A Review Of Current Risks

I had hoped to hold onto my NZX and ASX listed stocks for years to come and ride out any dips in the markets, with the view that my stocks were of such quality and a good balance that I could just get a nice dividend return to cover my retirement.

Also, the planned exit from one of my private equity holdings would be significant enough to cover any losses and secure my position. However as inflation unfolds around the world, with some countries experiencing hyper inflation and comments from the BoE saying that they’re not going to shy away from generating a recession to curb inflation, I had a moment of panic yesterday and sold some stocks. Specifically my panic was that as my private equity exit isn’t happening as early as planned (and I might end up holding for more years to come), if the RBNZ were to put rates up this could mean that I am unable to service my mortgage in future and my stocks could become so undervalued that I would be bankrupt with a negative equity situation on my home.

As I’m feeling a bit calmer today, I decided to reconsider things with a goal of holding on to as many of my stocks as possible, particularly the more resilient ones, while diminishing the possibility of bankruptcy from my future.

The first thing to consider is a summary of what’s currently going on that might affect me, so I made a list:

  • Inflation for all goods due to monetary policy and COVID related supply issues
  • Inflation of food and fuel throughout the world due to war related supply issues
  • Inflation of wages in NZ due to lack of labour supply
  • Wealth destruction from NZ housing policy
  • Wealth destruction from falling share market due to all of the above
  • … and it’s going to be a contentious one, but I’m going to add an incompetent NZ government to this list, too.

Looking at how this might play out, it seems that COVID is here to stay for a few more years; and while the war in the Ukraine is a bit of a wild card, from my research into Russia’s military losses vs stock, when considering the time it takes to resupply their losses, it seems that Russia can keep up their invasion indefinitely if they choose to do so. This means that consumer price inflation is likely to stay for a while – certainly at least as long as the war and sanctions persist.

From what I can see (with the limited research I’ve done), the media’s reporting of house price falls lags significantly (about a month). The superior data that I’m fortunate enough to have access to suggests that things might be a lot worse than reported, with houses similar to mine having fallen by 23% where I live (based on a limited dataset – I should probably do more research on the other data). What’s worrying about this, is that it’s likely common consensus that the housing market is in a downward trend, which becomes a self fulfilling prophecy, pushing prices down further. The same can be said for losses in the stock market, though this is forward looking in a different way.

Wage inflation is in my opinion, the only thing that’s allaying a recession. Here’s why I say that and why I was panicked yesterday.

Inflation results in high interest rates (aimed to reduce spending) which results in less spending by consumers. This results in less company revenue and then poor company outlook, which results in less company investment. When companies invest less money, they hire fewer people, resulting in less demand for labour and fewer jobs. This results in less money in the hands of the public, which results in less spending by consumers (which loops back to the start, causing a downward economic spiral that is difficult to manage. Even if this is managed well by our current government (I say government rather than RBNZ because there are problems in supply that cannot be fixed by monetary policy alone), this difficult challenge will have to be handled well by more than most governments of the world to avoid global contagion of financial issues.

To compound the problem, the above also results in lower house prices, due to less buyer capacity. Lower house prices are a particular problem for NZ because a lot of wealth is held in houses. The loss of the wealth effect from people having value in their houses looks like this:

House prices go down, which means that people have less borrowing power (think: LVR). This results in less spending which is the cause for the downward economic spiral I mentioned in the former paragraph.

As I mentioned before, wage inflation is the only thing that can allay a recession because it enables people to keep spending, and gives them enough money to pay more for goods and services, which means that companies can pass on their costs, keep their profits up and therefore keep investing, which means more people hired… etc. In other words, it breaks the downward spiral.

Because of this, I am keeping a sharp eye on retail stats which I believe are a bellwether for wage inflation. Unfortunately, even though I have things like Paymark stats that can give indicators, I can’t tell if costs are being fully passed on to consumers until retail stocks publish their NPAT figures. I believe that a fall in consumer spend reported by Paymark is an early recession indicator, but a flatline or below CPI increase is an indicator of a possible recession.

In terms of my strategy (without discussing the specifics), I will:

  • Assume my exit from the private equity will not eventuate
  • Assume that my 6 figure shareholder loan will be paid back at the start of next year
  • Use that money and other money from yesterday’s fire sale to reduce my mortgage as terms allow
  • Consider locking in a multi year term for my mortgages that come off fixed rates
  • Continue to hold onto my high quality stocks for the long term – which includes a retail stock that will likely struggle, but has a history of always paying a dividend
  • Not bother selling the remaining handful of lower quality stocks whose value is sufficiently low that it’s wouldn’t change my financial position to sell anyway (The value of which is about $4,000)

In the event that I lose my job during a particularly bleak recession, I will use the value in my listed stocks, savings and hopefully shareholder loan, to try to outlast the recession.

Risks to my strategy are:

  • I lose my job AND (the shareholder loan defaults OR stocks drop in value by >60% from their current position and I can’t get another job for 6 months)
  • Interest rates go crazy after next year when my largest mortgage expires and I don’t get pay rises. The level of “crazy” depends on what other failures happen in my investments that prevent me from paying down my mortgage.

2022 Stock Picking Competition

In last year’s stock picking competition, my picks gained a mere 10.8%, mainly lacking due to my selection of Ryman Healthcare (not a stock in my personal portfolio) and Fisher Paykel Healthcare not gaining much (a stock held in my personal portfolio, but as a bond proxy). Not bad compared to the NZX 50 which was in the negative for the year and not bad compared to the brokers picks, only 2 of which beat me (Forsyth Barr and Jarden). I’m not pleased with my result overall, but I didn’t expect much as this time of year is a difficult one to buy stocks after the Santa Rally and there wasn’t a lot of thought that went into it due to the holiday.

Hopefully I’ll do better this year (though I don’t have high conviction for this statement). My picks for 2022 are:

  • MFT
  • FRE
  • HLG
  • SCL
  • TRA
  • Sixth pick: SKL

I have to say that it’s hard picking out some stocks that aren’t currently over-priced and also have potential tailwinds for the coming (highly unknown) year. As with last year, very little research has been done in preparation for these selections. I picked these selection based on inflation expectations, previous performance and in the case of SCL, orchard fruition coming in 2023 (in the hope they’ll re-announce this towards the end of year and get re-rated). 3/5 of the above picks are in my personal portfolio.

Disclaimer: These picks (or anything on this website) does not constitute financial advice and [as inferred in the article] very little research has gone into this selection of stocks for the purpose of this competition.


Snowball Interview Part 2

It seems that the second blog article covering my Snowball Effect interview was released in early September.

I highly recommend reading this, as it nicely summarizes something I’ve written about before on how to make an investment strategy.


Buying Cryptocurrency In NZ

I’m vehemently against cryptocurrency as an investment for a number of reasons that I won’t go into in depth in this article (think: no intrinsic value, no laws governing the currency, no reason for particular cryptocurrencies, to many scams around, etc.). For me it’s not really investing because investing is about calculating return based on real factors; cryptocurrency investing is more like gambling in my opinion.

Nonetheless, I decided to partake in the fun and buy some Ethereum (ETH) and Bitcoin (BTC). I figured $1,000 on each wouldn’t do any harm and wouldn’t be the end of the world if I got scammed or lost my money in some other way (lost wallet, hardware failure, virus, currency related issues, etc.).

After reading an article on MoneyHub, I signed up for EasyCrypto. EasyCrypto is not a crypto exchange (matching buyers and sellers), but instead it’s a retail shop (selling you currency and buying it off you, making profit on the difference). Upon preparing to make my purchase, I noticed that the fees are very different for small purchases (~$100) vs “large” purchases of a whole crypto token ($6,239). Here are the prices I was offered:

NZD$6,239 = 1 ETH
NZD$105 = 0.01190783 ETH

EasyCrypto’s price to buy ETH vs NZD at the time of writing

If we divide NZD$105 by 0.01190783 to get the price for the whole coin, that gives NZD$8,818. That’s a 41% increase in price for buying a smaller unit of ETH, which is a phenomenal difference if we consider that the brokerage fee.

I didn’t bother looking at the difference in sell price (which could be less favourable as they may consider having you by the #@!!$ because if you’re buying from them, you might not have the technical nous to sell elsewhere), but if we assume that it’s similar, you’re looking at an 82% increase in your ETH investment to break even when buying and selling with EasyCrypto. This number is worse if you compare it to the ETH price listed on Google, rather than the rate they sell for when buying a whole unit of ETH. This shocked me enough to not even bother investigating the fees for the small volumes I was looking to buy.

In EasyCrypto’s defence, I guess it could be argued to be a fair rate; after all, a retail shop of any other nature might have similar markups and they are dealing in a commodity whose price can fluctuate wildly – coupled with the fact that purchases may be automated through the website and therefore subject to additional fluctuation risk.

However, given the fees of EasyCrypto I think this precludes me from making any investment through this website. Perhaps a crypto exchange is the way to go if I were to pursue an investment in cryptocurrency?


Thoughts On OCR Increases And Inflation In 2022

I’m feeling bearish about the economic impact of the RBNZ’s position on increasing the OCR.

The OCR is typically increased to reduce the economy’s propensity to spend money (AKA reduce demand) to cool an overheated economy, but also to put the central bank in a position where they can drop the OCR to stimulate demand in future, as required.

Inflation is a key indicator (and cause for concern) of an overheated economy; hence the RBNZ has started on the path of OCR increases to cool the inflation before it creates instability in the economy.

However I do not believe that OCR increases are the right tool to reduce inflation in this case, and I believe that OCR increases may actually harm the economy.

I say this because while increasing the OCR is a great way to keep price increases in check that result from a flourishing economy, that’s not what’s happening here. Instead we have a performant economy that is threatened by high prices due to supply issues.

The difference is subtle until you consider a supply and demand diagram.

If we consider a supply and demand diagram, we can see that as an economy performs well, participants have an increased propensity to buy (increased demand) and this pushes up prices. In this scenario, increasing the OCR is a great way to keep demand in check by presenting buyers with a more preferable alternative of a higher ROI for their money in the bank and reducing their debt levels. The below supply and demand diagram illustrates an increase in demand due to a flourishing economy.

A flourishing economy results in an increase in demand, causing prices to increase. This can be remedied by increasing OCR to decrease demand to a more desirable level.

Unfortunately our economy isn’t suffering from increasing prices due to increased demand (much). By far the greatest pressure on prices is due to a lack of supply caused by COVID related logistics issues and other supply constraints (lack of lorry drivers, shipping queues at ports, labour shortages, semiconductor shortages, etc.). This is represented in the below demand and supply diagram, which depicts the effects of a reduction in supply.

A reduction is supply causes increased prices and lower quantities of sales.

Let’s have a look at what happens when the OCR is increased to reduce demand along with the already reduced supply.

Reduced supply causes less to be bought and increases price. Reducing demand reduces the price, but at the cost of reducing quantities bought. Reducing demand to drop prices back to levels seen before a decrease in supply causes a massive reduction in quantity traded.

As we can see from the above diagram, when the OCR is used to tackle price increases from a reduction in supply, one of two things can happen:

  • The demand isn’t reduced enough, resulting in high prices and lower quantities traded
  • The demand is reduced (at least) enough to match prices before supply decreases, resulting in larger drop in quantities traded

In both scenarios we see a drop in trade and most likely this won’t fix the inflation problem (at least not without significantly damaging the economy). A drop in trade means a poor economy, job losses, business closures / contractions, etc.

I would argue that as the economy isn’t overheating and is performant, that minimal interference is appropriate. Also, as a lack of supply is causing price increases and the government can’t fix the lack of supply (I won’t discuss policies that could help remedy this situation right now), we’ll just have to try to cope with the increases in prices for now and suffer the consequences (which could mean permanently higher prices in some industries).

Finally, I will leave you with a definition of poverty, where poverty is described as people not having things (lack of supply) and not being able to afford things (high prices).


Thoughts On Valuing A Company (For Beginners)

I think that what has helped me improve my ability to value companies the most over the years is thinking about different aspects of valuations, and getting experience with different companies and the situations / people involved – all of which have an effect on valuations.

One of the most difficult things about that is getting the right experiences that lead to the right things to think about, because experience takes time and it’s difficult to know where to start. To that end, I figured an article about doing valuations which focuses on the thinking around valuations might help beginners.

To be clear, the aim of this article is not to teach you how to do a valuation. Rather it’s to get you thinking about how the valuations you do relate to your financial return and your situation.

This isn’t a planned set of thoughts, I’m just going to freewheel it and see what comes out. So let’s dive in!

Valuing A Company That Does Nothing

How much do you suppose a theoretical company is worth that doesn’t do anything, doesn’t have any costs and has $1m in the bank? It could be argued that it’s worth $1m, right?

But then why would you buy an entity that has the same value as money, but is less fungible? For all your efforts, all you could do is get your $1m back if you drained the money our the company’s bank account, then it’d be worth nothing. Perhaps we can say that actually it’s worth $1m, minus the value of your effort to extract the money and do the valuation, minus the profit you require for doing that work?

But what if you got it wrong and it turned out that the company had some hidden debts? Maybe that same company should also have a risk premium removed from it’s value to cover off some percentage change that you didn’t do your due diligence properly?

A Company That’s Earning

How much do you suppose a theoretical company that earns $10k every year is worth? I suppose in part it depends how much percentage of your money you want back each year. Say that company pays all the money out in dividends and you’re getting 5% pa from having your money in the bank, you might want at least 5% pa return from the dividends to match the bank (which we might consider the risk free rate). That would value the company at $200k ($10k / 5 * 100). I suppose you’d probably want to deduct a risk premium, etc. as in the previous example, so actually it’d be worth less than $200k.

What if the company earned $10k pa, but retained those earnings so you could never get them? Would that affect the value? Would it even be worth anything? Perhaps if you can buy the entire company then you can make them pay you out? Perhaps there’s another shareholder with different goals to you and wants to keep putting the money back into the company to try to grow the company? How does that affect the valuation?

A Company That’s Growing

How much do you suppose a theoretical company that earns $10k a year, but grows it’s earnings by 14% pa is worth? It wouldn’t be fair to ascribe the same value as the previous example because in 5 years of compounding return, the company would be returning double the yield. Perhaps it’s worth double? But then in 10 years time it will have doubled again. Perhaps it’s worth quadruple? But then you’re paying the price for a company now that’s actually a future version of itself. Somewhere in between there’s the right price. Maybe this depends on your investment time-frame, how much risk you think there is to future earnings and other opportunities that are available at the time? Here’s a set of graphs I’ve made to try to solve this problem (hint: I use these a LOT).


Hopefully that’s given you something to think about that you can apply to the logic you use in investing and valuing. What other considerations might impact how you value a company? Leave a comment below and we can continue the conversation and improve our thinking together 🙂


Why I Don’t Like DRIPs

What Is A DRIP?

A DRIP is also known as a DRP and stands for Dividend ReInvestment Plan / Programme. It is a way for company’s to offer shareholders a dividend in the form of money, equity or a combination of the two, at the choice of each shareholder.

The Advantages Of DRIPs

Company’s can offer shareholders a dividend or equity. This is a good way to raise capital for the company because the value of the company is set to the market rate (usually a 2% discount), while a capital raise (CR) tends to be at a bigger discount because investors have to be enticed to invest and the increased supply of shares lowers the value of the CR, causing more dilution to existing shareholders.

Why I Don’t Like DRIPs

I don’t like DRIPs because the amount of money raised is uncertain, so it’s not a good way for a company to plan usage of funds, which means the money raised (or rather retained) doesn’t get spent efficiently. If it was determined that capital was needed, it’s better to know how much, then use financial models to determine that the investment will give greater returns than the dilution. If money is perpetually useful to the company for growth, then it would be better to financially model CRs so they can be most efficient in terms of growth vs. dilution and also plan the risk of the investment in appropriate stages of approach.

My other problem with DRIPs is that (unless the company is an investment vehicle such as a managed fund) the company is not an investor. What I mean by that is that it’s the company’s job to run the company and an investors job to be in charge of their own investments. When the dividend is made available, the DRIP might not be the best place to invest at the time, so it’s unreasonable for a company to instate a DRIP to satisfy those shareholders who don’t want a dividend vs those who do. This is because the tax implications are the same and it’s not ideal to forcibly dilute shareholders who have better places to invest their money.

Finally, I don’t like to invest in DRIPs because it removes my ability to choose the best time and place to invest my dividends. Taking the market value at whatever price it might be relies on other investors to determine the price and therefore value of my investment. This is bad because what is a good investment for one investor might be a bad one for another. For example, an investor might pay a higher price for security, while another might not value security as much and find such an investment expensive. This concept is evident by the fact that different stocks find different prices based on different valuation algorithms – otherwise it wouldn’t matter what stock you bought as long as you diversified, which clearly isn’t the case.

The Exception To The Rule

Arguably DRIPs have a place in Exchange Traded Funds (ETFs) as the investor effectively hands off their role as investor and the company they buy into manages that role instead. The ETF would want to offer a dividend so it can be used as a passive income (otherwise hands off investors would need to actively manage their holding to create an income, which doesn’t make sense if you’re buying a managed investment).

The ETF would also want to give people a way to passively reinvest to grow their savings. In this case a DRIP is ideal and there’s also the benefit that as reinvested dividends would increase the value of the fund in a fungible fashion; investors taking the dividend are effectively not diluted because they still own the same amount of value in the fund.

Business Investing

Interviews And Public Relations

I recently had an interview with the nice folks from Snowball Effect, which is being used as content to write three articles, the first of which came out today.

It’s a well written piece that touches on some of my comments on the difference between investing in listed stock vs private equity, psychology around investing and some other factors of investing.

Learnings For Businesses Doing PR

While the interview was very friendly and both the interviewers and I both had the same goal (to produce helpful information about investing), it was very interesting from my perspective because it was an insight into what it might be like to publicly represent an entity.

This got me thinking about some of the issues businesses might have with public communications. While I have a bit of experience with this subject, I have never been responsible for non written communication (except in a few trade shows and the like). So today I thought I’d write a little about my thoughts on the challenges of PR and being quoted.

Generally speaking the main forms of PR representation that give rise to quotes are written communications, interviews and public speaking (speeches, presentations, etc.). These are very different forms of communication because they each have different levels of interaction (which leads to distractions), control and skill required.

Written Communication

Written communication is by far the easiest of the three because you can fully prepare, take your time and there are no distractions. This means that you have absolute control over what you put out to the public, you can analyze what you wrote before publishing it, which means you can look for ways that people could misinterpret or corrupt the meaning in your words, and generally stop yourself from presenting poorly.

Public Speaking

Public speaking is a little harder than written communication because you have social pressure; people might react to what you say (you might get clapping, booing or heckling). People’s reaction or the possibility of reaction might affect how well you communicate, though you can practice for this with groups like Toast Masters.

Nevertheless, with public speaking you are still in control and you can prepare in the same way as you can with written communication. There is just greater scope for errors. That said, it does have the benefit of being able to show some personality and charm, which is more difficult than with written communication. Also people can see your face, which means that peoples reaction will be different to written comms (think about how differently people treat others in a car vs as a pedestrian).This aspect may make it a more appropriate way to communicate certain types of information – such as apologies or things that require ‘spin’.


Interviews are easily the most difficult form of communication. You can walk in prepared, but get misdirected by the interviewer and end up talking about something completely different. You can have thoughts that distract and misdirect you even mid-sentence. Such thoughts could be about the subject matter or social matters (for example, you may be thinking “What does that look on the interviewers face mean?” or “Are they trapping me with this question?”).

There are also issues that as your speech is free, you may not communicate your point well. This gives rise to being quoted in a way that makes you look dumb or doesn’t present your whole opinion. For example, your rhetoric could reference something you previously said, which when quoted makes no sense without the former words.

My takeaway is that when talking in interviews, you should always ensure that you make your point clearly and ensure that whatever the distraction, always finish what you were going to say before discussing the next item.

My Snowball Interview

Fortunately for me the folks at Snowball Effect had no such mal-intentions, but given that I’m not a skilled interviewee, I wanted to take this opportunity to expand on some of the ideas touched on in the article.

“Prior to that, I’d been swimming around in the pool of sharks that is the NZX and ASX, which was great. But SuiteFiles was interesting. As a private equity investor, you’re not quite in the business, but you have to be business-minded. Whereas when you’re investing in listed stocks, you don’t have to be as much.”

Lewis Hurst

This first comment about the pool of sharks was a little jest about trading public listed stocks. It’s actually not too bad, but there are some shady companies out there (I won’t talk about specifics) and it does feel like there’s a bit of stock market manipulation going on sometimes, though that doesn’t bother this investor. I find that NZX listed companies tend to be more honest than those listed on the ASX in terms of the reliability of forecasts, though this is entirely just my opinion and I don’t have anything to back this up. I also believe that there is some insider trading that happens with many of these companies.

I found investing in SuiteFiles interesting because it is a closer nit community of investors and directors, though I would say that this definitely isn’t as much the case with my smaller private equity investments.

My comment about being business-minded with private equity is such a small quote with a lot behind it. When you are involved in a company (especially a closely held company) as an private equity investor, you have to also think like a businessman. This means that you have to be watching out for tricks and be prepared.

A good example of this is when I was looking at investing in a tiny home complex a few year ago. The offer was presented as a business with the security of each investor owning their own part of the complex which was managed by the business. In fact the owners intention was to structure it in such a way that the business would allow her to unfairly allocate revenue through homes she owned before homes owned by other investors.

Interestingly in business actions can be seen as fair or unfair at the same time. It’s necessary to be business-minded to think about what is right and what action to take. An example of this is an entrepreneur that wants to take a large salary from a company you are invested in. This might be fair because a person doing that job might be worth that much, equally it might be unreasonable because the entrepreneur is already motivated by their large stake in the company, so it’s unfair to compare their package to someone who needs a larger salary to remunerate the position.

As a private equity shareholder, like a businessman you will have to consider legal implications of your position. This means that you will have to understand the intentions behind sections in shareholder agreements and company constitutions. Like a businessman you may on occasion have to strongarm people or even take people to court. Fortunately I’ve never had to do the latter.

“With private equity investments, you have to do a bit more research as there’s less published information available. Snowball Effect is great at putting together offers and making that information available. With the NZX there’s a lot more information out there, newspapers digging out information on an investment opportunity and industry commentary – which you don’t necessarily get with private equity investments.”

Lewis Hurst

I think most of the above quote is pretty self explanatory, though it’s worth noting that although Snowball Effect does a good job of putting together offerings, you still need to do your own research because even for retail offers there’s a lot missing.

“Not just for a diversity spread, but also as part of a risk and reward spread. Don’t be put off with private equity, but if you’re nervous, start small.”

Lewis Hurst

Again, I think that’s pretty self explanatory. I’ve talked before about building a strategy, and I believe that private equity can fit into this for many people, especially younger people or people who have already reached their financial goals and are both capable of enjoying the benefits more risk.

“Use your gut to protect you against the negatives, rather than persuade you of the positives. You can convince yourself that something is a good investment and then not put in the leg work that you need to with private equity investments.”

Lewis Hurst

It’s really important to keep your emotions out of investing when decision making. Your gut can tell you something is good, but you need to put the legwork in to prove that it’s a good investment and find all the potential traps and things to be careful of. However if your gut tells you it’s bad, just don’t bother investing. You can do more research, but you might end up convincing yourself to believe the BS your gut is warning you about. It’s possible to be too open minded, sometimes.

“Investing can be complicated. There are so many things to learn, so many mistakes to make and so many ways of viewing things as well. What worries me about new investors is a lot of them haven’t thought about it much. Everyone’s been there. You start off in the stock market and the amount of research you do is looking at the line on the graph and considering whether you like the products being sold by the company or not. You feel pretty confident with yourself and throw some coins at it.”

Lewis Hurst

I suspect that this quote might seem derogatory to some, but it’s really important to realize that there is a lot of work in investing. If you’re doing less than half a day’s work of research, you’ve probably not done enough research.

I see a lot of big ego’s with new investors who think they’re an expert because they bought some stocks that went up, but when they talk about investing it’s clear that they know next to nothing.

I think we can all suffer from egos (especially us men), and ego is the enemy of intelligence. Consider how little scientists of the past knew, but were so certain that they knew everything (leaches could be used to remove demons from the sick, the Earth was flat, etc.). It was only when we accepted that we didn’t know things that we were forced to research and ended up learning things. It’s very easy to stop learning at that point because your ego tells you how great you are, but recognizing that we can never know everything is the only way to keep learning and improving.

Personally, I need to improve my knowledge and experience in matters legal, accounting and business, and everyone can always benefit from working on our people skills.

“Don’t follow some formula that you’ve read about in an investing book. You need to relate the opportunity back to how you’re going to get money out of it and how much return you need that investment to make to fit with your financial goals.”

Lewis Hurst

Reading this again, it comes across as though I meant to say that you shouldn’t invest based on whether the investment opportunity fits the values in a textbook, but instead whether it fits in with your strategy. That’s good advice, but not what I meant.

Additionally, I probably should have said “Don’t just follow some formula”, because books are great.

This quote was actually a reference to performing a valuation that matches your goals rather than how an accountant might perform a valuation. For example, you can apply a risk premium that’s relevant to the risk levels acceptable with your strategy, rather than what’s relevant to the business. This is a complicated subject, so I might circle back to this in a future article.

Lewis believes that Snowball Effect has simplified the process for investors and importantly, saved them time. “When Snowball Effect presents retail offers, they’re presented in a very easy to understand way.”

Snowball Effect & Lewis Hurst

There’s actually a lot in this sentence that was discussed in the interview, but didn’t make it to the page.

It’s a massive amount of work between getting an offer from a company to making that offer investable, and Snowball Effect tidy up the offer so you don’t have to deal with any of the mess.

Based on past experiences investing without Snowball Effect, I have found that accounts aren’t correctly presented, forecasts don’t match reality (this includes incorrect numbers and unrealistic expectations), there are legal documents to create and agree which take a long time and costs thousands, etc. There’s months of time goes by to prepare all that and I notice that I don’t have any such issues when investing in offers presented by Snowball Effect. This also increases the quality of the offerings because I don’t have to deal with time wasters with madcap ideas about valuations, etc.

The downside to this however, is that I don’t get to see the abilities of the entrepreneur. For example, I don’t get to find out if they’re bad with their finances, projections or strategy, because it’s all presented nicely to me. I don’t get to find out if they have good negotiation skills or if they are a difficult person to deal with, either.

Finally it’s worth saying that because Snowball Effect handle all this stuff, they’ve enabled an entire market of investors and businesses that wouldn’t otherwise be able to invest or get funding through smaller investors. This is because for all the work it takes to get an offer ready and do the research, and the cost of the legals (thousands of dollars) it wouldn’t be worthwhile for each investor who is spending less than six figures on the investment. Snowball Effect has effectively made it possible to invest four figure sums in private companies, which otherwise wouldn’t be feasible. That’s pretty cool!


Performant Companies Can Sometimes Be Uninvestable

Prior to the censorship of my stock analysis on this website, long-time readers will have often seen me refer to my PE graph which I use to justify higher PEs for growth companies. The idea behind this is that if you’re investing based on an expected 5% ROI, you might be willing to accept a lower ROI in the earlier years of an investment that’s growing in exchange for a higher ROI in later years.

But what if a company has growth that is affecting the share price, but that growth is driven from external sources (such as market forces) or otherwise is not annually repeatable?

I would argue that some types of growth should not be represented by valuations that rely on multiples, such as a straight PE calculation. This is because the growth isn’t due to an underlying, repeatable improvement in the business, such as an increase in the number of stores.

Along that line, I would argue that growth of this type should be added to the overall share price (or tucked into a DCF as a one-off), rather than be multiplied out in a PE or DCF valuation where consistent growth is assumed.

Sometimes the market doesn’t always consider reasons for growth and the same old formulae are used with the new numbers. As a result, companies can be overpriced, even though they are selling at prices on the same metrics. This can only result in a drop of ROI when conditions fall back to normal in future years. This is how performant companies can sometimes become uninvestable (during or directly after a period of one-off growth).

I advise watching out for this when doing valuations, particularly at times like these where we are seeing changes in market forces which may be temporary (such as industries that have benefited from altering consumer patterns during lockdown).

If you do have your heart set on doing a PE valuation of a company that has grown in a manor that is not sustainable growth, perhaps you could consider altering your valuation to match this theoretical company valuation:

Company earnings: $100m.
Typical annual growth 5% (affording a PE of 22, based on expected ROI of 5% in 2 years).
Annual growth in the last year 10% (affording a PE of 24.5, based on expected ROI of 5% in 2 years).
Assuming the next year will follow former years, we multiple $100m by 21 (PE of 22, minus 1), then add $111m (which is a ratio of the higher PE, divided by the lower PE and multiplied by earnings to account for one year of growth at the higher value of 10%), giving a valuation of $2,211m.

If you’re struggling with this logic behind this, consider that this is approximately (but not) the same as considering PE as the number of years you expect to get your money back, but considering one of those years as being at the abnormally higher rate earnings.

That said, you might just consider a PE of 22, then add the value of cash on hand, which will account for the boom year and distributable/reinvestable funds in the company as well. Long-time readers will know that I usually like to add net cash and equivalents to my valuations.


Thought Of The Day: The Three Ways To Get Rich

As I see it, there are 3 ways to get rich; These are: by getting lucky, by starting a business or by investing.

Getting Rich By Luck

There’s luck in everything we do, whether it’s in business, investing, or any other part of live. But this way to get rich by luck refers to things like lottery wins or being born rich. This isn’t a valid strategy to make yourself rich, and if it were, it would be mega risky and really fast (assuming you were lucky straight away). Clearly gambling is not a strategy for getting rich that you should consider.

Getting Rich By Creating A Business

This method is more work that getting lucky. In fact, I would say that creating a business is the most work of the three ways to get rich. I would say that it’s medium risk (less risky than gambling, but more risky than investing) because compared to investing, you have all your eggs in one basket (in terms of money and time). The benefit to starting your own business (as a strategy to get rich) is that it’s a faster way to get rich than investing. When you consider that luck isn’t a strategy, I would say that creating a business is the fastest way to get rich.

Getting Rich By Investing

Finally, this is the slowest way to get rich, but it’s also the most reliable and least work (excluding getting lucky, which isn’t really a strategy to get rich). This is good news because anyone with a regular job can become an investor, which means than anyone can become rich with time.