PowerWealth.com

Why Are Oil Prices So High? Gold Solves the Riddle.

By Logan Flatt, CFA

   As the price of a barrel of crude oil continues to rise unrelentingly past $120 a barrel, one begins to wonder, Is the price of oil rising due to the strong global demand for oil, or due to the U.S. Dollar (USD) falling in value so much that Americans are now forced to spend more and more increasingly worthless dollars to buy a single barrel of oil?

   One way to solve this riddle is to travel back in time to the 20th Century when after World War II the USD was considered 'as good as gold'¹ because the exchange rate between the USD and gold was fixed at 1 USD = 1/35th of an ounce of gold until President Richard M. Nixon shocked the world by yanking the USD off the gold standard on August 15, 1971. Or, travel even further back to a time centuries ago when men and women the world over used gold as a medium of exchange, a store of value, and a unit of account. Back then, prices of almost all goods and services were quoted in units of gold. Looking at the price of oil from this historical perspective, a new question arises: Would the price of crude oil be rising so much if Americans were paying for a barrel of oil with ounces of gold instead of the current 'goldless' USD?

   Using 1991 as a fixed point of reference, the graph shown below reveals that starting in late 2001 -- around the time of the September 11 terrorist attacks on the U.S. -- there has been a strong divergence in the price of the 'goldless' USD and the price of a barrel of crude oil, if both were priced in units of gold, just as they would have been centuries ago. The lines in the graph show how much an American could buy with one ounce of gold over time. In short, the lines show that, since 2001, an American could use one ounce of gold to buy an increasing amount of U.S. Dollars (the red line), or a decreasing amount of crude oil (the blue line).

Image © 2008 by Prof. Werner Antweiler, University of British Columbia, Vancouver BC, Canada. Used with permission. All rights reserved. Time period shown in diagram: 1/Jan/1991 - 6/May/2008.

   Looking at the graph another way, the red line reveals that an American today is having to spend almost 2.4 times the number of U.S. Dollars he had to spend back in 1991 to buy a single ounce of gold. This is confirmed by comparing the USD prices of one ounce of gold in 1991 and today: $362 and $876, respectively. Remember, gold never changes: it always has been and always will be the metallic element found within the Earth's crust that scientists have assigned the chemical symbol Au and atomic number 79. What has changed is the purchasing power of the USD. Since an American must now use many more units of USD to buy a single ounce of gold that is the same today as it was 1991, the USD clearly has lost its power as a medium of exchange, a store of value, and a unit of account.

   Similarly, the blue line reveals that an American today can buy only half as much crude oil per ounce of gold as he could in 1991. In other words, an American must now spend twice as much gold as he could in 1991 to buy one barrel of oil. This is confirmed by comparing the gold ounce prices of one barrel of oil in 1991 and today: 0.06 ounces of gold and 0.12 ounces of gold, respectively. Like gold, crude oil is simply earthen material. At base, crude oil is a hydrocarbon, an organic compound consisting of hydrogen (symbol H, atomic number 1) and carbon (symbol C, atomic number 6). However, oil springs forth from the Earth in a variety of different chemical flavors depending on the geology and geography of its source. Some people like it 'sweet', some people like it 'sour'; regardless, crude oil has become a hot commodity since 1991.

   So, a barrel of oil has doubled in price in terms of gold ounces since 1991 and, at the same time, an ounce of gold has more than doubled in price in terms of 'goldless' U.S. Dollars. Thus, gold solves the riddle: the price of crude oil is high and rising primarily due to the 'goldless' USD losing its value as a currency, and secondarily due to the strong global demand for oil. This is confirmed by comparing the USD prices of a barrel of crude oil in 1991 and today: $21.50 and $121.90, respectively. An American today is having to spend 5.7 times the number of U.S. Dollars he had to spend back in 1991 to buy a single barrel of oil. As the U.S. Dollar in his pocket becomes increasingly worthless, the average American is forced to cough up more 'goldless' U.S. Dollars to convince a seller of a barrel of oil to make a fair trade. Who can blame the oil seller if she requires ever more increasingly worthless U.S. Dollars to complete the sale of an increasingly valuable barrel of oil?

   Perhaps the riddle that the average American should be trying to solve has less to do with the price of oil going up and more to do with the purchasing power of the USD going down. Perhaps the real questions that Americans should be asking are: Why is the USD losing so much purchasing power? Why are our elected representatives in Washington, D.C. failing so badly in their constitutional mandate to provide We the People with a stable currency -- a currency as good as gold -- that helps us protect our wealth, our quality of life, and our future generations? Why are We the People simply allowing these officials to render all of us poorer and poorer as time goes by? When will We the People finally say 'enough is enough'?

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¹In fact, the U.S. Dollar pegged to the gold ounce was considered even better than gold because lenders could charge interest on the gold-backed dollar but they could not charge interest on gold itself.

Copyright 2008 PowerWealth.com. All rights reserved.

For The Love of Money.

By Logan Flatt, CFA

   One million dollars is a lot of money. Many Americans would love to have $1 million sitting in their bank and brokerage accounts. In fact, according to the 2007 World Wealth Report published by Capgemini and Merrill Lynch, over 2.9 million Americans do have at least $1 million in cash and securities on account today.

   Yet, do Americans really love money? For many, as soon as we get money in our hands, we spend it on some shiny new thing that pleases us, or on some new experience that, for a short while, distracts and entertains us. So, do we love money, or do we love what money enables us to possess and experience?

   Regardless, note what money gives us – freedom, opportunities, security, flexibility, and power – stems not from money’s quantity, but from its quality. It matters not how much money we possess or how impressive the rate at which we bring it home if our money steadily decreases in value over time.

   So, is $1 million really a lot of money? It depends – how fast is the dollar decreasing in value? There’s one simple way to tell: price inflation. As consumer prices increase, a dollar buys less than it used to. Thanks to America’s average annual inflation rate of 2.7% over the past seven years, $1 million in 2000 was worth only $829,864 by the end of 2007. In 2008, inflation has jumped to 4.1%, degrading the dollar faster still.

   What is causing price inflation today? It’s a two-fold problem. First, through deficit spending, the U.S. Congress spends today hundreds of billions of tax dollars borrowed from our future. This acceleration of future tax dollars into the present increases the supply of dollars sloshing around our economy in 2008, increasing demand for – and prices of – goods and services.

   Second, the Federal Reserve swells the U.S. money supply with credit. By lowering short-term interest rates – as it did by 1.25% in January – the Fed encourages banks to loan money to borrowers looking to spend their future earnings today. The result is more dollars sloshing around the economy, further driving up prices of goods and services.

   How can we stop the Federal government’s willful degradation of the U.S. dollar? Vote. Write. Call. Demand that your elected officials in Washington, D.C. practice sound fiscal and monetary policy: a balanced Federal budget each year; a lower Federal debt outstanding; and inflation-fighting (e.g., higher) short-term interest rates.

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NOTE: This article first appeared in the Winter 2008 issue (Volume 6 Issue 1) of The Swan, a publication of the Lake Forest Community Association, Inc., a nonprofit Texas corporation (www.lfhoa.com).

Image above copyright 2006 by Chris Palmer of Huntsville, AL USA. Used with permission. All rights reserved.

Copyright 2008 PowerWealth.com. All rights reserved.

Let's Be Frank, Barney: The Federal Reserve Hurts We The People.

By Logan Flatt, CFA

   In his counterpoint to Massachusetts Congressman Barney Frank's partisan diatribe against America's laissez faire approach to economic growth and its “unacceptable levels of income inequality” (Financial Times, “Why America needs a little less laissez-faire”, January 14), Mr. Jeff Erber made two mistakes that weakened his otherwise spot on argument (Financial Times, Letters, “Government regulation is to blame for mortgage market collapse”, January 17).

   First, Mr. Erber states, "it is far more likely that income inequality is wide because of the current phase of the US economy's business cycle." That’s baloney. Economic gobbledygook is not necessary to explain the broad distribution of household incomes in America. The freedoms enshrined in the U.S. Constitution explain it fully. The Founders and the States did not make "income equality" a founding principle of the United States of America. They also did not require that Americans' incomes be evaluated and judged for “fairness” by political elites in Washington, D.C. earning a cost-of-living-adjusted income of $169,300 per year – that’s in the top 3.2% of all U.S. households per the U.S. Census Bureau – just like Harvard-educated Congressman Frank has earned through good economic times and bad as a career politician free from the tyranny of term limits for the past 27 years. Congressman Frank’s vision of a statist America is indefensible vis-à-vis the fundamental law of the land, through which We the People, among other things, secured the Blessings of Liberty to ourselves and our Posterity. Such Blessings of Liberty include as much – or as little – income as we so freely choose to go out into America’s market economy and earn, thank you very much.

   Second, Mr. Erber states, “In order to stave off inflation, the Federal Reserve lowered the fed funds rate…”. Au contraire, mon frère! From 2000 to 2004, the Federal Reserve lowered its target for the federal funds rate repeatedly in hopes of staving off recession, not inflation. The Fed’s deliberate actions in favor of economic growth injected vast amounts of cheap credit into the U.S. economy which only stoked inflation, as evidenced by the upward trend in the annual rate of inflation from 2002 to today. The Federal Reserve’s cheap credit policy further stoked irrational exuberance in the markets for U.S. mortgages and real estate. Flush with money, urbane financial institutions lent foolishly while naïve borrowers speculated Trumpianly only to default on the “leverage” they never should have borrowed in the first place.

   For his part, Congressman Frank correctly notes that mortgage-backed securities spread the pain of default to other parts of the financial world, but he misdiagnoses the true disease that ails the U.S. economy today. America’s economic problems are not due to market forces, laissez faire economic policies, or clever financial engineering. The pathogen that most afflicts the U.S. economy today is the Federal Reserve, which engages unwarrantably in the central planning of U.S. economic growth. By creating artificial growth instead of vigilantly protecting We the People from the ravages of inflation, the Federal Reserve engorges the U.S. money supply with a debased currency backed by nothing more substantive than the “full faith and credit” of a bloated U.S. federal government beholden to foreign lenders to pay its bills. Next week, We the People as well as Congressman Frank will watch the Federal Reserve continue its brazen destruction of the U.S. dollar by expanding cheap credit throughout America’s economy yet again.

   NOTE: In a surprise move in the early morning of January 22 -- only a few short hours after this essay was completed -- the U.S. Federal Reserve cut its target for the fed funds rate by 75 basis points to 3.50%. The Fed continued its debasement of the U.S. Dollar at its regularly scheduled FOMC meeting on January 30 by cutting its target for the fed funds rate by a further 50 basis points to 3.00%.

   UPDATE: In the afternoon of March 18 the U.S. Federal Reserve yet again cut its target for the fed funds rate by 75 basis points to 2.25%.

   UPDATE: On April 30, the U.S. Federal Reserve once again cut its target for the fed funds rate, lowering it 25 basis points to 2.00%.

Copyright 2008 PowerWealth.com. All rights reserved.

It's Future Cash Flows, Stupid!

From The Financial Times newspaper:

Link to original Letter at FT.com

It’s future cash flows, stupid!*

Published: November 24 2007 02:00 | Last updated: November 24 2007 02:00

From Mr Logan Flatt.

Sir, It is no surprise that an academic study overlaying fundamental company data with equity market data (Long View, John Authers, “Number-crunchers are socially desirable again”, November 17) would conclude that reported earnings or earnings forecasts are the “best predictor” of the market’s valuation of a publicly traded company. After all, the market’s “valuation” represents the market pricing the company’s shares based on supply and demand.

Holding supply constant, market price is determined at the margin by speculative demand for the shares. Most speculators probably formulate their demand for the company’s shares based on a mixture of its most recent quarterly earnings report, analysts’ forecasts of future earnings, unofficial Wall Street whisper earnings, and random online chatter. In the spirit of “group think”, it is entirely possible that most speculators give more weight to earnings measures simply because more people in the market talk about earnings measures than cash-flow measures.

Ah, but there’s the rub: the objective and reasonable valuation of a company has little to do with the supply of and demand for the company’s shares and everything to do with the company’s ability to generate future cash flows. Many successful investors have proven records of using cash-flow-based valuation approaches to uncover and then take advantage of compelling investment opportunities that have exceeded historical market index returns.

They gained their advantage by using estimated future cash flows to assess a company’s intrinsic value – the economic benefit today of holding onto the company’s shares over the long term for the sole purpose of collecting future cash flows from the company – and then asking themselves: “What price am I willing to pay for the company’s shares today given the economic benefit the company’s shares offer me today?”

A quick look at the ticker tape told them whether or not it was prudent to pay the prevailing market price for the company’s shares. If the company’s prevailing market price exceeded the company’s intrinsic value, these successful investors likely took no action. If the company’s prevailing market price fell well below the company's intrinsic value, they probably committed significant capital to the investment opportunity and never looked back.

I submit that speculators’ focus on the company’s near-term earnings measures probably created the short-term market inefficiency that led to the mispricing of the company’s shares vis-a-vis their intrinsic value. Furthermore, I submit that long-term market efficiency probably ensured the successful investors' market-beating returns since, to paraphrase Benjamin Graham, the market is a voting machine in the short term, but a weighing machine in the long term.

Logan Flatt,
PowerWealth.com,
Dallas, TX 75230, US

Copyright The Financial Times Limited 2007

*NOTE: Title chosen by The Financial Times, not Logan Flatt.

Copyright 2007 PowerWealth.com. All rights reserved.

How to Get Ahead In America (5th of a 12-Part Series)

By Logan Flatt, CFA

NOTE: This article is Part 5 of a 12-part series detailing the “12 Refusals That Helped Me Pull Ahead in America.” To start at the beginning of the series, click here.

5. Refuse to let America's media and entertainment industry own your reality.

   If you live in the United States of America, one reason you may feel challenged to pull ahead financially is that America’s culture is heavily focused on the consumption of goods and services by individuals and families. While consumption may help grow America's mammoth $13.1 trillion economy, it can also hurt the long-term wealth of the average American family. Why doesn't America's culture focus on more fiscally responsible behavior like saving and investing? Because America's powerful media and entertainment industry keeps American culture centered on the consumption of products and services by offering and providing advertising and other marketing solutions to America's best and brightest marketers. It is the combined power of the industry and the marketers that keeps you and your family focused on spending your money on goods and services in the here and now instead of doing what is best for you and your family in the long run – building wealth by saving and investing.

Don't Fool Yourself – Your Home Is Not An Investment.

By Logan Flatt, CFA

   Recently, a respected blogger on the Web misquoted me on their blog in an entry referencing my essay, "You Don't Own Real Estate. Real Estate Owns You." The blogger made a couple of critical errors in quoting me but the errors have, for the most part, now been corrected based on three points I made privately to the blogger by email. Below, I present the text of my email (with some small edits) for all PowerWealth.com readers who have an interest in real estate investing to review and consider.

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   First, I never said on my PowerWealth.com site that a "home mortgage is not an investment." What I said was, "…your home is not an investment…" That's a huge difference! I think your confusion arises out of your merging of two separate and distinct financial considerations from the homeowner/borrower perspective:

1.   The Asset, which is the real estate property we would call "home"; it is an asset because it has marketable value to you and others in the real estate marketplace;

AND

2.   The Liability, that loan or mortgage serving as a lien on the real estate property only because the buyer of the home did not have enough cash on hand to pay for the property outright and had to borrow the money from a bank or mortgage lender to complete the purchase of the real estate property.

   From the borrower's perspective, a "home mortgage" could never be viewed as an investment. It is a legal contract obligating the borrower to pay back the money borrowed, plus interest charges and other fees. In effect, the home mortgage slowly drains the borrower of cash through those interest charges and fees paid out over time. Being legally obligated to pay someone else cash over time is a liability. One "invests" in assets, not liabilities. A freedom loving person seeks to rid themselves of a liability – having no meaningful financial obligations such as liabilities is what "financial freedom" means. Consequently, an investment in a liability is a non sequitur.

   It is important to note here that only the lender would view the "home mortgage" as an investment because that home mortgage is indeed an asset to the lender – in exchange for lending the money to the borrower, the lender gets the mortgage documents signed by the borrower agreeing to pay the money back plus interest charges and other fees. So, what is a liability to the borrower – the mortgage – is an asset to the lender. If you were writing about lenders, then your implication that a home mortgage is an investment would make more sense. Unfortunately, you were writing about borrowers in your post. So, contrary to what you posted, no, I do not agree with you.

   Second, my quoted statement on your site [Editor's note: the quote used from my article was, "To make it your home, you must take cash out of your pocket each month to finance it, insure it, maintain it, fix it, furnish it, and pay property taxes on it. Unlike investment real estate, your home generates no income to offset these out-of-pocket expenses. So, while you likely derive much pleasure from owning your home, you lose money on it every month. Don’t fool yourself – your home is not an investment. It is simply a purchase."] would be true for a home that had no mortgage on it if only we were to delete two words: "finance it." So, the home need not have a mortgage on it to fail my "investment test" – even if the homeowner owns the home free and clear, there are a litany of expenses associated with home ownership that make it difficult to call a home an investment (because the home generates no income itself to offset those expenses). This was the full point of the "Personal Real Estate is Simply a Purchase, Not an Investment" section in my article on PowerWealth.com.

   Third, both you and [a financial services professional who made, in my view, an erroneous comment to the blogger's post] appear confused on the notion that the use of "leverage" to buy a home somehow instantly transforms the purchase of a home into an investment. No, it does not. While "leverage" is a sexy term used by professionals in the trade to romanticize real estate investing and make it sound exciting conceptually, it is a red herring. It masks the truth: to use "leverage" is to legally obligate yourself to a lender. In other words, what you are doing when you "lever a deal" is voluntarily take on a liability and the risk of losing your home to the lender due to your failure to pay back that liability according to the lender's terms. The addition of a liability to your home purchase does not – poof! – make your home an investment.

   To clarify, when you use "leverage" to buy your home, you are essentially completing two separate and distinct transactions at the same time:

1.   purchasing a piece of real estate that will generate no income for you to help you offset all the expense associated with owning said real estate,

AND

2.   entering into a legal agreement to borrow money from a lender whereby you agree to repay the money borrowed plus interest charges and fees according to the lender's terms specified in the agreement.

   Note that the addition of "leverage" to the deal did nothing to change your home's ability to generate income for you one bit. In fact, by borrowing the money to buy your home, you simply increase your home ownership expenses by adding interest charges and fees. Clearly, "leverage" is sexy in concept only; in the harsh light of reality, it is anything but sexy.

   [Blogger], I hope that you and your readers will consider reading again my article, "You Don't Own Real Estate. Real Estate Owns You." at PowerWealth.com to recall and reinforce its key takeaways:

1.   to invest in real estate means to own and operate income-producing real estate;

2.   to speculate in real estate means to buy real estate at the prevailing market price and hope to sell later at a higher market price;

3.   your home is neither an investment nor a speculation – it is simply a purchase of a piece of real estate to enjoy and call "home", not to make money from it;

4.   you really don't own real estate if a government can swoop in and take it away from you because that government thinks your real estate stands between it and a just cause – a cause apparently less important than your personal property rights.

   Thank you,

   Logan Flatt, CFA
   PowerWealth.com

******

Copyright 2007 PowerWealth.com. All rights reserved.

"Growth Investing" Nothing More Than Rank Speculation

By Logan Flatt, CFA

   Recently, Financial Times columnist, John Authers, made a “Long View” case for growth investing over value investing (Market News & Comment – Long View, “Now may be the time to go for growth stocks”, October 6/7, 2007). Unfortunately, Mr. Authers’ case for growth investing is actually a case for rank speculation.

   Thanks to decades of promulgation by the financial services industry, it is now common for many people not unlike Mr. Authers to mistakenly use the terms “value” and “growth” to describe two contrasting styles of investing. However, there are not two styles of investing. Instead, there is investing and there is speculation. What is known as “value investing” is bona fide investing where fundamental analysis, reason, long-term ownership, and patience lead most investors to wealth.  What is known as “growth investing” is rank speculation where fear, greed, short-term trading, and the desire for immediate gratification lead most speculators to treat Wall Street like a casino, placing emotional bets on what seem like ever-increasing market prices. That is, until reason prevails, the tables turn, and the madding crowd rushes for the exits, losses in tow.

   Mr. Authers further errs in his contrasting definitions of growth investing and value investing: “Growth takes advantage of the market’s undervaluation of future earnings while value profits from undervaluations when a company gets into trouble.”  Unfortunately, neither definition is correct. Value investing takes advantage of the market’s mispricing of a company’s shares relative to their intrinsic worth (i.e., the present value of the company’s likely future dividends or after-tax free cash flows expressed on a per-share basis) regardless if the company is in trouble or is as healthy as it can be. For example, it’s the buying of a company reasonably worth $25 a share when the market has it emotionally priced at only $15 a share. In contrast, growth investing takes advantage of the “greater fool theory” – the belief that regardless of what price you pay for a high-flying stock, some other speculator will be there to pay you a higher price when you are itching to sell it.

   Another Financial Times columnist, Arne Alsin, had it correct months ago (Columnists – Inside Curve, “Two simple questions that protect against the siren’s song”, March 9, 2007) when he stated, “All great investors, from Warren Buffett to Peter Lynch to Michael Price, understand a single, fundamental premise. That is, in order to be a successful investor you have to be able to answer two simple questions: ‘What does it cost?’ and ‘What is it worth?’” As Mr. Alsin went on to point out, if an investor does not answer the second question, the answer to the first question is meaningless. We can surmise then that the speculator, in contrast, finds ignorance of the answer to the second question to be perilous bliss.

   That “growth investing” is rank speculation is made clear by Mr. Authers’ concluding statement, “…stick to stocks whose fundamentals are really growing and then be ready to sell at the first sign of trouble.” Only a speculator would think this way. Warren Buffett – investor par excellence – has suggested that selling the shares of a company with sound fundamentals may very well be the last thing an investor should do when “trouble” arises. Instead, Mr. Buffett suggests we take a harder look and determine whether the trouble at hand is short-term operating trouble or long-term strategic trouble. If the company has hit a rough patch operationally but nothing about the company’s winning strategy has changed, a reasonable investor would stand pat or even buy more of the company’s stock. After all, if the company was good enough for you to buy its shares in the first place, why not consider buying more of it when speculators overreact to “trouble” and post their shares up for sale at significantly lower prices?

   Ultimately, if Mr. Authers is correct and growth investing is “due for a period of outperformance,” we are entering – or, more likely, have already entered – a period of widespread speculation in stocks. Caveat emptor.

Copyright 2007 PowerWealth.com. All rights reserved.

How to Get Ahead In America (4th of a 12-Part Series)

By Logan Flatt, CFA

NOTE: This article is Part 4 of a 12-part series detailing the “12 Refusals That Helped Me Pull Ahead in America.” To start at the beginning of the series, click here.

4. Refuse to live a lifestyle you cannot afford on the income you bring home each month.

    Many Americans today run out of cash each month after paying the bills that enable them to live their chosen lifestyle. Their lifestyle leaves them no cash left over to set aside and save for their future. Without savings, these Americans have little to no chance of achieving financial security and freedom in their lifetime.

How to Get Ahead In America (3rd of a 12-Part Series)

By Logan Flatt, CFA

NOTE: This article is Part 3 of a 12-part series detailing the “12 Refusals That Helped Me Pull Ahead in America.” To start at the beginning of the series, click here.

3. Refuse to be a victim.

    Throughout history, many of us have been adversely affected when somebody or something oppressed, injured, tricked, mistreated, or otherwise afflicted us with emotional hurt, physical pain, or psychological damage. Due to no fault of our own – whether by cruel fate, happenstance, or divine intervention – we involuntarily suffered something unexpected and unfavorable that, by definition, reclassified our human condition to that of “victim”.

How to Get Ahead In America (2nd of a 12-Part Series)

By Logan Flatt, CFA

NOTE: This article is Part 2 of a 12-part series detailing the “12 Refusals That Helped Me Pull Ahead in America.” To start at the beginning of the series, click here.

2. Refuse to allow anyone else to take responsibility for creating your life.

    If there is one refusal that has been central to my financial success in America, I would say this is it. Simply put, I believe that I control my own destiny. Therefore, my life is my own creation. I’ve found that most people are ready to take credit for the good things in their lives, but are quick to blame others for the bad things. Not me. I take credit for both the good and the bad in my life.

How to Get Ahead In America (1st of a 12-Part Series)

By Logan Flatt, CFA

    The United States of America is a country where an individual wanting to improve his social or economic status, or simply get ahead one way or another, can make the choice to do so and then, through personal conviction and effort, create a new and better life around that choice. For centuries, poor, hungry, and courageous immigrants from around the world have come to America intent on transforming themselves into living, breathing examples of this fact. And they continue to come: in 2006 alone, the United States of America accepted 1,266,264 legal immigrants as permanent residents – more than the rest of the world combined.

Classic Analysis Always Wears Well

From The Financial Times newspaper:

Link to original Letter at FT.com

Classic analysis always wears well

Published: September 7 2007 03:00 | Last updated: September 7 2007 03:00

From Mr Logan Flatt.

Sir, Luke Johnson pines for high-quality stock research focused on the intrinsic worth of a company:

". . . classic analysis of shares will come back into fashion one of these days. I look forward to its renaissance." ("Bring on the rebirth of classic analysts", Ft.com September 4.)

Mr Johnson should note that classic, fundamental analysis never goes out of fashion. It is timeless in its design and wears extremely well. Also, I am happy to inform him that the renaissance festival is alive and well in downtown Chicago at the offices of Morningstar, Inc.

The company's five-star rating system is based on the "margin of safety" between market price and intrinsic worth, just as the dynamic duo of Warren Buffett and Charlie Munger advocate.

Furthermore, Morningstar's classically trained analysts can be an investor's source of calm amid the storm - they often remind their readers to remain focused on intrinsic worth when market prices get choppy and speculators get sloppy. Why wait for fashions to change when one can be wiser and richer today?

Logan Flatt,
PowerWealth.com,
Dallas, TX 75230, US

Copyright The Financial Times Limited 2007

Copyright 2007 PowerWealth.com. All rights reserved.

The Choice Is Yours

By Logan Flatt, CFA

    “Money makes the world go ‘round.” Although it is a cliché, I have not found anything in my years so far on planet Earth that seems to suggest otherwise. Money has a powerful influence around the world. People the world over make critical decisions – good or bad – based on money. They also change personal behavior based on money. Money does not have to be present to make people change decisions or behavior. Often, it is the lack of money that most influences how people think or behave.

    On the surface, the process of making money seems mysterious and complex. Don’t be fooled. Making money is simple:

    Sales – Costs = Profit

    That’s not to say, however, that making money is easy – because it’s not.

    In fact, making money is a challenge for most of the 6.6 billion people in this world. Most live in poverty or just above it. However, the 301 million people living and working in the United States of America – who represent less than 5% of the world’s entire population – appear to have mastered the art and science of making money quite well, thank you very much, as evidenced by the U.S.A.’s $13.1 trillion economy – nearly 20% of the world’s entire economic output. No wonder then that the United States of America – with disproportionate economic power given its relatively modest population size – is referred to by many people around the world as “The World’s Superpower.”

 

    What makes money so complicated and so seemingly hard to make? Human beings. You cannot make money in a vacuum. You need to transact with other human beings to make money. That is money’s fundamental purpose – to facilitate the exchange of goods and services among individuals, corporations, and governments. A human being or a group of human beings lies behind each of these economic entities. Now, I am sure that you will agree with me that human beings are highly complex creatures. Moreover, nowhere do human beings get more complex than when they are with – or without – money.

    Pessimists, cynics, and miserablists alike claim, “Money is the root of all evil.” As is typical of their negative, self-defeating ilk, they are wrong. Money is not evil at all. Money is not inherently good either. Money possesses no emotion, no feelings, no thoughts, and no beliefs. Human beings possess these things. Human emotion is the root of all evil (e.g., envy and hate) and of all good (e.g., trust and love). Money is indifferent. Money is innocent.

    Despite its neutrality, money has a special magnetic quality: money is highly attracted to reason. If you are new to the concept of getting ahead financially, you will soon learn that the best way for you to attract more money to your life is to control your own emotions. After all, emotions like fear, greed, anger, hate, envy, and even optimism can quickly lead you into financial trouble. But, to really stake your claim to lots and lots of money, you must learn to cut through the emotional haze created by other human beings with a razor sharp weapon: rational thinking.

    To get ahead financially, you have to concentrate and focus your rational mind on building wealth over the long-term. You must rid yourself of the emotional distractions that keep your mind mired in the short-term and its wealth-depleting temptations. I am not saying that you must ignore everything else in your life to the detriment of your health and those you love. I am not saying focus exclusively on building wealth either. What I am saying is that to truly build wealth for you and your family, you must make a conscious, rational choice today and be committed to your choice going forward.

    Your choice is between Option A and Option B:

    Option A: "I am willing to do what it takes to get ahead financially over the long term."

    OR

    Option B: "I am not willing to do what it takes to get ahead financially over the long term."

    Why are you not getting ahead financially? It is likely you have made the wrong choice between Option A and Option B in the past, or more likely, you have simply neglected to make the choice at all. The point is, you have a choice. And, to get ahead financially, you must make that choice.

    So which do you choose, Option A or Option B? Stop, think for a moment, and make your choice right now.

    (The waiting music from the game show “Jeopardy!” should now be playing in your head).

    OK, you have made your choice, right?

    And, you are firmly committed to that choice from now on, right?

    Congratulations! You are now further ahead financially than perhaps 90% of the American population. Most Americans have not made the choice. They simply fly their financial lives on autopilot every day. However, you are different. You have made the conscious, rational choice. You have made the commitment to yourself. You have officially turned off the autopilot and are now firmly at the controls as you fly through your financial future.

    Now, the Big Question:

    Did you choose Option A or did you choose Option B?

    If you chose Option A, I know PowerWealth.com can help you because you are committed to doing what it takes to get ahead financially over the long term. Please return to PowerWealth.com again and again over the coming months to learn more of the insights I will be sharing with you.

    If you chose Option B, I don’t believe PowerWealth.com can help you much. My insights into building wealth can only help those individuals who are committed to doing what it takes to get ahead financially over the long term. You, unfortunately, have chosen otherwise. Still, I hope you will continue to return to PowerWealth.com. Who knows? You might just learn something new. And, if you ever feel pangs of regret for the choice you have made today, please know that PowerWealth.com will be right here to guide you through the choice again.

    Until next time, be sure to take time out to notice and watch how “money makes the world go ‘round.”

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NOTE: The term "miserablism" is believed to have been first attributed to Neil Tennant in 1990.

Copyright 2007 PowerWealth.com. All rights reserved.

You Don't Own Real Estate. Real Estate Owns You.

By Logan Flatt, CFA

    Many Americans believe that real estate can do no wrong as an asset class upon which they can build wealth. I disagree. Building wealth through real estate depends on your ability to distinguish among the three types of real estate ownership – investment, speculative, and personal. If you don’t know the differences, you may soon discover that you don’t own real estate, real estate owns you.

Investment Real Estate Puts More Cash in Your Pocket Than It Takes Out

    Investment real estate refers to the ownership and operation of income-producing real estate whereby the income generated by the property – usually, rent payments from tenants – more than covers all the costs of owning and operating the property. If the income is high enough to cover all the costs of ownership and operation plus leave cash left over for the property owner, the property is said to be cash flow positive. If the income fails to cover all the costs of ownership and operation, the property is said to be cash flow negative, whereby the property owner must dig into his or her pockets to come up with the cash to pay for the remaining, uncovered costs.

    A bona fide real estate investment puts more cash in your pocket than it takes out, on a repeatable, consistent basis. As such, a cash flow negative investment property is really not much of an investment at all. If you continue to hold on to a cash flow negative investment property out of pride or any other emotional attachment to the property, you are not maintaining an investment; you are maintaining a hobby. A rational real estate investor would put a stop to the repeated, consistent cash drain ASAP. In many cases, it is simply best to swallow your pride and sell a cash flow negative investment property. That way, you can let a new owner cope with the income shortfall each month while you put your sale proceeds to work in a cash flow positive investment property you can find elsewhere.

Speculative Real Estate Is a Bet Against the Odds

    When buying real estate at or near the prevailing market price, many people firmly believe they will make a profit upon the future sale of their real estate. Unfortunately, there is wishful thinking and there is reality. Wishful thinking plays a prominent, defining role in speculative real estate. A new property owner may hope to sell his property at a higher market price in the future, but in reality, he has no idea what the future market price will be. Nobody does – all future market prices are unknown to everyone. That is, until the future arrives.

    In the face of such uncertainty at the time of purchase, all the new property owner  can know is that there are three outcomes for a future market price: significantly lower than, similar to, or significantly higher than the current market price. In other words, unable to know at the time of purchase what future market prices will be, the new property owner has only 1 in 3 outcomes where he can sell his property at a future market price significantly higher than the current market price. If each outcome is equally likely, the new property owner's odds of selling his property at a highly inflated market price are low.

    Unfortunately, the odds of making a profit on a property purchased at the prevailing market price are made even worse by the high transaction costs of buying and selling real estate. Even if a new owner sells his property at the similar future market price, he still loses money thanks to brokers’ commissions, legal fees, and other closing costs incurred to sell the property. He also loses money selling the property at a significantly higher future market price if that future market price is not quite high enough to cover the high transaction costs. Clearly, the odds of making a profit are against those who buy real estate at the prevailing market price and hope to sell later at a higher market price. Such is the nature of speculation and the wishful thinking that leads to it.

Personal Real Estate is Simply a Purchase, Not an Investment

    Personal real estate is real estate you buy primarily because you believe you and your family will enjoy living there. Making money, if at all possible, is secondary. In fact, it is hard to make money with personal real estate. To make it your home, you must take cash out of your pocket each month to finance it, insure it, maintain it, fix it, furnish it, and pay property taxes on it. Unlike investment real estate, your home generates no income to offset these out-of-pocket expenses. So, while you likely derive much pleasure from owning your home, you lose money on it every month. Don’t fool yourself – your home is not an investment. It is simply a purchase.

    Nevertheless, despite draining you of cash every month, owning personal real estate generally beats renting a house, condo, or apartment for an extended period of time. Owning personal real estate gives you at least two options that renting does not. These options provide you with real value.

    First, unlike renting, ownership of personal real estate gives you the option to keep more of your income out of the hands of career federal politicians in Washington, D.C. Current U.S. federal tax laws allow you the opportunity to deduct mortgage interest and local property taxes from your taxable income. This helps reduce your U.S. federal income taxes. So, when you own personal real estate, more of your outgoing cash ends up helping your surrounding community, its schools, and its hospitals instead of largely going to waste in Washington, D.C. This is especially true if the investors in your mortgage are also local and in your community; such investors are more likely to reinvest your interest payments locally as well.

    Second, if you ever have to move due to a job change or relocation, personal real estate ownership gives you the option to hold on to your personal real estate and rent it to tenants after you move out. Exercising this option gives you the opportunity to turn your personal real estate into investment real estate. Of course, exercising this option might not make sense given your personal interests or financial situation at the time of your move, but it is an option you would not have had if you were simply renting the roof over your head. When moving out of a rental unit, despite all the monthly payments you made to your landlord, you walk away with no ownership in any real estate asset whatsoever. The advantage goes to personal real estate ownership.

You Don't Really Own Real Estate If It Can Be Taken Away From You

    The differences among investment, speculative, and personal real estate ownership are clear. However, you don’t really own real estate. You only think you own it. Even if you have paid off your mortgage in full, a county, city, or local public school district can still take your property away from you. Just stop paying the tax bills these governments send you each year and you will quickly discover who really owns your real estate.

    Paying property taxes is all you need to do to keep your real estate out of government hands, right? Sorry, but no. You could pay property tax bills in full year in, year out for decades and still lose your property to eminent domain, whereby a government expropriates your real estate to use it for what it claims to be society’s “greater good” – your personal property rights be damned.

    Clearly, while many Americans believe that real estate can do no wrong as a way to build wealth, it sure is hard to build wealth with real estate when, in so many different ways, you don’t own real estate, real estate owns you.

Copyright 2007 PowerWealth.com. All rights reserved.

Change The Game: Replace Your Credit Score with Your PowerWealth Debit Score™

By Logan Flatt, CFA

    In addition to their income and material possessions, many Americans use their credit scores as a way to evaluate and judge their financial success in life. Through decades of marketing, product innovation, and the passing of personal finance myths from one consumer generation to the next, America’s financial services industry has most of us conditioned to focus our attention on improving the credit scores computed and maintained for each of us by America’s four major credit bureaus, Experian, Equifax, Innovis, and Transunion. Such effective conditioning comes as no surprise – it is, after all, the financial services industry that profits handsomely from us taking out mortgages, using credit cards, obtaining car loans, and otherwise borrowing money for just about anything we want to buy or do to enhance our lifestyles.

Your Credit Score Helps the Financial Services Industry, Not You

    Alas, the more we consumers borrow cash from the financial services industry, the wealthier the industry becomes and the poorer we become. This can readily be seen in the simplest definition of your wealth, which is determined by your net worth:

Your Net Worth = What You Own – What You Owe

    The more you borrow from the financial services industry, the more debts you owe. The more you owe, the lower your net worth sinks toward zero, or even into negative territory. The financial services industry has a net worth too. But, what is true for your net worth is exactly the opposite for the financial services industry’s net worth – the loan you must repay to the industry is an asset the industry owns. The more the industry lends cash to you and other consumers, the more assets the industry owns. The more the industry owns, the higher the industry’s net worth rises.

    From the financial services industry’s perspective, your focus on your credit score is a great thing. Your behavior helps the industry grow wealthier over time. The financial services industry has it good – the product it sells is cash, the price of its product is a given interest rate, the interest payments we make are the industry’s revenues, and thanks to the industry’s unique ability to scale by simply recycling our interest payments into still more revenue-generating product, the industry’s profits are hefty. The industry has made the rules of the game, and the ball used to “win” in that game is your credit score. So, as conditioned, you focus on the ball, trying to move it up the field toward the goal. But, clearly, your behavior – your focus on your credit score – is not such a great thing for you and your family’s wealth. While having ready access to cheap credit can be a good situation in which to be, obsessing about your credit score so that you can borrow more and more from the financial services industry could ultimately preclude you and your family from achieving true financial freedom and security in your lifetime.

Rolling a New Ball into the Game – the PowerWealth Debit Score™

    I submit to you that you and your family don’t have to play the financial service industry’s game. You have a choice. You can change the game. You can freely elect to change your behavior. You can remove your focus on your credit score and, instead, focus your attention and effort on a new score with which you can better evaluate and judge your financial success in life. Herewith, I roll a new ball into the financial service industry’s game: the PowerWealth Debit Score™.

    As you know, your credit score is an indicator of your ability to borrow, and borrowing can be damaging to your wealth. In contrast, your PowerWealth Debit Score is an indicator of your ability to lend, and as you understand from the activities of the financial services industry, lending creates assets – loans – that you can own and use to increase your wealth over time. If one of your goals in life is to build enough wealth for you and your family to achieve true financial freedom and security, doesn’t it just make sense to place more of your focus, time, and effort on improving your PowerWealth Debit Score than on improving your credit score?

Calculating and Interpreting Your PowerWealth Debit Score™

    So, how do you calculate your PowerWealth Debit Score? The proprietary PowerWealth Debit Score™ formula below shows you how:

For a given month, quarter, year, or other period:

PowerWealth Debit Score™ = 1,000 × (Your Free Cash Flow ÷ Your Total Income),

where Your Free Cash Flow ≥ $0

    You can use your calculated PowerWealth Debit Score to fully evaluate and judge your ability to lend cash to others for profit and wealth building. For example, let’s assume that your household’s Total Income is $85,000 per year, and your Free Cash Flow is $8,500 per year (don’t worry – Free Cash Flow is defined in detail below). Using the formula above, your PowerWealth Debit Score would be a 100. Likewise, let’s assume that your monthly Total Income is $4,000, and your Free Cash Flow in a given month is $500; here, your PowerWealth Debit Score for the month would be a 125. Note that if you have no Free Cash Flow or your Free Cash Flow is actually negative (i.e., below $0), your PowerWealth Debit Score is simply a 0.

    Now let’s interpret your PowerWealth Debit Score. Whenever your calculated PowerWealth Debit Score is a 0, your ability to lend money to others is non-existent -- you are not in a good position to be creating loan assets that you can own and use to increase your wealth over time. However, any positive PowerWealth Debit Score suggests that you are in a good position to be creating loan assets to increase your wealth. Furthermore, the higher your PowerWealth Debit Score, the greater your ability to lend money for profit and wealth building. Any PowerWealth Debit Score above a 0 is good. Any score above a 200 is outstanding!

The Critical Role of Free Cash Flow

    Clearly, the key driver to your PowerWealth Debit Score is your Free Cash Flow. As part and parcel to the proprietary PowerWealth Debit Score™ formula above, your Free Cash Flow can be calculated as follows:

For a given month, quarter, year, or other period:

	Your Total Income
−	Your Retirement Account Contribution*
−	Your Health, Life, & Disability Insurance Premium Payments
−	Your Federal & State Income Tax Payments
−	Your Emergency Savings Account Contribution*
−	Your Regular Payments on Mortgages, Loans, and Credit Cards
−	Your Basic Living and Lifestyle Expenses
=	Your Free Cash Flow

*Your contributions to your Retirement Account and your Emergency Savings Account should be made according to how your personal financial adviser has advised you to contribute to these important financial planning accounts.

    Ultimately, your Free Cash Flow can be used for a variety of wealth-building activities, not just for creating loan assets by lending money to others. Other important uses of your Free Cash Flow include paying off credit cards in full, making extra principal payments on mortgages and car loans, fully funding your Retirement Account and Emergency Savings Account, and making equity investments. Each of these other important uses of Free Cash Flow can increase your net worth by reducing what you owe or by increasing what you own, thus helping you build financial freedom and security for your family over time.

    Clearly, using your Free Cash Flow to create loan assets by lending money to others is but one option out of many good ones available to you. A positive PowerWealth Debit Score simply tells you when you have the luxury of taking one or more of these options to pursue an opportunity that could increase your wealth.

Use the PowerWealth Debit Score™ Right Now and Change the Game

    Why not go ahead and start using the PowerWealth Debit Score today? It is a great way to help you evaluate and judge your own financial success. By electing to focus on your PowerWealth Debit Score in lieu of (or, perhaps, in addition to) your credit score, you open up far more opportunities to increase your wealth over time precisely because you are focused on building your wealth rather than on playing the credit game that America’s financial services industry wants you to play. Take action now and change the game – you’ll be glad you did.

Copyright 2007 PowerWealth.com. All rights reserved.

Stop, Thief!: 9 Tips To Stop You From Picking Your Own Pockets.

By Logan Flatt, CFA

    Got money problems? Need help controlling your desire to spend, spend, spend? There are many different ways to insert financial self control into your life. One way that you may not have thought of is to take control of the power that America’s marketers have over you and your desire to spend your hard-earned money needlessly.

    Some of the most talented marketers in the world ply their trade in America every day, crafting TV commercials, radio spots, print ads, billboards, Web ads, direct mail pieces, telemarketing scripts, and other forms of marketing communications to “inform” you about various products and services they want you to buy. If a talented marketer can attract and hold your attention for just a few precious seconds, that marketer can use powerful techniques to tempt you to voluntarily hand over your hard-earned money in exchange for the product or service the marketer has to sell to you. Unfortunately for you, most marketers are really, really good at what they do. They know how to attract your attention and then work their marketing magic on you – possibly without you even realizing it!

    Nonetheless, you are not completely powerless in the marketing game. You can take specific actions to significantly reduce the power that marketers have over you and your desire to spend needlessly. Here are nine tips – some easy, some hard – that can help you insert financial self control into your life by holding America’s extremely talented marketers at bay.

Tip #1: Hide Your Telephone Number

    The best way to put a stop to unwanted telemarketing calls at your home is to pay your local phone company a few extra dollars a month to make your telephone number unlisted and/or unpublished. You can’t receive unwanted telemarketing calls if telemarketers cannot get access to your telephone number.

Tip #2: Register Your Telephone Number

    You can also place your telephone numbers on the Federal Trade Commission’s National Do Not Call Registry. By law, telemarketers must remove your telephone number from their call lists if you are on the federal registry list. If the telemarketers call you anyway, they could be subject to federal penalties. To add your telephone numbers to the Do Not Call Registry, call 1-888-382-1222 or go to www.donotcall.gov.

Tip #3: Mask Your Telephone Number

    Do not give out your real phone number when filling out forms on a company’s website unless you already know in advance that you would like for the company to contact you in an emergency (e.g., so an airline can let you know your flight has been canceled) or to tell you more about a product or service you are considering but want to talk to a company representative about it first (e.g., a used car you saw at a car dealer’s website). Sometimes, an online form will require you to put in a phone number before you can submit the form. What to do? Simply enter your area code and then 555-5555.

Tip #4: Opt-Out Your Credit Report

    If you wish to reduce U.S. Mail solicitations for credit card and insurance offers by companies that target you based on the information contained in your credit reports, there is an opt-out program operated by the four major credit reporting agencies, Equifax, Experian, Innovis, and TransUnion. Once you opt-out, your name stays on a “do not contact” list for five years. There is also a permanent option. For more information, call 1-888-5OPT-OUT or go to www.optoutprescreen.com.

Tip #5: Let Your Preference Be Known

    The Direct Marketing Association also maintains a database of consumers who prefer not to receive U.S. Mail solicitations. DMA members must remove those consumers from their mailing lists. Once registered, your name stays on the list for five years. Send your name, address, and a request that the DMA add you to the opt-out list to:

Mail Preference Service
Direct Marketing Association
P.O. Box 643
Carmel, NY 10512

    Or, for added convenience, you can pay a small fee and do it online at www.dmaconsumers.org.

Tip #6: Flag Your Account

    Do you already do business with a company that continuously sends you offer after offer by U.S. Mail each week – or worse, several times a week? There are many credit card companies out there that do this all the time, sending out credit card offers, convenience checks, and short-term loan offers by the millions each and every week. The easiest way to get them to stop sending offer after offer is to mail a polite letter to the company’s Customer Service or Consumer Relations department simply asking them to put you on a “do not mail” list, if they have one. Be sure to include your account number in the letter so that they know you are an existing customer and can flag your account as being on a “do not mail list.” Do this once, being sure to make a photocopy or two of the signed letter before you mail it. Then, wait at least two months to see if the offers from the company reduce in volume or stop altogether.

    If after two full months the company’s offers keep coming to you at the same rate as before, make your request more serious by writing a new letter addressed to the company’s General Counsel, the attorney the company keeps on staff or on retainer to handle its legal matters. You might be able to find his or her name on the company’s website. If not, just address it to “General Counsel” at the company’s headquarters address. Again, be polite in your letter to the General Counsel, and simply repeat your original request. Be sure to let the General Counsel know that you wrote the company about the request at least two months ago and experienced no change in the number of offers you received each week. For the General Counsel’s convenience, attach a photocopy of your original letter to the new letter. Getting the attention of the company’s attorney should help get you on an internal “do not mail” list at the company.