The old axiom holds that something is worth what someone is willing to pay for it. 

But what if the asset is not for sale? How do you value a business asset – a car or a computer for example – for the purpose of a balance sheet? 

There is a well established and eminently sensible approach that covers most cases. Take what was paid for the asset (the historic cost), subtract an amount every year for wear and tear (depreciation) and the value is what is left.

Sometimes, working out how much to subtract for wear and tear can be a bit hit and miss. In rare cases, assets appreciate in value because of scarcity or some other special condition.

But for the most part, common sense dictates that if you start with the historic cost, you won’t go too far wrong. 

The ACCC is presently discussing how to determine the value of Telstra’s fixed line network. It is doing this to calculate the appropriate rent that should be charged for other carrier to access, or use, the monopoly parts of that network.

Seemingly in defiance of common sense, the Commission is starting the process by offering up a list of alternative ways to calculate the starting value.

It is asking this question even though it has already calculated the depreciated historic cost of the network using information provided to it by Telstra under the law. That is, it has calculated already what Telstra’s network cost and what should be written down to account for how much it has been “used up” in the years since.

One of the other ways of working out the value of the network suggested by the ACCC is Depreciated Optimal Replacement Cost. This method basically involves constructing a model that tries to work out how much it would cost to build the Telstra network today.

This is a bit like working out what your car is worth by calculating how much it would cost you to build it in the backyard yourself.

From scratch.

Another method being considered is the Net Present Value method. This involves adding up all the income that Telstra gets from the network, multiplying the income by the number of years that it might continue to generate money and calling that the value of the assets.

The problem with this is that the ACCC believes that Telstra charges more than it should from those using its network. So NPV would simply turn inflated prices into an inflated asset value. 

Both DORC and NPV obviously and fundamentally fail the common sense test.

So why are DORC and NPV being considered at all? Because Telstra and other large incumbent telecommunications companies around the world have invested millions of dollars over decades dragging regulators such as the ACCC into theoretical nonsense games.

Compare the different outcomes from the different approaches and it soon becomes clear why Telstra is willing to make the investment in this regulatory fight.

According to figures presented by the ACCC to the Government, the accounts Telstra as provided to the ACCC indicate that the actual price Telstra network paid for its network minus deprecation (depreciated historic cost) is $8 billion.

But the model that Telstra has constructed to work out what it would cost to build its network today (Depreciated Optimised Replacement Cost) would value exactly the same network at closer to $40 billion.

It is easy to dismiss these arcane regulatory debates as egg head shenanigans, but there is a very good reason to pay attention.

The Commission’s choice of methodology will determine how much each and every telephone call, broadband connection and line rental costs for years to come. The price every Australian pays for basic phone services could be four times higher under the DORC methodology than under the depreciated historic cost approach

In the next few months, the Commission is going to have to make a decision about whether it stands up to Telstra and delivers the best deal for consumers and competition, or whether it trades their interests off to avoid a fight with Telstra.

Watch this space.

A short sale can be an excellent solution for homeowners who need to sell, and who owe more on their homes than they are worth. In the past, it was rare for a bank or lender to accept a short sale. Today, however, due to overwhelming market changes, banks and lenders have become much more negotiable when it comes to these transactions. Recent changes in corporate policy and the Obama administration have also improved the chances of getting a short sale approved.

But to be technical, here’s a more official definition:

A homeowner is ’short’ when the amount owed on his/her property is higher than current market value.
A short sale occurs when a negotiation is entered into with the homeowner’s mortgage company (or companies) to accept less than the full balance of the loan at closing. A buyer closes on the property, and the property is then ’sold short’ of the total value of the mortgage.
For homeowners to qualify for a short sale, they must fall into all of the following circumstances:

Financial Hardship – There is a situation causing you to have trouble affording your mortgage.
Monthly Income Shortfall – In other words: “You have more month than money.” A lender will want to see that you cannot afford, or soon will not be able to afford your mortgage.
Insolvency – The lender will want to see that you do not have significant liquid assets that would allow you to pay down your mortgage

So you’re interested in buying some stocks, and I’m happy to help. Whether you’re buying stocks low and then selling them high for quick profits, or you’re in it for the long run – a strategy loosely known as “buy and hold” – you’re bound to feel the burn of a stock price drop at some point. Stock prices move up and down every day, and you cannot control or manipulate them to your advantage. Price fluctuations and exposure to loss is certainly not exclusive to first-time investors or the inexperienced – top money managers lose cash with bad investments and downward price movements too. In fact, the only man in the history of finance to ever not lose client money in stocks and other financial products: Bernard Madoff, because he wasn’t actually investing it – he was simply stealing it (click here for more info on ponzi schemes and hot to avoid them).

So you’ll just need to accept the fact that you won’t always be right. But if you take the time to study, understand, and respect stock markets and their powerful abilities to give and take money, you’ll do just fine in the long run. The goal is not to be right every time – just be right more often than not. And the likelihood that you will achieve success in the stock market over the next 30-40 years (or however long you have until retirement) is almost guaranteed. You only need to look at the history of stock markets: consider that, at one point, the Dow Jones Industrial Average was worth only 1 point. Today, the DOW sits at 10,200 points.

Here’s a few lesson you should follow as a first-time investor when you have a company in mind that you want to buy, but aren’t sure if you should. After all, no one wants to lose money.

   First lesson: know your company. This is a simple concept that is not always followed by first-time investors. A lot of investors and traders (people who buy and sell stocks everyday for a living) use strategies that do not consider “knowing your company” to be very important. But if you’re considering buying a company, consider this: wouldn’t it be easier to understand what’s going on in a company’s market, their industry, or with their competitors than one you don’t know? Here’s an example. You’ve heard Microsoft is a great stock to buy, but you don’t know anything about technology or software. You know nothing of the company, who they are, or what they do – much less about Oracle Corp. or Apple Inc, their major competitors. You see their stock price – $28 a share – but you don’t know if that overprices, underpriced, or the right price. But you do know about retailing because you’re a manager in a clothing store. Maybe you already own stock in the company you work for because it was given to you, which is great. But it is the best retail stock to own? There are 5000 other retail industry company stocks in the markets to choose from – where do you start? Knowing your company is important in the event that the stock price plummet’s  because you’ll know if it’s worth holding or not. Consider that during the market crash of 2008, companies lost 40-80% of their stock value, and I mean almost ALL companies. Maybe financial stocks we’re deserving of their devaluation, but what about movie theatre stocks? Movie theatre stocks posted enormous profits because as investors saw last year, in a recession, people don’t stop going to see movies. It’s all about valuation.

   Second lesson: put a value on your company.  Attaching a value to the company whose stock you’re thinking of buying isn’t easy, and there isn’t one way of doing it. In fact, there are hundreds of different ratios, facts, figures, statistics, quarterly and annual financial reports and accounting practices that creditors and professional investors use to get very specific in their valuations. But as a first-time investor, you needn’t any of that confusion – keep it simple.

(The following valuations can be found easily on yahoofinance.com – keep an eye out for a video I’ll post that will accompany this post showing you how to find these figures for any company you’re considering buying).

For all these valuations, you’ll need to determine whether they are in an uptrend, a downtrend, or neutral. Click on the link to see an example of a company who demonstrates desirable uptrends/downtrends for each value.

Income – Find out how much income your company is pulling in. Find out what the revenues are (money before expenses). And while you’re at it, consider their expenses too. It’s found on the income statement of any company, and you’ll want to see an uptrend in revenues and a downtrend or neutrality of expenses.

Debt- Is your company swimming in debt? Forget the stock. Long-term debt is essential to a company’s growth, as long as assets outweigh the debt. Short-term debt, however, pilling up way beyond assets could be a red flag, especially if it’s been getting worse over the last few quarters. Look for an uptrend in assets, a downtrend in debt, or neutrality in debt.

Earnings – look for an uptrend in earnings over the last few quarters and the last few years. Neutrality is OK, but don’t necessarily expect a jump in the stock price based on shareholder equity (earnings) if the company isn’t growing in that regard.

That’s a solid start in determining the value of the company you’re thinking of buying. But it doesn’t stop there – even if your company has satisfied all these conditions, there’s still much more to consider. Contact us for more information on how to value a company beyond these three simple figures.

    Third lesson: don’t panic! You’ve done your homework. You’ve followed our recommendations every step of the way (or maybe you didn’t and still ended up with a great companies stock). Congratulations! But the stock price just dropped, and so did your stomach. You’ve watched your stock lose 5, 10, or maybe even 20% of what you paid for over the course of 5 days. Your mind is racing and your heart is pounding; when will it end? Could it drop more?

Again (unfortunately) there is no single answer. But here’s a start: don’t panic. Not all stock drops are deserved! Remember, stock prices drop because investors who hold the stock are selling them in large volumes. Sometimes, a stock can get “oversold” on hype or news. But here’s an important point: know how valued your company is – not just by your expectations, but by the market’s expectations, too. Will the stock price come back up? In the long-run, certainly (with a few historical exceptions such as the fall of GM due to overwhelming debt and a gradual loss of American car-maker market share, or the fall of Lehman Brothers due to extreme financial risk-taking). You’ll find yourself asking, “But what about now? Will the stock price come back or should I sell and cut my losses”? In most cases, cutting your losses is a bad idea. Once you actually sell your stock, the loss is permanent – as opposed to just holding a losing stock, which could come back eventually. Consider the 6-month stock market free-fall between September 2008 and March of 2009. Investors who sold their stocks after 5 long painful months of seemingly never-ending losses at the market’s bottom in March 2009 made their losses permanent. But March 2009 to November 2009 saw the world’s largest and most aggressive bull rally – stocks as an average gained between 40-50% in less than a year! In fact, a quick look at a chart of the DOW reveals a few interesting things – including the fact that if you got into the stock market in 2000 and stayed until today, you would have actually just went up, down, up, down, and then even. You would have lost only -1% over ten years!

So be a diligent and committed first-time investor and follow these tips. And of course, contact me with questions, comments, or concerns!

-Tom, Bullworthy.com.

tom@bullworthy.com

Inflation vs ROE

When even a consulting firm starts talking inflation, you know a big issue is at hand.  The chart above is from a recent Mckinsey note. It makes an interesting point, which investors often miss.

In inflationay times, companies will often tell analysts – we will be able to pass on costs, so there is no reason to worry about inflation. Mckinsey points out - maintaining reported net profits is not enough.  You need to maintain cash flow stream, and that will likely mean that RoE needs to go up. Or roughly speaking, the gap between inflation and RoE needs to be maintained.

So ask yourself this question – Inflation has shot up by say 1000 basis points,  or 10% points in India (never mind official WPI data). So have corporate RoE’s gone up by the same amount?

This almost never happens, as Mckinsey’s chart for US points out. Corporate RoE’s dont swing by that much, and certainly not at times of high inflation. No amount of belt tightening can generate that response for entire listed corporate sector. So atleast some, or quite a few companies will suffer. The US markets were flat for much of the decade of ’70s and early ’80s when inflation was high.

A note from Nomura points out how Indian markets have Indian markets tend to fall sharply whenever WPI has crossed 8% in the last decade.  It says – only a matter of time, and ‘when’ not ‘if’ – the markets will react to inflation. They already are reacting, but atleast another 10-15% further down from here needed as a decent response to high inflation.

Inflation versus Market Performance - India (source- Nomura)

 Anyway, a correction is welcome. Valuations are too high for most companies.

Will CRE valuations drop further?  Harold D. Hunt shows multiple reasons why cap rates will go higher in January’s For What It’s Worth: Accurate Valuation Makes the Difference, published in Tierra Grande, journal of the Real Estate Center at Texas A&M University.  Hunt points out the difficulty of estimating the impact of declining rent rates…

Despite a challenging backdrop for the U.S. consumer, the pet industry continues to perform at or above expectations.  While the pet market has not proven to be “recession proof”, as touted by many, key pet verticals have demonstrated strong resistance to the macro-economic turmoil impacting the broader market. Notably, an earnings recovery, beginning in late 2008, sent equity values of core publicly traded pet companies higher.  This peer group out performed the S&P500 by ~ 16% in 2009.

While the macro outlook remains strong, a look into the performance of PetSmart, a proxy for pet retail, provides insight into the challenges facing the industry.  PetSmart’s equity value increased 44% in 2009, on the back of a strong rally (31%) in the fourth quarter.  However, a deeper look at the numbers reveals the impact the economic downturn had on the retail segment.  Notably, growth in average ticket size decelerated in 2009 and traffic volume continued to slow, despite core consumers seeking lower price alternatives and one-stop-shop solutions.  Further, a considerable amount of growth over the past two years was driven by commodity price inflation, mainly in the food category – but sales comps, excluding inflation, remained positive through 3Q09.   PetSmart’s management issued strong guidance for 4Q09; the company produced its first positive units comp since 1Q07; hardgoods comps continue to be negative, but are improving; service sales increased 8.0%, after declining 9.3% in 3Q09 — grooming outperformed training and hotels.

Throughout 2010, we encourage industry followers to keep an eye on PetSmart, as its fortunes will provide a very good proxy into the health of the industry.  In addition to keeping a keen eye on retail, here are other key trends we are tracking for 2010.

Facing the Facts

The reality is that the growth rate of the companion animal population is moderating, which will impact prospects for the industry.  That said, the future still looks bright.  The humanization of pets thesis remains strong, but growth will not be industry wide in the near term as economically challenged consumers face difficult purchasing decisions.  We expect sectors and products that tap into the core themes of value, health and wellness, and convenience to outperform the industry at large.  International opportunities will also be a source of growth for leading domestic suppliers.

Retail Landscape Continues to Evolve

In 2009, PetSmart and Petco lost market share to other big box retailers, grocery and independent pet specialty.  Wal Mart has established itself as a major force in mid-range pet retail, providing a compelling one-stop-shop solution.  Independent pet specialty continues to deliver a more attractive product mix and service solution for premium customers.  Recovery in generic foods enabled supermarkets and the natural channel to rebound. These realities are forcing changes into the PetSmart and Petco business models.   PetSmart is trying to create stronger customer bonds through adoption and services, which other channels cannot match, while Petco has launched “unleashed by Petco” to compete directly with independent pet specialty chains.  We expect further changes from Petco and PetSmart in an effort to protect share.

Healthcare in Focus

Pet health and wellness remains top of mind for pet owners due to the rising cost of care for pets.  Consumers continue to seek product solutions that deliver perceived health benefits to their companion animals.  Additionally, they are proactively trying to control health care costs by purchasing pet insurance products, products that may mitigate or delay large health related expenditures, and trading down to generics for pet prescriptions.  End of life care has become particularly challenging in light of current economic realities

Transaction Environment Transition

Over the past two years, the industry has seen capital inflows, primarily in the form of growth equity.  While the pet industry remains a key target for consumer-oriented equity funds, the transaction landscape is likely to be characterized by a greater M&A orientation.  Henry Schein Animal Health/Butler Animal Health,  Pet Valu/Roark Capital, International Absorbents/Kinderhook Industries, and the pending sale of Pets at Home (UK) are recent examples of what we see as an emerging trend.  We anticipate strategics will begin to use their balance sheets to purchase growth.  Lacking access to cheap debt, private equity buyers will be at a disadvantage.

As always, our full industry update is available upon request.

/bryan

When it comes to making money, investors choose from a broad menu of investment categories, ranging all the way from baseball cards and wines to collectible cars and art. Two of the larger and more popular investment categories are stocks and real estate. Unfortunately for those poor souls (such as me) analyzing these two classes of assets, the stock and real estate investor bigwigs hav not come together to create an integrated metric system. Much the same way the United States has chosen to go it alone on a proprietary customary unit measurement system with Burma and Liberia – choosing inches and feet over centimeters and meters. On the subject of stock and real estate valuation, investors and industry professionals have been stubbornly defiant in designing unique and cryptic terminology, despite sharing the exact same financial principles.

 Who Cares About Real Estate?

Well, apparently everyone. Southern California doesn’t have a monopoly on real estate, but through my practice in Orange County, I find it difficult to not trip over real estate investors on a daily basis. I work in effectively what was “ground zero” of the subprime debacle and the commercial real estate pains continue to ripple through “the OC.”

Ramping up the real estate learning curve reminds me of my high school Spanish class – I understood enough Spanish to work my way through a Taco Bell menu but little else. In order to actually learn Spanish I had to completely immerse myself in the language, even if it meant continually speaking to my classmates in Spanish as my alias (Paco).

Real Estate Foundational Terms

Despite being a relative new resident in the Orange County area, engrossing myself in real estate hasn’t been much of a challenge. Over a brief period, my interactions and conversations taught me my financial degrees and credentials were just as applicable in the realty world as they were in the stock market world. While evaluating real estate valuation techniques, I discovered two new key terms:

1)      NOI (Net Operating Income): Unlike stock analysis, which uses “Net Income” as a core driver in determining an asset’s value, real estate relies on NOI. Net operating income is generally derived by calculating income before depreciation and interest expense. In finance, there are many versions of income. I’m sure there are more explanations, but two reasons behind the selection of NOI in real estate valuation over other metrics is due to the following: a) NOI may be used as a proxy for cash flow, which can be integral in many valuation techniques; and b) NOI is “capital structure neutral” if comparing multiple properties. Therefore, NOI allows an investor to compare varying properties on an apples-to-apples basis regardless of whether a property is massively leveraged or debt-free.  

2)      Cap Rate (Capitalization Rate): This ratio is computed by taking the NOI and dividing it by a property’s initial cost (or value). In stock market language, you can think of a “cap rate” as an inverted P/E (Price – Earnings) ratio – an inverted P/E ratio has also been called the “earnings yield.” Complicating terminology matters is the interchangeable use of income and earnings in the investment world. In the case of the P/E ratio, the denominator generally used is “Net Income.”

A shortcoming to the cap rate ratio, in my view, is the failure to deduct taxes. Although comparability across properties may get muddied, if determining profit availability to investors is the main goal, then I think an adjusted NOI (subtracting taxes) would be a more useful proxy for valuation purposes. Tax benefits associated with REITS (Real Estate Investment Trusts) complicates the metric usage issue further.

The simplistic beauty of marrying NOI and a cap rate is that a crude valuation estimate can be constructed by merely blending these two metrics together. For example, a commercial real estate property generating $500,000 in NOI that applies a 5% cap rate to the property can arrive at a valuation estimate of $10,000,000 ($500,000/.05).  

Similarities between Stocks & Real Estate

At the end of the day, the theoretical value of ANY asset can be calculated by taking the projected after-tax cash flows and discounting that stream back into today’s dollars – whether we are talking about a stock, bond, derivative, real estate property, or other asset. Both stock and real estate analysis use readily available income numbers and price ratios to estimate cash flows and valuations. Regrettably, since real estate and equity investors generally play in different leagues, the rules and language are different.

The lingo used for analyzing separate asset classes may be unique, but the math and fundamental examination are the same. The formula for learning real estate is similar to that of Spanish – you need to dive in and immerse yourself into the new language. If you don’t believe me, just ask Paco.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing had no direct positions in YUM or any other security mentioned. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

There are many similarities between investing in stocks and handicapping in sports betting. For example, investors (bettors) have opposing views on whether a particular stock (team) will go up or down (win or lose), and determine if the valuation (point spread) is reflective of the proper equilibrium (supply & demand).  And just like the stock market, virtually anybody off the street can place a sports bet – assuming one is of legal age and in a legal betting jurisdiction.

Right now investors are poring over data as part of the critical, quarterly earnings ritual. Thus far, roughly 20% of the companies in S&P 500 index have reported their results and 78% of those companies have beaten Wall Street expectations (CNBC). Unfortunately for the bulls, this trend has not been strong enough to push market prices higher in 2010.

So how and why can market prices go down on good news? There are many reasons that short-term price trends can diverge from short-run fundamentals. One major reason for the price-fundamental gap is the following factor: expectations.  Just last week, the market had climbed over +70% in a ten month period, before issues surrounding the Massachusetts Senatorial election, President Obama’s banking reform proposals, and Federal Reserve Bank Chairman Ben Bernanke’s re-appointment surfaced. With such a large run-up in the equity markets come loftier expectations for both the economy and individual companies. So when corporate earnings unveiled from companies like Google (GOOG), J.P. Morgan (JPM), and Intel (INTC) outperform relative to forecasts, one explanation for an interim price correction is due to a significant group of investors not being surprised by the robust profit reports. In sports betting lingo, the sports team may have won the game this week, but they did not win by enough points (“cover the spread”).

Some other reasons stock prices move lower on good news:

• Market Direction: Regardless of the underlying trends, if the market is moving lower, in many instances the market dip can overwhelm any positive, stock- specific factors.
• Profit Taking: Many times investors holding a long position will have price targets or levels, if achieved, that will trigger selling whether positive elements are in place or not.
• Interest Rates: Certain valuation techniques (e.g. Discounted Cash Flow and Dividend Discount Model) integrate interest rates into the value calculation. Therefore, a climb in interest rates has the potential of lowering stock prices – even if the dynamics surrounding a particular security are excellent.
• Quality of Earnings: Sometimes producing winning results is not enough (see also Tricks of the Trade article). On occasion, items such as one-time gains, aggressive revenue recognition, and lower than average tax rates assist a company in getting over a profit hurdle. Investors value quality in addition to quantity.
• Outlook: Even if current period results may be strong, on some occasions a company’s outlook regarding future prospects may be worse than expected. A dark or worsening outlook can pressure security prices.
• Politics & Taxes: These factors may prove especially important to the market this year, since this is a mid-term election year. Political and tax policy changes today may have negative impacts on future profits, thereby impacting stock prices.
• Other Exogenous Items: Natural disasters and security attacks are examples of negative shocks that could damage price values, irrespective of fundamentals.

Certainly these previously mentioned issues do not cover the full gamut of explanations for temporary price-fundamental gaps. Moreover, many of these factors could be used in reverse to explain market price increases in the face of weaker than anticipated results.

For those individuals traveling to Las Vegas to place a wager on the NFL Super Bowl, betting on the hot team may not be enough. If expectations are not met and the hot team wins by less than the point spread, don’t be surprised to see a decline in the value of the bet.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and GOOG, but at the time of publishing had no direct positions in JPM and INTC. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

Today’s world is embroiled in uncertainty at all levels—political, economic, social, and commercial. This is nothing new, although every generation seems to believe that they faced the worst. In the last hundred years, the world has seen much—world wars, nuclear bombs, airplanes, computers, and the Internet. Quantum theory was revealed, options theory was forged, planets were discovered outside the solar system, and the human genome was mapped. Bigger wars were followed by smaller but more potent ones, as some tried to spread philosophy and others, religion. Diseases spread across the globe by air, water, airplanes, and human contact but were conquered by chemicals and magic. Capital and labor clashed, some driven by profits and others by power, aided and abetted by philosophers of various persuasions. Countries were freed by war and peace, divided into many by walls and mountains, and then combined into one again. Democracy and religious extremism has spread hand in hand. Planned economies failed, while the foundations of the free market philosophy were also shaken. Companies grew to gigantic proportions, with revenues dwarfing the GDP of countries, and they spread across the globe, creating sprawling multinationals. They merged with others or acquired smaller rivals, creating even larger enterprises using size and revenue as the fundamental measure of success. Trade blocks and alliances formed, aided by geographical proximity of countries with different specializations, and then grew into unions of currencies and cultures. Bitter enemies became best friends and vice versa for oil and gold. Frozen alliances in a cold war broke into pieces while new ones were put together with no real objectives. Nobel laureates lamented about a warming globe fueled by dirty coal while dirtier energy policies went unheeded.

Read More: http://www.amazon.com/Flexibility-Flexible-Companies-Uncertain-World/dp/1439816328/ref=sr_1_3?ie=UTF8&s=books&qid=1262102582&sr=1-3

It didn’t escape me this week to spot a house for sale – at the eyewatering price of $75m! And its in my favourite City – New York. Details here if you are interested. In case the link breaks a brief description…

This grand and elegant neo-Italian Renaissance mansion is exceptionally wide (45′) and one of the largest and most important townhouses in New York. Commissioned in 1922 by Julius Forstmann, a prominent German merchant, the house was designed by C.P.H. Gilbert, the renowned architect who created majestic mansions for the leading families of the city. Behind a stately and distinguished limestone facade are five floors with an additional garden level and a full sub-basement comprising a total of approximately 21,000 +/- sq ft. The dramatic entrance foyer leads to a magnificent reception hall and grand-scaled rooms which feature many superb original details, including a spectacular sweeping marble staircase, an enormous skylight, marble fireplace surrounds, hand-carved moldings, and soaring high ceilings. This extraordinary townhouse offers the rare opportunity to own a Manhattan landmark with the versatility of luxury residential or trophy commercial use.

As a good agent I should offer to assist you in the purchase if this grabs you.

As for me, the $316,818 (£194,000) monthly mortgage might be ok for a while (around 4 weeks?) but after that I’m renting I think!

What really made me smile was that the agent had measured it to the nearest 1,000 sq ft! I am not sure what commission would have been negotiated, but I would do the job for 1% – a cool £460,000. And I would measure every room too!

I think I feel the need to go and have a look, after all, it’s four months since I was last in the Big Apple…

As I sat watching “build a new life in the Country” this week I find myself sitting asking – why?

The lighthouse at Eastbourne - courtesy Rob Wassell

Then there’s the builder who is modelled on David Brent – but with tattoos!

The couple paid £500,000 and think they will have to spend another £500,000 on refurbishing. The project suffers delays – and cost overruns. “We bought it in a moment of madness” the owners said. They applied for planning permission whilst the builders was on site. They spent “between £700,000 and £750,000″!

I couldn’t help wondering why on earth they didn’t take advice? A plug for all professionals – a Surveyor would have spotted the access road and might have expressed concern about the close cliff. An Architect would have made the building even better – and might have spotted the need for planning permission. He / she might have also avoided a sliding door! A QS would have tightened up on the costs before the work started – and enabled the owners to be able to be able to prioritise. The Project Manager would have kept the whole programme in check.

Yes, these services cost money, but the schoolboy errors can be avoided.

I did wonder when the owners apply for these programmes whether the first question is “ok so you have a great project and cool building – but have you taken ANY professional advice?” – Answer “No” and we’ll be there!

I have done two dilapidation surveys this week – where the tenants will almost certainly cry “it’s not fair”. In neither case did the tenant have a schedule of condition at the start of their lease. I have done one of those too this week – it cost £750. It will probably save the tenant tens of thousands of pounds at the end of his lease.

It sounds like money that can be saved (and spent on stripey fabric?) – but in the long run, it does pay to employ a professional. Plug over.

Below is a link to the 2nd Dishy Mix podcast interview with Susan Bratton and me regarding Digital Media M&A.

http://blogs.personallifemedia.com/dishymix/

Look for DM 136 podcast: John Doyle.

It’s always fun to speak with Susan and we decided to make this an annual conversation.  Enjoy!

Best,

John

Facebook Valued At $14 Billion On SecondMarket

Washington Post

Offers to buy Facebook common stock have surged to $32 per share on SecondMarket, a marketplace for the buying and selling of private company stock. …

Read more

The valuation has always been a tricky issue to handle for any company or any investor, as there are no definite guidelines to calculate the valuation of a company. However, there are certain parameters that can be logically defined to arrive at a valuation of the company. There are three key matrices, which are of critical importance to arrive at the valuation. These three matrices are -

1. Expected Return on Investment: The investor is investing in the company with a return expectation in mind. Given the stage and risk profile of the company, any investor will reasonably expect a minimum annualized return of 30-35% on his investment.

2. The company’s valuation at the time of exit: Most investors would exit the company either through IPO or M&A after 5 to 7 years and there would be a certain valuation of the company at the time of exit. The exit valuation can be calculated by standard valuation methodologies like DCF (Discounted Cash Flows), PAT multiple etc. which cannot be applied at the investment stage due to startup nature of the business at that time.

3. Amount of investment made in the company: This is the amount of money investor is investing into the company.

The valuation of the company at the time of investment can now be determined by connecting these three parameters together.

For example, lets assume that the investor is investing Rs. 5 Cr. and he is expecting an annualized return of 30% and after 5 years at the time of investor’s exit, the company is valued at Rs. 200 Cr.. To arrive at the valuation at the time of investment-

a. Calculate the value of investor’s investment at the time of exit. In the above example, that value would be 5*(1+30%)^5 = 18.6 Cr which is equal to (Initial investment) multiplied by (1 + expected return) to the power (no. of years before exit).

b. Calculate the investor’s share at the time of exit to get his desired return on investment. In the same example, to get his 18.6 Cr. in a company that is valued at Rs. 200 Cr., the investor should have 18.6/200 = 9.3% stake in the company. The investor’s stake is equal to (investor’s value) divided by (company’s valuation).

c. Calculate the company’s valuation at the time of investment. Now, based on his stake in the company and initial investment, the valuation of the company at the time of investment would be 5/9.3% = 53.7 Cr. which is (initial investment) divided by (investor’s stake).

Having said all this any promoter must keep in mind that there are a number of other subjective parameters which play a crucial role in determining the investor’s stake in the company. These parameters are decided with the purpose of protecting investor’s interest and keeping the promoters group motivated to grow the company. More of this in a later article.

Bill Daniels, a cable tycoon, was a consummate deal maker.  I never had the honor of meeting Bill, but his reputation in the industry has stood the test of time as have some quotes that have been attributed to him. My Partners, some of whom had the great pleasure of knowing and doing business with Bill, are fond of one such quote:

You set the price and I’ll set the terms.

From what I am told, Bill understood the interaction between pricing and structure better than most. The essence of the quote is that pricing and structure are inextricably linked; you cannot fully understand the valuation of the deal without fully understanding each of its elements.

Often, I find that entrepreneurs overemphasize pricing (the pre-money valuation) and under-value structure. This is understandable. The pre-money is “a number”. Being a number, it is easy to understand, requires little interpretation and is easy to communication.

Yeah, we got the venture guys to pay-up with a $(fill in the blank) pre-money.

The pre-money valuation of a deal lends itself to soundbite marketing and entrepreneurial chest-thumping. By driving pricing up, the entrepreneur can bring a big number back to his/her existing investors and Board, thereby validating what the entrepreneur has accomplished. This is all well and good; I’m all for entrepreneurs doing their fiduciary duty and battling to maximize pricing on the behalf of their existing investors. But a focus on pricing completely ignores the other half of the valuation equation, structure.

Unfortunately, in my experience, entrepreneurs over-value a high pre-money price and undervalue structure. Take the example of a $10 million last institutional growth capital round. Lets say the Company is choosing between a convertible preferred structure priced at a $20 million pre-money and a participating preferred structure with a $30 million pre-money. The chart below shows the payout to the new investor from this structure (the bottom axis is exit value, the left axis is $ returns to new investors. I’ve posted the full spreadsheet here.

This is an overly simplistic example, but I think it shows the interplay between structure and pricing very well. Notice that the returns for both structures diverge at the $10 million mark; this is the level at which the liquidating preferences of both structures are paid back. The difference is that the standard convertible preferred structure does not begin participating again until it is advantageous to convert and that happens only when the post-money valuation of the round is exceeded ($30 million). The participating instrument however begins to participate immediately after the liquidation preference is paid back. Although the participating instrument owns less of the company, it returns more than the standard convertible preferred structure all the way up to the $90 million exit value, where the structures are equal. The participation feature acts as a return accelerant at lower levels of exit valuation.

Why is this important? For me, the goal of pricing and structuring a new investment is to get a fair deal that maximizes the alignment between new investors, existing investors and management. By “fair”, I mean that it provides my limited partners with an expected return on capital invested that is commensurate with the risk of the investment. Getting to the right risk-adjusted return is a matter of both pricing and terms. When entrepreneurs try to push the pre-money valuation higher, investors have no choice but to respond with structural return “kickers” like participation features. In the scheme of things, a participating feature is a mild structural advantage for new investors; I’ve seen much worse (multiple liquidating preferences, performance based ownership ratchets, etc.) But even a participation feature can create a disconnect between the interests of existing investors/management and new investors. In this case, the participation feature may lower the new investor’s exit threshold, creating an incentive to sell earlier than they would otherwise. Caps and catch-ups can help to remedy this, but add another layer of complexity. And in my experience, complexity is rightly to be avoided because it often results in unintended consequences.

The point is that entrepreneurs should understand that valuation is matter of both pricing and terms. You cannot understand one without the other. The goal of alignment will always favor a simpler structure at a fair price. Unfortunately, in practice, things are never quite that straightforward.

You may be a regular mover who understands the buying and selling process or you could be buying or selling property for the very first time. Whatever your situation teaming up with an estate agent you can trust will make a big difference to your moving experience.

There are hundreds of estate agents out there and selecting one can be a tough job, but making the right choice will certainly help with selling your property and the moving process.

So how do you find an outstanding estate agent?

1. Start with friends, relatives and colleagues etc. Use word of mouth recommendations and local reputation. Have a drive or walk around the local area and see which agents have the most “Sold” boards outside properties. It may sound cheeky but knock on a couple of doors and ask them about their agents. If their agent has done a great job, you will always get good feedback. Give a couple of agents a ring. How do they deal with your initial call? How quickly is the phone answered?
2. Shop around and compare fees from at least three agents. However bear in mind that the lowest fee agents may not always offer the best service. They may lure you in with low fees just to get your property on their books. Low fees could also mean low service. If you feel the fees are too high, then don’t be afraid to negotiate. Another point to consider is that if an agent quickly/easily reduces their fees to get your property on there books, then how quickly/easily will they suggest to a potential buyer, to put a low offer in? Is this an agent that you want to deal with? The agent should always be working for the vendor to obtain the highest possible sale price.
3. Get valuations from at least three agents before making a decision. An estate agent who undervalues, may be giving an honest appraisal, but by the same token they may also be trying to get a quick sale, so that they get a quick fee. An agent that overvalues may be hoping to flatter you and feed your greed, so that they get your property on their books. However your property may remain unsold and eventually the agent will suggest reducing the marketing price. Get the three valuations and then you can make an informed decision about the marketing price. Again a good agent should always be working for the vendor to obtain the highest possible sale price.
4. Ask the agent about their recent sales and successes in your area? Ask them what is sought after, and how your home stacks up against the local competition.
5. How would they deal with your property sale if it was not selling as hoped?
6. Is the agent a member of the National Association of Estate Agents (NAEA) and the The Property Ombudsman? If the agent is not a member of the NAEA or The Property Ombudsman, then ask them why not? However just because they are not members doesn’t necessarily mean they are not reputable.
7. How will the agent market your property? Which websites and property portals will they advertise with? Which local newspapers and publications? Do they use any other forms of marketing? Do they offer “Open house” days? If you have more unusual marketing expectations discuss these with your agent, and ask if they can accommodate? Does the agent have a high street location? Is a high street location important to you in the modern digital age?
8. Ask to see a copy of the sales contract and examine it closely. The contract is legally binding so make sure you read the small print. Short term contracts can indicate that the agent is confident about selling your property and is confident about providing you with good level of service.
9. If they are trying to tie you into long contracts, either negotiate shorter term contracts or walk away. There is nothing worse than being tied in for a long period, when there doesn’t appear to be any sales activity. Agree contracts that will allow you to change agents if your current agent doesn’t appear to be doing anything.
10. Good agents will also offer you some tips on how you can present your home to appeal to the buyers. Don’t let their tips offend and although you may not want to follow their advice, by doing so will probably result in a better offer and a quicker sale.
11. What is the agents knowledge of the local area, schools, clubs etc
12. Finally go with your gut feeling. It will be a lot easier and smoother dealing with someone you like, trust and get on with. You’ll be doing a lot of communicating with your agent and this compatibility will make the process a lot easier.

Take your time and perform a thorough investigation. That way you will select the right agent who will save you a great deal of aggravation and effort in selling your property.

© differentmoves 2010

Choosing the right estate agent to sell your property is probably the most difficult task you will face.

Here are some tips to help you choose the agent that’s right for you.

What are the signs of a good agent?
When you speak to theagent, request an appraisal, not a valuation (this can only be done by a licensed valuer). When the agent inspects your home make sure you give them an inspection! Pay attention to how they dress as this can reflect their attitude.

Your agent won’t get buyers to part with large amounts of money if they don’t look and act professionally. If the agent doesn’t impress you, they won’t impress the buyers.

Shop around
Shop for an agent the way you would shop for a good lawyer, accountant, mechanic, plumber or any other professional.

Don’t be afraid to ask direct questions
Ask things like:

• “How often can I expect to hear from you?”
• “What sort of feedback will you give me from potential buyers” and “How frequently?”
• “Who else in your office would work on the sale campaign?”
• “Are you too busy to take this on?”
• “Will you handle the sale personally?”

Ask about a marketing approach
Make sure you ask about how and where your property will be advertised and what types of buyers will be targeted.

• Does the agent have a buyer database, for instance?
• Web marketing is an essential component of any campaign but how effective is the agent’s website, blog, social media?
• What strategies will they employ to make sure buyers find your property on their website rather than another agent’s listing’?

Ask for feedback on your property’s presentation
An experienced agent will have ideas about how to improve your property to ensure a successful sale. They will be honest about any problems they can see. If you don’t get both positive and negative feedback about the property, you might be talking to the wrong agent.

Talk price
If one agent gives a vastly higher opinion of your property’s value, try not to get carried away. This is the most costly mistake a property owner can make – signing up with the most optimistic agent. You want a realistic opinion of your property’s value, one based on the agent’s sound knowledge of the area.

Remember, it’s not the seller or the agent who decides what a property is worth, it’s the buyer.

What type of agreement to sign
When you’ve chosen your agent you’ve another decision to make. What type of agency agreement should you agree to? Some people list their home with multiple agents. This is known as ‘Open Listing’. However, agents earn their income through sales, not listings, so they’re less likely to give a great commitment unless they’ve got a chance of success.

Like all business people, real estate agents dedicate time where they’re most likely to gain. Another method of sale is a ‘co-agency’. Consider this method from the agent’s standpoint again. Why should they work as hard on a sale when they’re only making 50% of their normal fee?

Finding the ideal combination of professionalism, experience and drive can be challenging in an industry where skills vary so widely. Now you’re ready to speak to an agent.

The latest figures for property investment have just been published. We subscribe to PropertyData which provides detailed analysis of Investment transactions month on month. The December 2009 figures have just been released – which also give us a chance to review the annual performance of the market.

The value of transactions over 5 years - from Property Data

The general view is that the market improved at the end of the year – so perhaps 2010 will be better?

Property values are also published – and in the investment market we measure value by ‘yields’. This is simply the return of rent in comparison to capital value. It is no more complex than looking at returns at the Bank or Building Society. We like to make valuation something of a ‘black art’ though – by doing various adjustments for costs, tax etc. But the fundamentals remain – it is a return on value.

It is helpful to compare what you might get for your cash at the Banks. According to the ubiquitous Martyn Lewis the best you can get on instant cash is around 3.35% (worst is 0.1%!). If you lock your money up for 3 years then you could get 4.7%.

PropertyData calculate some average yields (and acknowledge the dangers of averages). But they show some interesting figures for the last three months, by property type:

West End offices London – 6.66%
Regional Offices – 7.75%
Unit shops – 6.7%
Retail Warehouses – 7.14%
Industrial Units – 7.65%

It is interesting to note is the bunching of yields – the average spread across the sectors is only approximately 1%.

Also, returns are higher than cash – there are some obvious reasons. The market is quite illiquid – i.e. the costs of entry and exit are high (Stamp Duty can be 4% on large value transactions). There are risks associated with the income – it is not note necessarily ‘gilt edged’. Buying with borrowed money is difficult too – although the Base Rate is low at 0.5% – this rate is not readily available!

But if you can find property to invest in – the current returns look quite attractive! And if you need help give me a shout!

There has been much to celebrate during 2009 as the stock market ended its’ free-fall and set off on one of the biggest single year gains since the Great Depression. We have seen continued improvements in many economic indicators and their second derivatives such as temporary hires, corporate earnings, initial unemployment claims, and even the more comprehensive measure of U-6 unemployment registered a slight improvement in November. However, the improvements have been very slow coming and I do not anticipate any radical improvements in the near term that would justify additional sudden upside in equity markets.

Despite the improving flow of news, I remain cautious because of many structural issues  carried over from the last few years that remain to be dealt with and because of the significant caveats that apply to much of the good news we have had. For example, the big recent fall in initial unemployment is to be expected at the end of the year because companies usually try to avoid the bad PR of laying off employees going into the holidays. Also, the slight improvement in U-6 unemployment during November is more likely to be a statistical blip than the emergence of a new trend considering that it is still above the reading from September and December’s reading ticked higher as well.

At the end of the fourth quarter, the S&P 500 was sitting at the 50% Fibonacci retracement line from the July 2007 market highs to 2009 lows following more than a 64% move from the March bottom. At 19.9, the  projected 2010 price/earnings ratio of the market is certainly above the historical average of approximately 16 but it is still well within normal ranges during the beginning of a recovery.  Although I do not feel that the market is significantly over-valued at current levels, I see few catalysts for significant additional gains and after pouring over historical data, I believe there is a relatively high likelihood that the market will correct moderately to the downside as the previously mentioned issues play out and the following headwinds begin to manifest themselves:

Although the initial unemployment claims number has been declining recently, a disturbing trend in the data has been emerging in which continued unemployment has been rising in an almost inversely proportional way. This indicates that a growing number of people have been and are being disconnected from the labor market for almost a year. These people will lose their unemployment benefits soon, depressing their ability to contribute to the economy while also subtracting from the spending power of those people who remain employed because many people are now using discretionary income to support family members and friends who have fallen on hard times.

To make matters worse, many of the jobs that have not yet come back (such as manufacturing, financial services, automotive, etc.) are not likely to return to pre-crash levels of employment and sectors that are growing such as health care are not hiring as much as they normally would be because of persisting uncertainty regarding regulation in the sector. Also, the longer someone stays out of the labor market, the more their skills become obsolete, diminishing their long term productivity and earnings potential. I’m also beginning to factor in a slight chance of a double dip recession similar to 1937 if the Government and Fed are forced to begin withdrawing stimulus and liquidity before the labor markets can fully stabilize.

A large part of the recent rally has been due to strong fiscal and monetary policies enacted over the past two years that I mentioned previously in my October 20th Buffett vs. Bullion post. However, these will be disappearing relatively soon as the Troubled Asset Relief Program (TARP) expires in 2010 and liquidity is withdrawn from the market by the Government and Fed to prevent inflationary pressures from building into another asset bubble. The U.S. Government hasn’t even come close to issuing all of the debt that is required to fund its’ growing deficits but now that a complete financial meltdown is off the table, investors are already demanding higher yields to make purchasing the treasuries worthwhile considering the balance sheet problems facing our country. If yields continue to rise, it will eventually put serious pressure on an already strained credit market and economy.

Commercial banks are the backbone of the worlds’ credit markets and they have been badly injured over the past few years by and are still being held together by unprecedented levels of legislative (termination of mark-to-market), monetary (lowering Federal Funds Rate below 0.25%) and fiscal (TARP) support. The banks are still being hobbled by a multi-year build up of toxic “assets” and unprecedentedly high default rates on a wide range of consumer and commercial loans which has significantly curtailed the ability of banks to loan out new funds in the market which would spur further economic growth.

In recent past recoveries, credit has always continued to expand and the savings rate has continued its’ long term downward trend. However, the most recent recession seems to have fundamentally changed things. The weakened banks can no longer increase the credit they give (in fact, credit has been contracting), and Americans have begun rejecting their debt-loving nature sending the national savings rate average above 4.5% in 2009 for the first time since 1998. The markets rejoiced and rallied on the news that many of our nations’ major banking institutions had returned to profitability. Unfortunately, the opposite reaction could take place when/if investors realize that the return to profitability was heavily aided by taxpayer support and that normalized bank earnings will be lower in the near future because of the previously mentioned reasons and lower levels of lending.

Certainty in and of itself is not necessarily a good or bad thing, however a lack of certainty is the breeding ground of volatility in the stock market which tends to reduce realized returns over shorter time frames. There continues to be a great deal of uncertainty concerning the Federal Funds Rate over the next several years and Government intervention in the market as we mentioned in our newsletter from the Third Quarter. There are also other issues which have been temporarily swept under the rug which could come back to haunt during 2010 such as health care reform, regulation of the financial industry, changes to the tax code and taxes on greenhouse gases. I feel that these are important issues which must be tackled comprehensively and in a timely manner. This will almost ikely continue to be a challenge for the current Congress and could become even worse following the 2010 midterm elections. Every day that goes by without there being solid laws on the books is another day that executives will delay hiring or expenditures because of uncertainty over what the business and economic landscapes of the U.S. will look like five years from now.

For example, (1.) Should healthcare companies hire more people to meet growing demand from regulation that would increase the pool of customers, OR should they fire people because the industry might get regulated to death instead? (2.) Should financial institutions begin putting money back to work in the economy, OR should they be divesting certain assets because of a possible return of Glass-Steagal? The answer barely matters in this case; CEO’s just need to know what the rules of the game will be so they can plan for it. (3.) Should employers like General Electric continue to take advantage of our skilled labor force as well as our great technical and legal infrastructure, OR should they relocate to a more fiscally responsible country for fear of draconian tax rates being employed to sustain Congress’ out of control spending habits? (4.) Should companies continue investing in green and other sustainable technologies to improve our planet, OR should they shut down because they won’t be cost competitive with fossil fuels unless carbon emissions are taxed appropriately?

Maybe Congress could answer these questions for us when they are done squabbling over who gets the most pork barrel money.

All this being said, I continue to maintain a positive long term outlook because there are still many exciting areas which I feel offer favorable risk/reward fundamentals and will take advantage of longer term shifts in the global economy. I will continue to revisit my investment thesis regularly throughout the next quarter and I am very interested to hear what executives will have to say about their outlooks on the conference calls during the upcoming earnings season which Alcoa (AA) just kicked off.

We have just emerged from one of the worst financial crises since the Great Depression and I use this comparison because of the great similarities between then and now. The Great Depression began in 1929 when the market fell steeply following years of greed and financial excess (sound familiar?). Market sentiment quickly recovered and stocks experienced one of their greatest runs in history over the next several months as investors covered short positions and began to anticipate a strong recovery (sound familiar?). The rally took the market all the way to the half-way back point (right about where we are now) but investors began taking profits as they waited for the projected fundamental economic improvements to materialize and the market proceeded to dive, not truly bottoming until almost four years later in 1933.

Mark Twain once said “History doesn’t repeat itself, but it does rhyme” and with this in mind I plan on returning to a more defensive posture than I was in the beginning months of 2009 when prices as well as expectations were much lower.

Words of Wisdom for 2010
“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”
- Warren E. Buffett

“The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities — that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future — will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.”
- Warren E. Buffett

Happy 2010 everyone!

-MJB

ONE OVERVALUED MARKET?

Courtesy of The Pragmatic Capitalist

A recent research note from Gluskin Sheff’s David Rosenberg highlights the high valuation, high sentiment, and technicals  of the equity markets to highlight the bearish case:

• Fully 85% of S&P 500 stocks are now above their 50-day moving averages, and;
• The median P/E multiple is now a whopping 22.2x.
• The degree of bullish sentiment in the latest Investor Intelligence Poll is a huge 72%;

Of course, much of this has been the case throughout the rally. While the technicals appear somewhat extended this is not unusual during a major market rally.   As we can see in the chart below, stocks have been well above their 50 day moving average for much of the rally and this has not served as an impediment:

As for earnings, we all know my thoughts here.  Earnings hit such a deep trough and estimates spiked so low that this has actually been fuel for the fire.  It might sound counter-intuitive, but the trough in estimates actually led to very poor earnings expectations which has fueled the rally higher.  As we’ve explained before, using the PE ratio to time investment decisions is a recipe for disaster.  The PE ratio is nothing more than a moving price target (which rarely reflects the true market value) divided by the guesstimates of the analyst community.  If we’ve learned one thing over the last 6 months it is that analysts can’t guess their way out of a wet paper bag.  The result is, in my opinion, one of the most misleading and overused investment indicators of all time.

In terms of sentiment we continue to see conflicting messages.  While the Investors Intelligence poll remains overly bullish we continue to see bearish data from the CFTC’s commitment of traders report, neutral data from the AAII and neutral data from State Street’s Institutional Money poll.  Cherry picking one report doesn’t mean sentiment is overly bullish.

There are real fundamental reasons to worry about the long-term viability of this rally, but these three should be taken with a grain of salt for now.

In launching a new business venture, one of the issues I have difficulty with is working out the return it needs to generate over say a 5-7 year period. Or in other words what return should investors (and founders) expect.

Obviously the riskier the investment the higher the expected return, and I’m aware that VCs typically tend to look for a return of 10 fold over a 5-7 year period from individual investments, expecting an overall return of 25% per annum on their portfolios.

According to portfolio theory, the larger an investor’s portfolio the more risk that can be diversified away. So by not diversifying one is effectively taking on “unrewarded” risk. On the other hand friendly investors such as family members, or business partners may be willing to accept lower financial returns than professional investors. Entrepreneurs who are normally not diversified may perceive their ventures as lower risk and therefore be willing to accept lower returns than institutional investors.

The other important factor is the exit strategy. Any investor is going to look for an exit after a certain period, and the expected return will depend on how the company is valued at that point in time, and whether a buyer can be found at this valuation. Popular valuation techniques are Discounted Cash Flow, where the time value of future cash flows are considered or by comparing key ratios such as the popular P/E or P/ Sales ratio with peer companies, or using industry specific metrics .

In designing a business, and constructing the business plan, I would assume the expected return needs to be considered in light of the above mentioned factors, i.e:

1/ The inherent operational risks in the business.

2/ The profile of investor or investors. Institutional investors will generally require a higher return than people who are connected emotionally to the business. 

3/ The exit strategy, and how the company will be valued at exit.

Making it very much dependent on the context, which will probably change over time.

It would certainly be useful to get peoples’ views on this subject.

The Mobile Internet Report:

Ramping Faster than Desktop Internet, the Mobile Internet Will Be Bigger than Most Think.

Material wealth creation / destruction should surpass earlier computing cycles. The mobile Internet cycle, the 5th cycle in 50 years, is just starting. Winners in each cycle often create more market capitalization than in the last. New winners emerge, some incumbents survive – or thrive – while many past winners falter. The mobile Internet is ramping faster than desktop Internet did, and we believe more users may connect to the Internet via mobile devices than desktop PCs within 5 years. Five IP-based products / services are growing /converging and providing the underpinnings for dramatic growth in mobile Internet usage – 3G adoption + social networking + video + VoIP + impressive mobile devices. Apple + Facebook platforms serving to raise the bar for how users connect /communicate – their respective ramps in user and developer engagement may be unprecedented.
Decade-plus Internet usage / monetization ramps for mobile Internet in Japan plus desktop Internet in developed markets provide roadmaps for global ramp and monetization. Massive mobile data growth is driving transitions for carriers and equipment providers. Emerging markets have material potential for mobile Internet user growth. Low penetration of fixed-line telephone and already vibrant mobile value-added services mean that for many EM users and SMEs, the Internet will be mobile. We use a data-rich, theme-based framework for thinking about how the rapidly emerging / changing mobile Internet may evolve. One thing is clear: new computing cycles create / destroy material wealth – and the mobile Internet cycle should be no different. For our compilation of well positioned / potentially challenged / unclearly positioned companies, see pages 11-13.

Go to document>

This is the kind of analysis I love. Fran Baily put together a nice piece on the apparent drop off of $600k + condo sales in North Center compared to last year. The lack of comps makes valuation difficult and weakens the confidence of buyers. I can only assume that high end homeowners in North Center have the cushion to wait for an appreciating market before selling, thus the diminished transactions in this neighborhood.

Article Here: http://www.chicagometroarearealestate.com/north-center-3-4-bedroom-condo-sales-evaporate-above-600k/

North Center 3 & 4 Bedroom Condo & Townhouse Sale Price Distribution Past Year (green) vs. Prior Year (black outline)