The Velocity of Wealth Creation


 

What’s the difference between speed and velocity? Speed has only a magnitude, while velocity has a magnitude and a direction. In other words, it’s a “vector” physical/mathematical quantity.

What does velocity have to do with wealth? A lot!

Like it or not, time is an essential variable in the wealth equation. We’ve seen in several places how we could use time to our advantage, as intelligent investors. For example, once you find a “wonderful business”, you don’t pay the “sticker price”. You “wait” till the share price of that business drops low enough to give you a Margin Of Safety (MOS). Please review the first few articles.

The velocity of wealth is the pace and direction at which you move towards achieving your wealth objectives.

There are several factors that affect that pace. Your age, the stage of life you’re currently at (a student, an employee, a family man  a retired person, etc), the geopolitical environment you happen to be in, the influence of your family, friends, co-workers, your upbringing, the level of your self-esteem, the amount and quality of the financial knowledge you have.

At some stages, it’s wise to focus a considerable portion of your time and energy on wealth creation. This would give you the freedom to slow down at other stages, and focus on other priorities.

So your wealth creation velocity changes speed, and sometimes direction, as you move from one stage to another, or as you change any of the factors mentioned above (the list is not inclusive, you could come up with other factors relevant to you).

You could also derive from the above that your financial wealth creation, is but one of your priorities. Hence, it’s essential to have a vision of your life that encompasses all your priorities, values and roles. And a mission statement, which maps out the distribution of all of these elements across your life.

A question may arise here: Can one increase or decrease his/her wealth creation velocity, without negatively affecting other areas of their lives?

Yes they can, but not randomly or abruptly. For example, when your family responsibilities are at their minimum, you can dedicate yourself much more to wealth building (instead of wasting your resources on meaningless activities). This would pay dividends later on, when you don’t have the same amount of free time.

As a rule of thumb, the earlier you start the better. I know people who started investing in their teens. Don’t wait till before retirement to think about your financial future. It would be late, but not impossible. There are always ways to start all over again, and as the saying goes: It’s never too late!

The Wealth Maker

 

Value-based Investment- The Intrinsic Value of a Stock


Last time we concluded by defining the IV of a stock. An Intrinsic Value is not always the same as the sticker price (but sometimes it could be). Rather, It’s the inherent value that this business deserves in today’s market.

Simply put, it’s very similar to the net-worth of an individual. You add up the sources of income and subtract the expenses. What you’re left with is that person’s net-worth. Same thing with businesses. What is the expected income from operation? What would be the value of all assets if they got liquidated? Patents, royalties, etc. Anything that the company owns and can convert into cash, minus whatever loans or liabilities it has in the market.

Next, divide that by the number of shares the business has (or intends to make) available in the market. For example, say the calculation we just made above resulted in ten million dollars. That is the net-worth of the business. The number of shares is one million. This gives rise to an IV of $10. This is what a single share of that business is intrinsically worth!

Armed with this knowledge, your decision-making process becomes a whole lot easier. You now have a baseline to come back to. Now, and only now, you go ahead and check the current sticker price of the business; what Mr. Market “feels” the price of one share of that business should be today! If Mr. Market was in a good mood and wanted to raise the price above $10 per share, then as an “Intelligent Investor”[1], you would hold back and keep the stock symbol on your wishlist. If the sticker price was less than ten, then the next step of investigation would kick in: Is it a business you would own for a 100 years, proudly? In other words, Is it a “wonderful”, growth, and money-making business?

That will be the subject of the next episode of this series. Stay tuned and be well…

To be continued…

 

The Wealth Maker

 

[1] Ben Graham has a book holding the same title. I’m not sure if he was the first to use this term though. The book is one of the best references on value-based investing.