 20 was ALWAYS overpriced.  But the rule back then was to take the P/E and subtract the current prime interest rate.  Today the prime interest rate is ~1%, so using that old rule, a P/E of 19 would be acceptable.  Right now it’s difficult to make a return on capital because so much money is flooding everywhere . . .

Why was the rule like that?  It was assumed that you could either get returns from saving your money or from investing it.  Currently there is no benefit from saving it with historically low rates, so the P/E has continually wandered higher.

Alone, however, P/E tells you nothing.

  1. Low Price to Book Value – The book value of a company is how much all of its “stuff” is worth. In theory, if a company has a price to book value of less than one, you could buy the company (price), sell all of its stuff (book value), and come out ahead.  In theory.  If you have ever driven past a boarded up factory (and you have) you know that the book value just might be overstated.

Again, like P/E, Price to Book tells you nothing.

One video I watched while climbing on an infinite staircase to nowhere showed a screening method for value stocks that was alleged to have come from Warren Buffett:

  • Pick the Price to Earnings ratio,
  • multiply it by the price to book value, and
  • if the number was less than or equal to about 30,
  • the stock was a candidate.

Simple, right?

It is (and it’s overly simple).  Because what stocks have low P/Es and low Price to Book?

  1. Great, Undervalued Companies in Great Markets and
  2. Failing Businesses in Crappy Markets.

How do you tell the difference?  Sometimes you don’t.  Buffett will go on at length, if you let him, about all of the failures he’s had in picking companies.  But he had a consistent strategy that he followed for years that obviously resulted outstanding returns.  And he didn’t pick only small companies – Coca-Cola® was one of the companies he picked that produced amazing gains for Berkshire Hathaway.

So, how does a company like Berkshire Hathaway measure up on the value score?

  • It has a P/E of 20, and a Price to Book of 1.5. This would result in a score of about 30, so it would be within Warren’s window.  According to Warren, Warren is a value!  Also, Berkshire Hathaway has a credit rating better than (really) most countries.

What about . . . Tesla?

  • Tesla has never made any money, so its P/E is infinite. Its price to book is 12, so, 12 times infinity is  . . . still infinity.  Probably not a Buffett candidate?

And Honda?

  • Honda, maker of the best-selling electric car has a P/E or 8.6. It has a price to book of 0.77.  That means it scores an amazing 6 or so on Warren’s scale.  Wow!

So, let’s also look at a company that no one understands, Amazon:

  • It has a P/E of 120.  A price to book of 20.  That’s an astonishing 2400.  Again, probably not a “buy” rating from Buffett.

But is Honda a good buy right now?  Or not?

The only way to tell is to go back to Buffett’s first point.  But you and I can’t call up the CEO of Honda and expect to get real answers.  Warren probably could.

But we have help fortunately:  Joseph Piotroski, an accounting professor at the University of Chicago came out with a list of criteria that are objective and that anyone can find in the annual report of any publically traded company and named it the F-Score, which I really hope was based on the 1960’s show “F-Troop.”  I’d go through the list, but it’s much easier to pop up a link.  So here’s the (LINK) to Piotroski’s criteria.

ftroop

I think that Agarn was a horrible value investor . . . did you see the episode where he traded the blankets for a handful of small marbles that were supposed to bring Custer back from the dead?

Source- mycomicshop.com

Profitability

  1. Return on Assets (1 point if it is positive in the current year, 0 otherwise);
  2. Operating Cash Flow (1 point if it is positive in the current year, 0 otherwise);
  3. Change in Return of Assets (ROA) (1 point if ROA is higher in the current year compared to the previous one, 0 otherwise);
  4. Accruals (1 point if Operating Cash Flow/Total Assets is higher than ROA in the current year, 0 otherwise);

Leverage, Liquidity and Source of Funds

  1. Change in Leverage (long-term) ratio (1 point if the ratio is lower this year compared to the previous one, 0 otherwise);
  2. Change in Current ratio (1 point if it is higher in the current year compared to the previous one, 0 otherwise);
  3. Change in the number of shares (1 point if no new shares were issued during the last year);

Operating Efficiency

  1. Change in Gross Margin (1 point if it is higher in the current year compared to the previous one, 0 otherwise);
  2. Change in Asset Turnover ratio (1 point if it is higher in the current year compared to the previous one, 0 otherwise);

The lower the F-Score, the crappier the company.

And it, when combined with the screen above the Piotroski F-Score produced a return 7.5% higher than any other Value Investing test.  So, does Honda suck or not?

I don’t know.  But I’m going to check with the help of Dr. Piotroski.

But the biggest failure in Value Investing is to allow your emotions to rule.  Markets are driven by emotion:  Elon Musk is awesome, so I’ll buy Tesla!!!!!

Tesla might be awesome, but there are way too many Tesla fans for the price to be rational.  Part of finding value in the market is understanding that you want to buy at the lowest prices.  When are the lowest prices?  “When blood is running in the streets.”  When people have given up.  When people are running scared.  At that point, amazing companies can be picked up at incredible values.

In April of 2000 I was thinking of buying Microsoft®.  I had generally been a pessimist, but, at a certain point, I was finally ready to give up being a pessimist.  I was talking to a broker and then . . . the Dotcom Bubble burst.  If I had bought Microsoft© back then?  It would have taken thirteen years to be at breakeven.  And that’s not including inflation, which ate away at the buying power of the dollar.

But can I still get a Cheeseburger in Paradise?  Sure!  Jimmy Buffett will even have a Margarita with you if you have the proper parrot apparel.  But don’t expect Warren Buffett to pay for it.  But he will take your discount coupons so he can use them to get some suits he bought in 1983 altered.

 John Wilder has no positions in any stock mentioned, and won’t take any for the next week or so, until he can calculate the F-Score of Honda.  Especially Tesla – he’s not buying that though he loves Elon.  John Wilder is NOT a financial advisor.  And he’s had wine tonight.  Don’t trust him.