When I first started investing back in 2003 or so, I was obsessed with buying companies trading under book value. Like most obsessions, this one wasn’t healthy.
Book value, for those of you unaware, is one of the simplest financial ratios out there. If a company’s share price was under the net worth of that enterprise, it traded under book value. Buying $1 worth of assets for 75 cents seems like a pretty easy way to make money, especially if those assets historically traded for $2. All I needed to do was repeat this process a few dozen times and I’d be RICH, BABY.
Alas, it turns out investing is much harder than that. Who coulda thunk it?
These days, book value only enters the equation as a secondary ratio when I’m doing analysis. It turns out there are lots of reasons why it’s not the greatest. Asset values can go down, and companies are not excited to admit this. The logical conclusion to this is obvious; assets that really should be impaired remain fully valued on the balance sheet, giving investors the illusion they’re still worth the full amount.
(Note that book value is still useful when looking at some sectors, like REITs and financial stocks. It’s not a completely valueless ratio)
Intangible assets make up the majority of value when looking at a company’s balance sheet today. Pepsi is a great example. Much of that company’s value lies in its brands. People like Pepsi, Lays chips, Quaker oatmeal, Tropicana orange juice, and so on. Because they like those brands, they’re going to keep on buying them. Both those attributes have value, just like a piece of real estate. But unlike physical property, you can’t easily value them. Intangible assets will always be trickier to value.
How about your own balance sheet?
We’re taught that net worth has a very simple definition.
Assets – Liabilities = Net Worth
Both categories only include tangible items. Stocks. Real Estate. Debt. Note the absence of intangible items. Hell, the next net worth statement I see with intangible items on it will be the first.
But I’m becoming more and more convinced this is the wrong way to go about it. Let’s use getting a college education as an example. As much as I’m anti-college, I’m also the first to admit the statistics are right. People who go to college and graduate tend to enjoy much higher earning power. Let’s say the average university graduate earns $1 million more in their life versus the average high school grad. Sure, there are some duds who took gender studies in there, but they’re cancelled out by all the finance and engineering folk.
Now let’s imagine the net worth statement of a recent college grad. Assets likely are pretty close to zero. Liabilities are through the roof, thanks to all the debt taken on to fund the degree. We’re left with a negative net worth and a recent grad hopefully super motivated to get that ratio back to positive.
This isn’t entirely accurate, however. That debt wasn’t acquired for shits and giggles. It exists because becoming proficient in a topic is profitable. That knowledge is clearly worth something, yet it’s never put onto a net worth statement. Why is that?
There’s one very simple reason why not. Like the value of Pepsi’s brands, it’s tough to figure out. There are also a million variables that could impact the value of that intangible asset over time too. Is a degree really so valuable if you plan to drop out of the workforce in five years to start pushing out babies? Or because you want to work 15 years and then retire early? Degrees are still worth something to these folks, but perhaps not as much versus someone who plans to use their degree for 40 years.
One could argue the benefits of the college degree end up on your net worth statement anyway, thanks to the increased income it provides. Okay, fine. I’ll allow that. But what about other intangible assets? Unless you’re a weirdo hermit living in your mother’s basement (THAT’S ME, BABY!), you know people. Those relationships have value. They could lead to a lucrative new job or a business opportunity. It’s the same thing with your family. I know a kid whose family is worth anywhere from $20 to $50 million. His last name absolutely opens doors for him. Why shouldn’t he be allowed to put that value on his own balance sheet?
The bottom line
I admit this becomes a slippery slope very quickly. It also opens up all sorts of uncomfortable questions about privilege and whatnot. And to be completely honest, I think allowing people to put intangible assets on their net worth statements is a bad idea. The average person overvalues the hell out of everything they own. They’ll do the same with their university degree and contacts.
But at the same time, these intangible assets are hardly worthless. They’re definitely worth something, even if it’s hard to value. They shouldn’t be immediately valued at nothing. Keep this in mind while paying off your college loans and it’ll make that journey a little better. It might even cure someone of the “student loans must be paid off at all costs” mentality.
I know someone who recently lost the diamond in her engagement ring. After about eight hot seconds of looking — the phrase needle in a haystack seems apt here — she declared the stone lost forever and her life over. Her husband (the nicest guy in the world, btw) was going to beat her like Chris Brown after losing at an awards show. Topical!
This did not happen, of course. Instead he bought her a gigantic new engagement ring to symbolize their more secure financial status. The ring cost $2,500 on sale at some jewelry store. She loved it so buddy forked over the cash. Hopefully he got laid that night.
One of the major selling points for this ring was the jeweler’s appraisal that came with it. According to this IRON-CLAD CONTRACT, this ring had $6,100 worth of gold and diamonds on it. Confident they were getting a deal, our story’s heroes emerged from that jewelry store with the assumption they were somehow richer from the experience. What a fantastic marketing job by this store. I want to buy them all medals.
Anyway, here’s why that appraisal (and every other jewelry appraisal) is a giant scam.
The business of jewelry
Buying jewelry is kind of like buying underwear. Very few people are going to buy it used no matter what the deal is.
Which is a real shame, really. 50% of marriages end in divorce. Even some happily married couples are forced to hock the family jewels for pennies on the dollar to make rent money or buy diapers for their whiny offspring. Nobody can argue jewelry is a necessity, meaning it’s the first thing sold when the going gets tough. Put all of these factors together and the conclusion is obvious — there’s a lot of supply out there. Demand? Not so much.
Who exactly is going to pay appraised value for a diamond? Nobody. If you’re one of the few women who would ever wear second-hand jewelry, you want a reason to do so. It’s only logical. If you can’t save significant cash buying used, why even bother? It’s the entire reason anyone buys anything used.
Think back to the original story for a second. If that ring was really worth $6,100, why was it on sale for $2,500? Why wouldn’t the jeweler sell it for much closer to appraised value? Why wouldn’t they take the stones off and use them in other pieces?
FWIW, my guess is that piece was purchased, returned, and then the store blew it out. The ring looked brand new and the people buying it never thought to ask whether it was used or not. It’s probably better not to ask.
The true test of value
Let’s look at the bigger picture here for a second. What exactly determines the value of an object, house. investment, or your body? Don’t answer that last one. Financial Uproar is a 100% hooker free space and we’d like to keep it that way, thanks.
Come on, Italics Man. Even you can do better.
I don’t even exist, you moron.
What determines the value of anything is pretty simple, really. Something is worth what someone will pay and not a nickel more.
In theory, this is a fine hypothesis. Things get a little trickier in the real world though. Say you’re selling your house. Your Realtor comes by and says the place is worth $500,000. Congrats, baller. The market seems pretty efficient, so you accept this explanation.
But what if there was a non-zero percent chance you could convince somebody to pay $525,000? Or $550,000? Would it be worth it to price your house accordingly? These are the kinds of questions every home owner struggles with at some point. After all, it takes just one person to pay a wildly inflated price to make it worthwhile. And if one person would pay $550,000, what are the odds of that person finding your listing and slapping down the cash?
The opposite can happen, too. An impatient seller takes $450,000 because they want out now, dammit. Is the house worth $500 large still? Or has the value magically dropped to $450,000? I certainly don’t think so; this is why I increased the value of my house on my net worth statement a full 14 seconds after buying it. An efficient market often takes time, especially in big ticket items like houses.
The bottom line
Appraisals are just some guy’s opinion of value. Take them all with a grain of salt. Jewelry appraisals are especially suspect. No, you’re not selling your ring for more than what you paid for it.
(Blows off the layers upon layers of cobwebs)
(Starts to slowly clean up the rubble that used to be a prominent personal finance blog)
(It’s moving, but only barely)
(Oh my. What could it possibly be?)
You tried to kill me, but you couldn’t. I’ll never die.
OH GODDAMMIT IT ITALICS MAN.
So I guess I’m wading back into this whole PF blogging thingamajig. I know I said I’d go away forever and there was no place for my particular kind of finance commentary (92 dick jokes attempting to make a coherent point about something), but time (and quitting meth) has helped me come up with an interesting new business plan. I’m still hatching out the deets so I won’t say too much. Let’s just say it totally doesn’t involve me coming to all of y’all’s houses and stealing $20 from your wallet. At least not anymore.
It’s going to be lit. Do the kids still say lit? (Texts the only 18-year-old who will talk to me) He says if I don’t stop contacting him he’ll call the cops. Bummer.
Let’s talk a little about a personal finance mistake I may have made recently — paying off my house so damn aggressively.
Here’s the deal. It costs a surprising amount of money each month to live in a house you own. I still have to pay the stupid water bill and the electric to keep the A/C on 24/7. What? I refuse to take off one of my three sweaters. Then there’s the house insurance, the property taxes, the constant small improvements/fixes that keep popping up, and a billion other expenses. I own a ladder now. Why? Damned if I know. The only thing that scares me more than heights is the shower. YOU CAN’T MAKE ME GO IN THERE.
It costs about $700 a month to live in my paid off house, a figure that doesn’t factor in a nickel for house maintenance. That is more than I anticipated, to say the least. And I’ve got at least $1000 worth of upgrades planned in the next few months.
We figure if we’re patient we can get a decent place to live for $1000 all-in. A super-nice apartment at our former building is up for $1400, a figure that includes power, heat, water, and internet.
Let’s assume we throw up our hands and rent that place. On the surface, it would cost $600 more per month, or $7,200 per year. That’s bad.
But I can get access to $200,000 worth of capital by selling my house. If I invest that money and get just a 4% return, I’ll gain $8,000 per year. If I can do better than 4%, it makes all sorts of sense to free up that equity. That’s good.
At this point the only thing stopping me is laziness. $1400 per month is a little steep for my tastes, too. Note that if we settled and rented an $800/month apartment (there are probably a dozen of these available at any one time in town) we’d be miles ahead of the game. The problem is the $800/month apartments don’t have the kind of amenities we’re used to. Also, they’re cursed. Yep. Built on ancient Indian burial grounds. That’s bad.
That’s right. I’m one of those guys now. Someone who needs a dishwasher and stuff. Italics man would kick my ass if he actually, y’know, existed.
Hot damn is the Globe and Mail Financial Facelift series bad. I could almost do a recurring post every week making fun of it. It’s just the same thing every week. Can this couple who has clearly never read a personal finance or early retirement blog hang up their proverbial skates with juuuuuuust $1.4 million in the bank? You’ll never guess what our generic financial planner has to say!
Yeah, that’s right. I like gifs now. Just in time for them to fade into obscurity.
Also anyone who makes fun of Financial Facelifts is copying me.
Is it just me, or is every damn financial blog littered to death with ads? I understand my peers are happy RBC and BMO are taking them seriously, but enough with the 14 different reminders to sign up for the newest Johnny Come Lately roboadvisor.
The wife and I went to China in May. It was bananas. China might be the most interesting place I’ve ever been. I simultaneously loved and hated the place. It’s crowded as hell, noisy, dirty, and many of the citizens lack the basic respect given to each other that is so prevalent in the other parts of Asia I’ve visited. There’s also plenty of poverty. It’s everywhere.
At the same time, you’ve got to hand it to the government there. They truly are the next upcoming superpower. They’re hungry too. North Americans are too comfortable. The Chinese want desperately to be taken seriously. They’ll easily surpass us in 50 years. Hell, it might even be 20 years.
I kinda want to move there until I hear some of the horror stories. Certain hospitals won’t treat white people. Racism is rampant. Violence is much more common than other parts of Asia. And the government watches everyone. I couldn’t go to a soccer game without buying a ticket online and giving my passport info to some stadium employee. I’m surprised I wasn’t asked to piss in a cup too.
That’s about it. I gotta work in the morning.
As you read this, there are currently 529,839 entrepreneurs in Canada struggling to take their business to the next step. Y’know, give or take.
Every business has its own unique challenges, but most can be broken down into one main category. Some struggle to get sales. Others have costs slowly ballooning out of control. The lucky ones are swept off their feet, barely keeping everybody happy as orders keep pouring in. Naturally, the first and second groups hate the third. Uppity bastards.
This here blog, back when I was serious about making money at it, suffered from some of the same issues. Writing for other websites was much more profitable (in the near-term, anyway) than pecking away on the keyboard for Financial Uproar (the website which is like a tightly coiled sex robot in a jar). I spent so much time on content that I didn’t have time to establish relationships with real brands. And besides, why would any legit business partner with a website that made 13,920 different kinds of dick jokes?
That last paragraph was a little depressing, huh? Good thing I only do this for fun these days. Oh, you’re not enjoying yourself? I will make you have fun.
If I were to start over in the world of websites, I would make one major change. In fact, it’s something I would recommend many entrepreneurs do.
That change is…
I once poo-pooed partnerships, talking about the somewhat uneven relationship between two anonymous partners who started drifting apart once their business was running smoothly.
But some six years later, I now know there’s more to that story. The first partner was much more ambitious than the second, so he went ahead and worked on his own ventures. The second guy was content to run the business. So even though they drifted apart over time, the hard feelings quickly diminished.
Even though the two partners grew apart, they still accomplished more together than either one could have on their own. Their business has grown by leaps and bounds, and each of them have substantial investments outside of the partnership. Both spend money like drunken sailors too, so it’s obvious there’s some decent cash flow there.
Coming back to this blog, it’s obvious the advantages I’d have if there was another person helping out. I could focus on the writing while they worked the advertising side. Or we could both write, giving y’all differing opinions on stuff. This would leave time for both partners to network more effectively. The possibilities are endless with two people, while one quickly runs out of time. At the end of the day, it’s all about using different strengths to maximize benefit to the business.
One of the things I really enjoy about my grocery job is working out problems with my co-workers. It’s amazing how helpful it is sometimes to get a different perspective on things. If I’m stumped on a problem, a different set of eyes can easily find a solution. If you’re a solopreneur, you don’t get that benefit without reaching out to one of your peers.
Not every partnership will work, and that’s okay. I entered into a joint venture with an unnamed former PF blogger back in 2016. It only lasted a few weeks before fizzling out. I didn’t have the time to dedicate to the venture, while my partner had his own flaws. But we got as much traction in that first month as Financial Uproar got in its first year, including mentions on a couple of major blogs. Not bad for a couple guys working on something part-time.
Not every business would benefit from a partner. And there are certainly some entrepreneurs who would drive even the most optimistic co-owner batty. But on the whole, most businesses would benefit from having two (or even more) people with different strengths and weaknesses. I know if I were to ever go into business again, I’d do so with somebody else.
Admittedly, this story has very little to do with personal finance. Sorry about that, but not really. I’m also not 100% sure it’s true, since all the info I have on it is second-hand. I trust my “sources” on this, but haven’t done any of the work to verify. Yes, kids, I’m even a lazy investigative reporter.
Still, I think it’s a fascinating tale with a lot of fun lessons about unintended consequences. Which, to be frank, are easily the best consequences. It’s not even close, either.
The year was 1996, and my local golf course had big expansion plans.
Located on the edge of town, the course featured a nine-hole track with plenty of trees along the river. It was a standard par 36 course, playing a little over 3,000 yards from the middle tees. Like many local courses in Alberta, it was publicly owned but was managed by a board of directors. The board then set policy, hired a manager, and so on.
There were a few problems with only having a nine-hole course, however. It struggled to attract big tournaments, simply because they all play on 18-hole courses. Tourists were avoiding the place for the same reason. And, of course, having a back nine would allow the course to sell more 18-hole rounds. More people would cough up the extra cash to play 18 unique holes versus the same nine holes twice.
There was just one problem. The course is nestled between a highway and a river. It’s bordered by houses on one side and a farm on the other. Even if the farmer was willing to sell (he wasn’t), the land was too flat and boring to make a good location for nine more holes. And buying out homeowners was impossible.
There was a multitude of undeveloped land just across the highway, but it was hilly terrain filled with coulees, ravines, and more cacti than the set of a Hollywood western. This land would be expensive to develop and would create a golfing experience vastly different than the existing real estate.
Despite the obvious reasons against choosing this land, the board went ahead and did it anyway. And to their credit, the result was spectacular. The back nine is a wonderfully unique experience. It might be the hardest nine holes in the province (I once lost 10 balls in nine holes), but it’s unlike anything else out there. Each hole presents a different challenge. Some demand length to carry your ball over a ravine. Others require precision to place your ball in a narrow, sloping fairway. And one particularly nasty hole requires a 190 yard carry over a water hazard and bunker to a narrow green.
The problem wasn’t with the back nine itself, which worked out quite nicely. The problem was how it was paid for.
Here’s the unintended consequences part
Building nine new holes in terrain not suited for holding a golf course was expensive. The price tag quickly ballooned into something worth several million dollars.
To pay for the expansion, the board of directors tapped multiple sources, including going to the local community with a unique offer. The golf course would sell two tiers of lifetime memberships. The first, which cost $10,000, would be good for one individual to golf as much as they wanted. The second, which cost $25,000, would let a business owner and a number of their employees golf for free. Avid golfers snatched up the deals, and the course ended up selling dozens of each kind of memberships.
Fast forward 20 years, and the establishment was beginning to have some serious money problems. Despite increasing rates annually and a book filled with tee times, the top line just wasn’t budging. After bringing in an outside consultant to crunch the numbers, it was obvious what the problem was. Some 60% of rounds were played by individuals using these lifetime memberships.
Here’s what happened. Most avid golfers snatched up these lifetime memberships like your author scarfing down Doritos. Casual players were then driven away by the increasing costs on a per round basis, the general decline in the sport’s popularity, and an unwillingness to play the incredibly difficult back nine. Sure, some tourists came to play the venue, but those numbers are steadily falling as well. It turns out fewer and fewer people are golfing these days.
The board faced an interesting conundrum at this point. The wording in the lifetime memberships was ironclad; there was only one way to get away from the commitment, which would be to declare bankruptcy and start over again under a new organization. But it’s not quite that simple, since the place wasn’t necessarily insolvent.
Certain lifetime members also reacted in a predictable way. Once word got out the board of directors were looking for ways to end the gravy train, they put themselves up for nomination. I’m told the board is now mostly filled with these people.
The moral of the story
If I had a time machine, one of the first places I’d go is back to those board meetings in the mid-1990s to see if anyone foresaw this coming. Yes, I am that lame.
The lesson is simple. Beware of the long-term unintended consequences of today’s actions. This is often easier said than done, of course. Second-level thinking is hard but is often necessary.