William Ackman: Everything You Need to Know About Finance and Investing in Under an Hour
Hi. I'm Bill Ackman I'm the CEO of Pershing Square Capital Management, and I'm here today to talk to you about everything. You need to know about finance, and investing and I'm gonna get it done in an hour and you'll be ready to go, so. Let's begin in, order for you to get a better sense, of finance, and some of the basic terms associated with a, business. And investing in a business I'm gonna use the example of a lemonade stand we're, gonna go into business together we're, gonna open up lemonade soon so. The reason, why I'm using an example of a lemonade stand is a very simple way to understand. The basics of the business how. To understand how our business works our, business generates profits, what's, involved in raising capital to, start a company what, you do when you're ready to decide, to monetize, your investment, or take some money off the table you'll, be able to understand each of these concepts, through the very simple, lens of a small. Startup business like a lemonade stand. We're. Gonna go into business together we're. Gonna start a company and. We're gonna start a lemonade stand and no, I don't have any money today so I'm gonna have to raise money from investors to launch the business so. How am I gonna do that well I'm going to form a corporation it's. A little filing that you make with the state and you've come, up with a name for your business will call it Billy's lemonade stand, and, we're gonna raise money from outside investors, we need a little money to get started so we're going to start our business with a thousand, shares of stock we just made up that number and. We sell 500, shares more for $1 each to an investor, the. Investor is gonna put up $500. We're gonna put up the name, and the idea we're gonna have a thousand, shares he's gonna have 500, shares he's, gonna own a third of the business for his $500, so, what's our business worth at the start well, it's worth $1,500.
We Have $500 in the bank plus, $1,000, because I came up with the idea for. The company now, we need a little more than $500. So what am I gonna do I'm gonna borrow some money and, borrow from a friend and he's gonna lend me $250, and we're. Gonna pay him 10% interest, a year for, that loan now. Why do. We borrow money instead of just selling more stock well by borrowing, money we, keep more of the stock for ourselves so, if the business is successful we're. Gonna end up with a bigger percentage of the profits. So. Now we're gonna take a look at what the business looks like on a piece of paper we're gonna look at something called a balance sheet balance sheet tells you where the company stands what, your assets are what your liabilities, are and what your net worth or, shareholders, equity is you take your assets in this case we've raised five hundred dollars in exchange for the five hundred dollars the person who put up the money only got 1/3 of the business the other two-thirds is owned by us. For starting the company well that's a thousand, dollars of goodwill for. The business, we're. Borrowed two hundred fifty dollars we're. Gonna owe twenty. Fifty dollars it's a liability so, we've got five hundred dollars in cash from selling stock two, hundred and fifty dollars from raising debt and we. Owe, $250. Loan and we have a corporation, that has and you'll, see on the chart shareholders, equity of fifteen hundred dollars so, that's, our starting point now let's keep moving. What. Do we need to do to start, our company we need a lemonade stand that's, gonna cost us about three hundred dollars that's called a fixed asset unlike. A lemon, or sugar or, water this is something you like, a building you buy and you build it it wears out over time but it's it's a fixed asset and then, you need some inventory what do you need to make lemonade well you need sugar you need water you need lemons you need cups you, need little. Containers and. Perhaps some napkins and you need enough supplies so, let's say have 50 gallons of lemonade in, our of the start of our business now 50 gallons gets us about eight hundred cups of lemonade and we're ready to begin, let's. Take a new look at the balance sheet so now we've. Spent five hundred dollars we only have two hundred fifty dollars left in the bank but, our fixed assets are now three hundred dollars that's our lemonade stand our, inventory is two hundred dollars those are the supplies and things that lemons that we need to make the lemonade goodwill hasn't changed at a thousand, so our total assets are. $1,750. We. Still owe $250. To the person who lent us the money surely. The equity hasn't changed we haven't made any money all we've done is we've taken cash we've. Turned it into other assets that we're going to need to succeed in our lemonade. Stand business. Let's. Make some assumptions, about how the business is going to do over time we're. Gonna soon we're going to sell eight hundred cups eliminate a year we're gonna assume that each cup we can sell for a dollar and. It's gonna cost us about five hundred thirty dollars per year, to staff our lemonade stand so. Now let's take a look at the income statement so the income statement talks about. The profitability about. The revenues that the business generate what the expenses are and what's left over for. The owner of the company so we've got one lemonade stand, we're, selling eight hundred cups of lemonade and our stand charging. A dollar so we're generating about eight hundred dollars a year, in revenue and, we're spending two, hundred dollars in inventory there's, a a line item here called cogs, that, stands for cost of goods sold, we have depreciation. Because our lemonade stand gets a bit beat up over time and it wears out over five years so it depreciates, over, five years we've, got our labor expense, - for. People to actually, pour the lemonade and collect the cash from customers, and, we have a profit we, have an e bit and. That's earnings, before interest in, taxes, of ten dollars it's kind of our pre-tax profit. For, the business we didn't make very much money because you take that pre-tax, profit. Of ten dollars and, you compare it to our revenues. It's about a 1.3. Percent margin. That's not a particularly, high profit, now. We've got to pay interest on our debts and. We have a loss of $15, and then we, don't have any taxes, but at the end of the day we still lose money. Should. We continue to invest in the business we've lost money in the first year is it time to give up well let's think about it. Let's. Make some projections about what the company's gonna look like over the next several years, let's. Assume that we take all the cash the business generates and we're gonna use it to buy more lemonade stand so we can grow let's.
Assume We're not gonna take any money out of the company let's we're not gonna pay a dividend, we're gonna keep all the money in the company and reinvest it as we build our brand we can charge a little more each year so we're gonna raise our prices about a nickel five. Cents more for each cup of lemonade each year and then. We're going to assume we can sell 5% more cups, per stand per year so we've got a built in growth assumptions. So. Let's take a look at the company, take. A look at this chart you'll see in year one we started out with one lemonade stand we add one, a year and then we buy, your five we're up to seven. Because we've got a big expansion, plan our, price per cup goes up a nickel a year and our revenue goes from eight hundred dollars and starts to grow fairly, quickly and the growth comes from increased, prices, four cups. Of lemonade and it also comes from opening more, stands so, by year five we have almost $8,000, in revenue our. Costs, are relatively. Constant which is lemonade, and the sugar that's. About seventeen, hundred two, dollars we, have depreciation. As the more and more stands, start. To wear out over time we've. Got labor expense, but. By year five the business actually doing pretty well we went from a 1.3, percent margin, to, a over a 28 percent markets, the business is now up to scale we're starting to cover some of our costs we're growing, we're. Still paying $25 a year in interest for our loan and. We have a earnings, before taxes. After interest of $2,300. By the end of year five so, we put five hundred dollars into the business we, borrow 250, and by, year five we're making a profit of, $2,300. That sounds pretty good now we have to pay taxes to the government that's about thirty five percent we. Generate net. Income or another word for profits of fifteen hundred dollars by the fifth year and about. A dollar, a share so, if you think about this our. Friend put up five hundred dollars to buy five. Hundred shares of stock he paid a dollar and. After five years if our business goes as we expect he's actual making $1 a share in profit that sounds like a pretty good peel. Let's. Look at the cash flow statement so. As the business becomes more and more profitable, we, generate more and more cash and the, cash builds, up in the company we go from $500, of cash in the company to over, $2,000, of cash over the period. The. Balance sheet you know again the, starting balance sheet had shoulders. Equity of fourteen, hundred ninety dollars but as the business becomes more profitable, the. Profits add to the cash they add to the, assets of the company our liabilities, have not changed, and the business continues to build value over. Times again by the end of year five we've got four thousand, dollars. Of shareholder equity, and that's almost, three times what it was we started. Now. Is this a good business or a bad business how do we think about whether. It's good or bad one, thing to think about is what, kind of earnings, are we achieving compared. To how much money went into the company. Now, this is a business that we valued at $1500, when he started someone put up $500, for a third of the company we give it a $1,500, value but the Ender fear your five it's earning 50 over $1500. In earnings. So, that's a over a hundred percent return on the, money that we put into the company that's actually quite a high number, we've spent $2,100. In Capitol. Building lemonade stands and, we earn twenty, three hundred and thirty six dollars in year five on the capital we invested that's over, a hundred percent, return on capital that's a very attractive turn. Earnings. Have grown at a very rapid, rate a hundred. And fifty five percent per annum this is really a growth. Company and our, profitability is gone from 1.3 percent to 28.6%. By. Year five that sounds pretty, attractive and it is so. Let's look at the. Person who put up the loan well that person put up $250, and the. Business has been profitable we've been able to pay them their interest of 10% a year $25, a year and, they're happy because they put up $250, they're getting a 10% return on their loan and the business is worth well more than $250.
We've Got more than that in cash as, a result they're in a safe position. But. They've only made 10%, of their money now let's compare that with the equity investor the person who bought the stock in the company that. Person earned $1 a share in year five versus. An investment, of $1 a share so, he's earning over, a hundred percent or about a hundred percent return on his investment versus. Only ten percent for the lender so. Who who got the better deal well obviously the, equity investor now, why do the equity investor why do they have the right to earn so much more than the lender the, answer is they took more risk if. The business failed the, lender is entitled to, the first 250 dollars of value that comes from liquidating, the company so the if you sell off the, lemonade stands and you only get 250, dollars the lender gets back all their money they're safe they got their 10% return while the business was going they, got back their $250. But, the equity investor the person who bought the stock is, wiped out because they come after the. Lender. So. What's what's the difference between debt and equity debt. Tends to be a safer, investment because, you have a senior, claim. On the assets of a company and. It comes in lots of different forms you've heard of mortgage debt on a home that's a secured, loan secured by a house but you could have mortgage debt on a building for a company there's. Senior debt there's junior debt there's mezzanine debt there's, convertible, debt bottom, line it's all debt comes. In different orders of priority, and a company and. Your the, rate you charge is in. You know is inversely, related to your security, so the better the security, and, the less risk the lower the interest rate you're entitled to receive the. More junior the loan the higher the interest rate you're entitled to receive but you, don't you can avoid the complexity, all you need to think about is debt comes first, it's a safer, alone but your your, profit opportunity, is limited now. The equity, also. Their varying forms or something called preferred equity or preferred stock there's common, equity or common stock and again stock and equity are basically synonyms. There, are options but really, not worth talking about today the important point is that equity gets everything that's left over after the debts paid off so it's called a residual, claim. Now the good thing about the residual claim is the business grows in value you, don't own your oh your lenders anymore. But all that value goes to the stockholder so the question is why was the lender willing to take only a 10% return when. The equity earned a much higher rate of return and the answer is when the business started there was no way of knowing whether it would be successful, or not in, the lender made a bet that if the business failed well they could sell off a lemonade stand you know cost 300 dollars to make it that would have some lemons and lemonade even. If they sold at a much lower price than the dollar they originally projected the. Lender felt pretty comfortable, that they get their money back whereas.
The Stockholder is really taking a risk they, were betting on the profitability, of the company and they're taking a risk that if it failed they would lose their entire investment so they were entitled, to get a higher return, or. That the potential to have a higher return in the event, the business was, successful. Let's. Talk about risk you, know a lot of people talk about risk in the stock market is the risk of stock prices moving up and down every day we. Don't think that's the risk that you should be focused on the risk you should be focused on is invest in a business what are the chances that you're gonna lose your money there's gonna be a permanent, loss when, you're thinking about investing your own money when, you're thinking about one investment versus another don't worry so much about whether, the price things up and down a lot in the short term what matters is ultimately. When you get your money back will, you earn a return on your investment, how, do you think about risk well, one way to think about risk is to compare, your. Risks to other alternatives so you can buy government, bonds and government bonds are considered today the lowest risk form, of investment, and the US Treasury issues. 10-year. Three-year, five-year debt there's a stated interest rate and today a 10-year, Treasury you earn about a three percent return so, you give your government, thousand, dollars you get thirty dollars in interest at the end of ten years you get your thousand. Dollars back so that's very very safe and that sort of provides a floor now obviously you're gonna make a loan you, can lend money to the government and earn three percent well they're gonna lend money to a lemonade stand you want to earn meaningfully, more so in this case, the. Lender, is charging a 10% rate. Of interest why ten percent because. They, want to earn a nice fat spread over what they can make lending, to the government because the start up lemonade stand business is a higher risk business. Equity. Investors sort of think about things similarly so the, higher the. Valuation. The more, risky, the business. The. Higher the rate of return the equity investor is going to expect and the, lower the risk business the lower the return the equity investor is going to expect and, equity. Investors don't get interest. The, same way a lender does what equity investors get is they get the potential, to receive dividends, over the life of a company. Let's. Talk about raising, capital you started this lemonade business on the point of this was to make money in the first place, business. Is doing very well yet. I as, a as. Having, started the business coming. Up with a name and the concept, hired all the people I've made nothing all, right so the business is grown in value but where's my money I need money to buy a car for examples I want to buy a car for $4,000. What. Are my choices what can I do well. We've, taken all the cash the businesses generated, we reinvested, in the business now the good news is we've, taken all that money we've, been able to use it to buy more lemonade stands and these lemonade stands are more and more productive, and it's grown the value of the business faster and faster and. My alternatives, could include well, instead of growing the business so quickly instead of investing, in more lemonade stands I could simply pay dividends, to myself now. The good news about that is I get money along the way it's. Bad news about that is the business wouldn't grow as quickly you have a business as profitable, as this lemonade stand company and we can earn you, know hundreds of dollars in each and you stand it makes sense to keep investing well, how do I keep my business going and growing taking, advantage of the opportunities, but take some money off the table how do I do that sell, my lemonade stand business, you know I started this one in New York maybe. There's someone in New Jersey who wants to buy me consolidate. My. Lemonade stand company, my problem. With that is once I sell it I can no longer participate in the opportunity, going forward I believe in this business I think it's gonna be very successful. Over, time so that's, one alternative the, other alternatives, other, than selling up a hundred percent of the business is to sell a piece of the business now I can do that privately I, can find an investor who wants to buy a private interest in the company, and.
If The business is working off I can sell them a piece of the business and we can be successful the. Other alternative is I can take the business public an IPO the abbreviation, stands for an initial public offering and its. Initial because it's the first time a company's going public going public means you're selling stock to the broad, general public, as opposed to finding one investor by an interest in the company and it's, an offering because you're offering people the opportunity, to participate what's. Interesting as an IPO doesn't make someone rich all it really does is it takes a business that they already own and it. Sells a piece of it to the public and it, gets listed on an exchange when, you decide you want to take your business public you're gonna have to reveal a lot of information to the public in order to attract, investors, to participate and the Securities and Exchange. They're gonna study, this perspectives, very carefully you're gonna make sure that you disclose all the various risks associated with investing in the company and, you're also going to have an opportunity to talk about the business that's kind of an exciting time for you because when you sell shares to the public that's really in most, cases the way to get the optimally, high price for the company but, you don't have to sell a hundred percent of the business to the public in fact typically. You only sell a small percentage you get to keep the rest you get to keep control of the company but, you get to raise money in the offering and you can use that money to buy the car that, we were talking about before. Now. Before you decide to go public or even to sell it at all probably. A good idea to figure out what the business is worth so let's talk about valuation. Or how to value. Business. One. Way to think about the value of your business is to compare it to other similar businesses now. The stock market is actually a pretty interesting place to look the stock market is a list. Of companies, that have sold shares to the public and you can look in The New. York Times or The Wall Street Journal or online on Yahoo Finance or, Google or other sites, and look, at stock prices, for Coke for McDonald's, and what, the stock prices tell you is what the value of the company is and how do you figure out the value of the company well you look at where the stock price is you, count how many shares are outstanding shares. Outstanding will be listed in various, filings with the SEC you multiply the shares outstanding times, the stock price that, tells us the price you're paying for the equity of the company so if you go back to our example of our little. Lemonade. Stand we have, fifteen hundred shares of stock outstanding we sold them for a dollar, initially, a one. Third of them to a investor. And the business initially had a. Value. Of fifteen hundred dollars so, what is the business worth today well. One. Way to look at it let's look at other lemonade, stand companies let's assume another other lemonade stand companies, have sold either, in the private market the public market or a price, of 10 times earnings or 10 times profits, that will give you a sense of value so let's assume another lemonade stand company is trading at 20 times earnings in the stock market, well, we earned $1 per share in year 5 we, put 20, multiple, on that dollar, the, business is worth according, to the comparable about $20 per share we've, got 1,500, shares outstanding. Multiplied 1500, times 20 now our businesses worth $30,000. Its we had a company that started that fifteen hundred five years later it's worth thirty thousand dollars that's, actually quite good well, how do we raise four.
Thousand Dollars if that's the appropriate value, for our business well. If we sold, 200. Of our shares to, under, our shares that are today now worth twenty, dollars a share we could raise the four thousand dollars that we are talking, about now. What. What would that do what would happen if we sold two of our share two hundred of our shares in the market well our interest, in the business would go down because we write, today we own 66. And two-thirds percent or two thirds of the company a third is owned by our private investors, well, if we sold stock in the market if. We sold 200, of the shares that we would own our. Share our ownership would go from sixty-seven, percent to 53 percent so the good news there is we still have control of the business because in most public companies owning a majority allows. You to control, the business going forward but, because the company's now owned by, public. Shareholders you have to make sure their interests are properly represented so you have to have a board of directors a group, of individuals, who represent the interests of the shareholders who, have a duty to, make sure that their shareholders are treated properly, and. You wouldn't have the same degree of flexibility, you had when you were a private company because, you have other constituencies. That you need to think about, now. The benefit of the IPO is the stock would now be liquid, there'll be a market, where it would trade in the public markets and then over time if I wanted to sell more stock I could do, so or new. Investors wanted to come in they could buy stock and our stock would now be liquid make. Me feel better about this business in terms of my ability to at. Some point exit or if I wanted to raise more money I could sell stock fairly easily in the market because each day you could look up the price, either. On the web on. New. York Times or otherwise and you can figure out what your business is worth. Okay. Now how. Does this matter to. You now, the purpose of the example of our lemonade stand is just going to give you a primer on, what companies, are what. They do how. They earn profits, what the various reports they provide to investors who investors, can figure out what they're worth and. The. Purpose of this lecture is to give you a sense of some, of the things you need to think about when you're thinking about investing perhaps, some of your own money whether you want to invest in a lemonade stand whether. You want invest in a cup, the market. Let's. Assume at, 22 you got a pretty good job instead, of spending your money on you. Know gadgets. Or fancy. Apartment, or not so fancy apartment, or going out and drinking, a fair amount you put some money inside you start investing money let's. Say you could save $10,000. At 22 and, you can earn a 10%, return on that money between. Now and then time you retire what. Would you have in 43. Years the answer is you put aside $10,000, you don't save another penny and. You invested it in your 10%, of your money each year you'd. Have six hundred thousand dollars in. Your 43 and the reason for that is well, in year one your $10,000. Would become 11 your two year $11,000. Would grow by 10 percent and so you'll be earning interest not, just on your original principle, but, you'd earn interest on the interest you.
During The previous year and that compounding. Effect allows, money to grow in an almost exponential. Fashion now, obviously if ever more than 10%, you. Can earn even higher returns no that's. If you put $10,000. Inside in 22 you, have $600,000. In 43 years that's pretty good what, if you had to wait not until you were 32 the problem there is a year, 33 you'd only have two hundred and thirty two thousand dollars maybe that's not enough to retire so a key thing here is if, you're going to be an investor it's, really one of the most valuable assets you have today as someone who's 18 or 19 years old is your youth you, want to start early that your money can grow over time. And. What if you get her and 15% give me a better sense of how powerful compounding. Is remember at 10% for 43 years you'd have $600,000. That's pretty good but, if you're in 15%. You'd have over 4 million now you're in a pretty good position. In and so, obviously making. Smart decisions about, where you put your money has. A huge difference in what your retirement assets are now obviously you put aside more than $10,000, we could put aside $10,000. Each year then, your your your wealth would be you know quite enormous. Now. Just for fun if you were one of the world's great investors, Warren. Buffett being a good example if you could earn 20% per year for, 43 years you'd have 25, million dollars again the original $10,000. Investment would. Increase by twenty-five hundred times over that period of time just. By earning a 20% return, Albert. Einstein said the most powerful force in the universe is, compound, interest. So. Key is start early earn. An attractive, return and avoid losing money and you're going to have a very nice retirement. Okay. Now, let's talk about the risk of losing money now let's assume that in order to try to get a 20% return you took a lot of risk and it, turns out that every, you. Know every 12 years you, lost half your money because you hit a bad patch and the market you made dumb decisions where. You're twenty five million dollars at. 20%, would, now only be worth a million eight in. 43 years so a key success factor, here is not, just shooting, for the fences try to get the highest return it's. Avoiding, significant.
Losses Over the over the period, okay. So. As Warren Buffett says rule, number one in investing, is never lose money rule. Number two is never forget rule number one so if you can avoid losses. And earn. An attractive, return over time you're gonna have a lot of money in many if you can stick. At it for a long period of time. Okay. So how do you be a successful investor. Now, I'm assuming that you're not gonna go into the business of investing assuming, that you're gonna be a doctor or a lawyer you're gonna pursue your passion, but, you're gonna have some money they're gonna save over time and. I'm. Gonna give you my advice on the topic it's not necessarily definitive vice but it's what the advice I would give my sister my. Grandmother on what she should do if you were in the same position I think. That's probably the right way to think about it so. Number one how do you avoid losing money what are good places to invest well my first piece of advice is despite the story about the lemonade stand I'd, avoid investing in lemonade stands I'd avoid investing in start-up businesses. Where. The prospects, are not, very. Well known because again you don't need to make a hundred percent a year to have a fortune you, just need to invest at, an attractive return ten fifteen percent over, a long period of time your money grows very significantly, so, how do you avoid the. Riskiest investments, I would my advice would be to invest in public, security invest in listed. Companies companies that trade in the stock market why, because those businesses, are tend, to be more established, they have to meet certain hurdles before they go public the. Stocks are liquid, so you can change your mind if you want to sell if you invest in a private lemonade stand it's hard to find someone to, take you out of that investment unless, that business becomes fabulously. Profitable, that's, a piece of advice number one invest, in public companies number. Two. You want to invest in businesses that you can understand what I mean by that is there, are lots of businesses that you come in that you deal with in the course of your day, and your personal life whether it's a retail store that you know because you like shopping there or it's a product. Your, your your iPad or that, you know you, think it's a great product but, you know you understand, you have to understand how the company makes money the. Business is just too complicated you don't understand how they make money even if they've had a great track record I would, avoid it a lot of people thought Enron, was an incredible business. Because it appeared to have a good track record but very, few people understood, how they made money it, was good to avoid it. Another. Very important criteria is you want to invest at a reasonable price it, could be a fabulous, business that's done very well over a long period of time but, if you pay too much for it you're not gonna earn a very good return the. Last bit is that you want to invest in a business that you could theoretically own, forever the stock market were too close for ten years you wouldn't be unhappy, what, do I mean by that now again if you're going to compound your money if at, a 10 or 15 percent return, over a forty three year period of time you, really want to business it you can own forever you don't want to constantly have to be shifting, from one business to the next and, what, of what are businesses that you can own forever well the very few that.
Sort Of meet that standard. May. Be a good example is coca-cola all right what's good about coca-cola, is, it's relatively easy business to understand you understand how coke makes. Money right they sell a formula. Syrup. We. Two bottlers, and two retail, establishments, and they make a profit every time they serve a coca-cola people going to drunk, a lot of coca-cola for a very long period of time the, world's population is growing they, sell in almost every country in the world and, each year people drink a little bit more coca-cola so it's a pretty easy business to understand and it's, also a business that I think it's unlikely to be. Competed. Away as. A result of technology, or some other new product right it's been around long enough people. Have grown used to the taste you. Know, they make, parents. Give it to their children and, you can expect that'll be around a long period of time I think that's one good example another good example might be at McDonald's you, may not love McDonald's hamburgers but it's a business that it's been around for 50 years you. Understand how they make money they open up these little build these little boxes they. Rent them to the franchisees, they charge them royalties, in exchange for, the name and they sell hamburgers and french fries and you know what people have to eat it's, relatively low-cost food the quality is pretty good and they're great and they continue to grow every year so I think the consistent. Message here is try to find a business that you can understand, that's. Not particularly complicated that, has a successful, long term track record that. Makes an, attractive profit, and. Can, grow over, time so what, are the key things to look for in a business as I, say that lasts forever we. Want a business. That sells a product or a service. That, people need and that. Is somewhat. Unique and. They. Have a oil. T2 this particular, brand, or, product. And the people are willing to pay a premium for that and a good example it. Might be a candy, business while. People are willing to buy generic versions, of many kind of food products flour, or sugar they, don't need to have the branded, product, when, it comes to candy people don't tend to like the Walmart version of the Kmart version they want the you, know the Hershey chocolate, bar or the Cadbury, chocolate bar or the See's candy, they want the the, brand and they're, willing to pay a premium for that and so. That's I think a key thing you want the product to be unique you don't want it to be a commodity that everyone else can sell because when you sell a commodity, anyone. Can sell it and they can sell it at a at, a better price and it's very hard to make a profit, doing that if you're investing for the long term you want to invest in businesses that have very little debt in. Our little example before we talked about our lemonade stand you, know there's $250, worth of debt I didn't, put too much pressure on the lemonade stand company, but if it had been a thousand dollars we, hit a rough patch the. Business could have got on a business for failure to pay its debts the, shareholders could have been wiped out so if you can find a company that can earn an attractive, profits it, doesn't have a lot of debt they generate vastly, more profits, than, they need to pay the interest on their debt that's a safe place to put your money over a long period of time you. Want businesses that have what. People call barriers, to entry you want a business where, hard. For someone tomorrow to. Set up a new company to compete with you and put you out of business I mean going back to the coca-cola example, Coca Cola has such a strong, market presence you know people have come to expect when they go to a restaurant they can ask, for a Coke and get a coke it's, very hard for someone else to break in and of course there's Pepsi and there are other soda. Brands. Perhaps she's been around a long time coca-cola, and Pepsi have continued, to exist.
Side-by-side Over long periods of time so when you're thinking about choosing. A company make sure that they sell a product or a service that's. It's hard for someone else to make a better one that you'll switch to tomorrow, you, also want businesses, that are not particularly sensitive to outside factors, so-called extrinsic, factors that, you can't control so, if a business will. Be affected dramatically if the price of particular. Commodity goes up or, if interest rates move up and down or, if, currency. Prices change you want a company that's fairly immune, to what's going on in the world and I'll use my coca-cola example, I mean if you think about coca-cola it's a product that's been around probably 120. Years over. That period of time there's been multiple world wars the development, of nuclear weapons all, kinds, of unfortunate. Events, and tragedies, and so on and so forth but each, year the company pretty much makes a little bit more money. To made it before and they're gonna be around and you can be confident, based on the history that, this is a business that's going to be around almost regardless of, whether interest rates are at 14% when. The US dollar is, you. Know not worth very much or the price of Gold's up or down those are the kind of companies you want to invest in a long term businesses, that are extremely. Immune. To, the events that are going on in, the world another, criteria, if you think back to our lemonade stand company as, we grew we had to buy more and more lemonade stands those lemonade stands only cost $300, each but, imagine a business where every time you grew you had to build a new factory to. Produce, more and more product and those factories, were really expensive. Well, that company might generate a lot of cash from the business but in order to grow you're gonna have to just reinvest, more and more cash into the business the best businesses, are the ones where it doesn't they don't require a lot of capital, to be reinvested in the company they, generated lots of cash that you can use to pay dividends, to your shareholders or, you can invest in new high, return, attractive. Projects I guess, the last point I would make is, there you invest in public companies it's. Probably safest to invest in businesses that are not controlled, controlled. Companies, kind of like our lemonade stand business that we took public the. Problem with a controlled company unless. The controlling shareholder is someone you completely trusts unless. There's someone that has a great. Track, record for taking care of so-called minority, investors than non controlling, shareholders, you can risk with proposition to invest in that business because you're at the whim of the controlling shareholder and, even if the controlling shareholder today, is some of that you feel comfortable with there's no assurance that in the future they, might sell control to someone else it's not going to be as. Supportive. Of the shareholders. The business so it's not that you just you. Can simply. Have a profitable, business and a business that has. Has done well you have to make sure that the management and the people that control the business think. About you as an owner and I can protect your interests so these are some of the key criteria, to.
Think About. Now. When, are you ready to start investing money my. Guess is you're a student you probably have student loans perhaps. You even have some credit card debt you're gonna graduate you're gonna get a job so. You don't want to jump right in and, while. You have a lot of debt outstanding start, investing the stock market stock, market is a place to invest, when you've got a good you have money you can put away and you won't need for five years or maybe ten years so. If you're paying relatively. High interest rates on your credit cards you definitely want to pay off your credit cards first before, you think about investing in, the stock market, your student loans are probably lower cost and your credit cards but again here my, best advice would be you know once. You if your student, loans are costing you six or seven percent well. If you pay them off as if you earned a guaranteed, six or seven percent return and. You're just better off getting rid of your credit. Card debt and even your student loan debt before you commit a lot of material. Amount of money to the to. The stock market even. Once, you you paid off your credit card debt or perhaps you're paid down your student loans you want to have enough money in the bank so that even if you were to lose you lose, your job tomorrow you've got a good six. Months maybe even 12 months of money, set aside. Let's. Talk a little bit about the. Psychology, of investing so. We've talked about some of the technical factors how to think about what a business is worth want, to buy a business at a reasonable price you want to buy a business that's going to exist forever that, has barriers, to entry where it's going to be difficult for people to compete. With you, but, all. Those things are important, and a lot of investors follow those principles. The, problem is that when they put them into practice, and there's, a panic in the world and the stock market is heading down every day and they're watching the value of their IRA. Or their, investment. Account decline, the. Natural tendency is sort of to do the opposite of what makes sense to be a successful investor you have to be able, to avoid some. Natural human tendencies, to follow the herd the, stock market's going down every day your natural tendency used to want to sell when, the stock market's actually going up every day your natural tendencies want to buy so.
In Bubbles, you probably should be a seller in busts. You should probably be a buyer and. You have to have that kind of a discipline. You have to have a stomach, to withstand the volatility, of the stock market. Key. Way to have a stomach, to withstand the volatility, stock market is to be secure yourself you've. Got to feel comfortable, that you've got enough money in the bank that you don't need what you have invested, unless. For. Many years that's a key factor number, two you have to recognize that the. Stock market the short term is what we call a voting machine it really represents, the whims of people. In the short term stock. Prices are affected by many things my events going, on in the world that really have nothing to do with the value of certain, companies that your investments, you've got to just, accept the, fact that what you own can go down meaning clean value after, you buy it that doesn't actually mean you've made an investment mistake just, the nature of the volatility of the stock market how, do you get comfortable don't, just buy a stock because you like the name of the company you, do your own research you get a good understanding the business to make sure it's a business that you understand, make. Sure the price you're paying is reasonable, relative, to the earnings of the company. Let's. Say this is just not for you I don't want to invest by. Individual, stocks that just seems too risky I don't have the time to do my own research what. Are your alternatives well, your alternatives, are to outsource, your. Investing. To, others you can hire a money manager or you can hire a group of money managers there are a couple of different alternatives, for, a start-up investor. The. Most common, alternative, are mutual. Fund companies so what's a mutual fund a mutual fund is a I. Guess, technically, it's a corporation, but, where you buy stock, in this corporation, and the and the manager, selects. A portfolio, of stocks so what they do is they pull together capital. Money from a large group of investors, let's, say they raise a billion dollars and they take that money and they invest in a diversified, collection, of securities now. The benefit of this approach is that with a tiny amount of money you know you can even less than a thousand dollars you can buy into a diversified, portfolio, managed. By a professional manager. Who's compensated. To, do. A good job for you investing in the market so mutual, funds are a good, potential area for investment the, problem is they're probably seven, eight thousand maybe ten thousand different mutual funds and, some are fantastic, and some are not particularly good you need to do research to find a good mutual fund manager in the same way that, you need to find. Individual, stocks so it's not just the easy thing of just, invested neutral funds. So. Here are a few key. Success. Factors in identifying a, mutual, fund or, or a money manager of any kind. To. Select number. One you want someone who has an investment strategy that makes sense to you you, understand, what they do and how they do it they're. Not appealing, to your insecurities, by using complicated, words and expressions, that you don't understand if, they can't explain to you in two minutes what, they do and how they do it and why it makes sense then it's a strategy you shouldn't invest in number. Two this is not necessary this order this is probably should be number one as you want someone, with a reputation for integrity if, again if you're starting out you probably want to invest in some of a mutual, fund that's sponsored, by some of the larger. Mutual. Fund complexes, as opposed to a tiny, little mutual fund that's privately, but, by a mutual. Fund company that you've never heard of there's some Dennis in, the. Larger. Institutions you, can be more confident, that they're not going to steal your money you, want someone an, approach where the investor invest money on the basis of value, I know it sounds kind of kind, of obvious but you know value investing, is has, a very long-term track record and now there are other kinds of investing, including, technical investing, where people are betting on stocks. Based on price movements, but, I highly recommend. Against those kind of approaches so you want someone who's making investments, where they're buying companies, based, on their belief that the prospects, of the business will be good and that the price paid relative, to, what the business is worth represents. A significant, discount. You. Want to invest with someone that as a long-term track rep long, term track record and I would say five years is the absolute minimum and, ideally you want someone who's got 10, 15, 20 years of experience investing.
In The markets because there's a lot that you can learn being. A long term investor, in, the market you, want someone who has a consistent, approach where, they haven't changed what they do materially. Year by year that they have a stated strategy, that they've kept too thick and thin that's, enabled them to earn an attractive, return over. Their. Lifetime. As an investor what we. See in some ways most importantly, you want someone who's investing, the substantial, majority, of their own money alongside. Yours, you want someone whose, interests, are aligned with yours if it's a mutual fund you want them to have a lot of money in their own mutual fund if, it's a hedge fund which is a privately. Sold. Fun. For investors who have higher. Net worth you, wants a manager who's investing alongside you as well. We. Started with a little lemonade stand company and the purpose of that was to give you some of the basics and how to think about a business you know where the profits come from what revenues are what expenses, are what a balance sheet is what, an income statement is how, to think about what a business is worth how, to think about what. The difference between a good business is versus, a bad business, how, dead I offer, is, generally lower risk but, lower return how equity investors. Or investors who buy the stock, or the ownership of a business have, the potential to earn more or lose, more we, use that as a back just as the basics, to get some of the vocabulary, to, think about investing and, we talked about. Investing, in the stock market we talked about ways. To think about how to select investments, how to deal with some of the psychological, issues, of investing we covered a fair amount of ground in a relatively short period of time. Now. I entitled the lecture everything. You need to know about finance, and investing in less, than an hour well it really isn't everything you need to know it's really just an introduction and hopefully I didn't. Mislead you and induce, you watch, this for an hour but, there's a lot more that can be learned and there's some wonderful books that can teach, you on the topic I think what's interesting about investing, whether. You choose this as a full-time career. Or not if, you're gonna be successful in. Your career you're gonna make some money and how you invest. That money doesn't make a big difference in the quality of life that you have and perhaps that your children have or the kind. Of house you're able to buy or the retirement. That you're gonna be. Able to enjoy and we talked about the difference between a 10%, return and a 15 and 20% return over a very long lifetime what, impact that has in terms of how much wealth you create over the period so. Investing is gonna be important to you whether you like it or not and learning. More about investing is gonna have a big impact on your.
Your, Your. Quality, of life if, money is something that you need in order to meet. Some of your goals I. Got. Interested. When. I was probably, 22, or 23, I started, interested. In being an investor and I read a book I read, book. Called the intelligent, investor was written by Ben Graham and Ben. Grimm is a famous value investor and, it's kind of like reading jean-paul. Sartre Zechs essays, and existentialism, you read it and it's either is an epiphany and it affects the way you live your life where, it's of no interest to you and this was the, equivalent but in investing, I found it fascinating and, what. I'd like to about investing is something, very accessible, even to someone who's 22 or 23, what's kept me intrigued. Is that. One, of the it's one of the few jobs where. Every. Day you can study. Something new you're constantly learning about new businesses, new situations, new management teams new issues, so. It's infinitely challenging, and. The. In the stock market are obviously, very dynamic, places so the challenges, continue. These same concepts, while they're useful in deciding, how to invest your portfolio, they're also very useful to you in thinking about decisions. Like buying a home making. Decisions in your line of work whether to hire, additional people you know this these kinds, of calculations and, thought processes, are are, helpful and they're helpful in life and I recommend that you learn. More thank, you for paying. Attention and I. Wish. You well.