2009 investment lessons you must not miss

BY: JOEWATSON GAKUO | CEO, BLACKSTONE EMERGING CAPITAL

In his annual letter to shareholders for the year 2000, the second richest man on planet earth, Mr Warren Buffet wrote that the principle for valuing an asset for financial gain was established by Aesop in 600 BC, and it remains largely unchanged since then. The fable’s moral – a bird in hand is better than two in the bush.

What does a bird in the bush represent? The “bird” represents an investment choice. Cash is what you start with after you save enough for all your necessary expenses. So, a bird in the hand is your current cash position. Aesop says “A bird in the hand is worth two in the bush.” This means that we should be grateful and appreciate what we have instead of always wanting more.

Aesop’s investment axiom is immutable. It applies to outlays for farms, oil royalties, bonds, stocks, lottery tickets and manufacturing plants. And neither the advent of the steam engine, the harnessing of electricity nor the creation of the automobile changed the formula one iota, nor will the Internet. Just insert the correct numbers, and you can rank the attractiveness of all possible uses of capital throughout the universe.

You have to go through these explanations several times before it starts making sense but once it does, it hits you that the thing is absurdly simple and insightful. Thus, when you, as an investors decide to pay very high prices for the birds that were supposed to lurk in the branches of the businesses and stocks… you will be making such a gross and obvious error that it shall scream out for correction. A point in case is the people who bought Mumias company’s shares at 49 bob.

Lessons in 2009

Year 2009 is coming to a close in a few days. A lot has happened in the investment and financial world over the last twelve months. Am sure that you have a story to tell too about how your investment decisions have turned out.

We shall spend some time here looking at the year 2010, looking forward, vis-a-vis where you are today. In doing this, we shall be using an analogy of a bird in hand, and a bird in the bush. Is a bird in the hand worth two in the bush? Put in another way, is a beautiful lady or a handsome guy in a car worth five in your phonebook?….you get the drift.

A bird in hand is the risk free rate of interest that you would get if you bought government securities. So the returns that you are expecting from your investments should be much more lucrative than the risk free rate of interest that you can earn. And to find out whether it is lucrative enough or not you have to look in the bush and answer these three questions:

Are there any birds in the bush? When will the birds emerge and how many would there be?

How to judge a good investment

Put simply would the business or your investments ever generate positive cash flows? When it does generate positive cash flows, would the discounted cash flows be greater than what has been spent in the initial years to be profitable and lucrative? We stress upon the fact that ultimately it is the cash generation ability of an investment or business that will decide its true worth. Other factors like P/E Multiple, book value, dividend yield etc. are at best just clues as to how much the business is worth.

When you use P/E multiple in deciding whether a stock is selling at a reasonable price or not, the fallacy is quite obvious. A company which is struggling will have a comparatively lower p/e but that does not make it lucrative. On the other hand a company which has performed sturdily over the years and promises to do the same in the future would have a higher P/E but that doesn’t make it expensive either.

Projecting cash flows for a business isn’t an easy thing to do, however, it is not a very difficult thing to do either. What you need is a general understanding of business economics and a sense of independent thinking which can see you reach a well founded positive conclusion.

The projected cash flows should be a range rather than a fixed number so that you get an estimate of the most pessimistic view to the most optimistic. This would help in ironing out any errors in forecasts that may have been made. In industries where technology changes rapidly or in the case of new businesses, even getting a range of estimates becomes difficult, and hence you should only invest in businesses that you fully understand. These questions try to seek answer whether what you already have or own is more valuable than what you want to have or own.

Valuability is the key here. You need to look at the current position with regard to the investments you have made, and determine whether you want to move ahead (risk) getting more, by investing more.

To do this, you should answer the following questions. How difficult will it be to get them? How long will it take to get the birds in the bush? What are the other benefits of gaining the bird? If I invest, how will it improve my life? And how will I know? These are things we need to consider as we seek to grow and create more wealth in the year 2010 and beyond. Sometimes, a bird in the hand is better than two in the bush, and at other times, two in the bush are better than one in the hand.

Be careful what you wish for

In one way or the other, you will have to make a decision whether to hold on to the birds you have in your hands, or to chase for the ones in the bushes.

A lot of advisors and economic analysts are predicting that this economic recession could end as early as in 2010. My two cents; don’t pop-up the champagne yet, we are in for the long haul. The famous physicist Max Planck was talking about the resistance of the human mind, even the bright human mind, to new ideas when he said “science advances one funeral at a time” and I think there’s a lot of truth to that and it’s certainly been true in investments.

It is true. In any discipline, for every three ideas you come up with, only one will move forward. But the solution to this is not to stop having new ideas but to churn out more…

Let me wish you a Merry X-Mass, and a Happy New Year.