I’m enjoying the preparations more as I make steps toward opening my business.  Today’s actions were ordering business cards, and sending out an RFP to firms that could be custodians/clearing brokers.  The latter of those two actions will prove to be important.

It is difficult to be a start up RIA.  Most custodians don’t want to deal with you unless you have something above $8 million, or even $35 million.  Yet, they are crucial to managing assets, because they provide security to investors, so that the investment advisors cannot misappropriate funds.  If Bernard Madoff had had a third party custodian, he would never have been able to defraud investors.

Now, my objective is to manage a large number of accounts such that they are broadly similar to the model account, which is my account.  I eat my own cooking.  Anyone investing alongside me should know four things:

  • I have made a commitment to investors to keep at least 50% of my liquid net worth in my strategies.  For me that should be easy, at present, that amount is over 80%.
  • I want all accounts, leaving aside differences for reasons of tax and ethical constraints, to get the same performance.  On any given day, when I trade for multiple accounts, all of my clients, including me, will get the exact same price.  It’s only fair.
  • I am trying to minimize net cost for my clients; services that have no value for them I eliminate.  I aim for clarity in pricing, and so I plan to avoid soft dollars.  If I need resources, I will buy them myself.
  • This also offers the possibility for small accounts (my minimum is $100,000) to get good execution and the equity markets.  But that brings up another issue: when talking about this to a friend of mine who wants to invest with me, he said, “But what if someone gives you a small amount of money?  Will you go out and buy a share here and share their in order to match your portfolio in percentage terms?”

That last one made me think.  In the short run, my solution would be to buy Spyders, and wait until I have enough critical mass from another capital contributor to do another group trade.  That might worsen the dispersion performance somewhat, but I don’t want my clients to be hurt by high commissions in order to enforce low dispersion.  The same issue would appear if someone wanted to withdraw a small amount of money.

I looked down on a lot of ideas that would allow me to run portfolios in such a way that I would have discretion in allocating trades.  Fairness is paramount.  Unless you can assure people that no one is getting an unfair advantage or disadvantage for your management, you’ll not be able to last as a manager in the long run.

Audits and Pseudo-Audits

I’m currently reading a book called, The Last of the Imperious Rich. Sometime in the next few months, you should see a review of it here.  But as I was on the train to New York, as I read about the part where one of the Lehmans met Goldman and Sachs, I commented, “So that’s who Goldman and Sachs were.”

That started a conversation with the fellow sitting next to me.  It turned out that he was an accountant who dealt with registered investment advisors.  He told me that he was doing attestations for a number of his registered investment advisor clients.  I asked him what an attestation was, and he told me that it was verifying the accuracy of the performance figures of an RIA, but not to the level of GIPS level two, and certainly not level of a full forensic audit.

So I asked him how much the attestation cost, and it was remarkably reasonable.  So, my question to readers is this: how much credibility would you put into an accountant attesting to the accuracy of the performance figures that I have put forth, but not to the degree of a full audit?

Another way to think of it is this: clients have access to all my brokerage statements, together with a file that I have put together that reconciles all of them.  Personally, I think having the third-party look over my shoulder is valuable.  Even if you think I am an honest man, having someone else look over the figures, even if they are just comparing my brokerage statements and the Excel file that I produce is still valuable because it is another set of eyes looking at it.

One more question to all of my readers: are there other areas in separate account management where you think that if investment advisors might be unfair?  If so, please list them in the comments, because I am interested in knowing about that.

Again, thanks to my readers, who have been very helpful to me in the past.

Sorry for not blogging much lately, I’ve been busy with two things:

  • Completing and filing my paperwork for registering my investment advisory in the State of Maryland.  My electronic and paper filings are in the hands of the good people at the Maryland Division of Securities, who have been prompt and unfailingly polite?
  • Preparing for my talk to the Society of Actuaries on 10-20-2010. The date is a palindrome if taken two digits at a time.  If you want to read my slides in PDF, they are here.  Powerpoint: they are here.  I give the talk somewhere around 11:15.  Gate crashers can look here. And here.

Just a few notes before I go to sleep:

1) When problems are systemic and large, as they are with foreclosure fraud, and securitization fraud, solutions tend to appear in order to avoid chaos.  This is an awkward time, being before an election, so solutions are hard to arrive at.  But my belief is that given a little time, Congress and the courts will come to a solution that forces the banks to come up with the note, or a close substitute.  The same will happen for securitization certificateholders: since their economic losses on a held to maturity basis are not that great, they will get some small settlement to go away.

2) Insider Monkey’s post on Buffett drew a lot of attention, but there needs to be more critical thinking here.  IM is using Carhart’s four-factor model, and says the recent decade’s alpha is near zero.  Well, Buffett beat the S&P 500 by 6.7%/year over that stretch, which is a hefty margin, beaten by few.  And more remarkable, because he is managing so much money, the dollar amount of true alpha is huge.

But the hidden assumption in the use of the Carhart factors is the idea that no one can use them to make money over time on average.  As a value investor who does try to adjust to when those factors are cheap or dear, I find that assumption ridiculous.  Buffett is always looking for companies that are relatively out-of-favor relative to their prospects.  Even if it is not showing up in the alpha, he still prospers by buying the out-of-favor betas/factors.

3) The US is leading the “race to the bottom” on currencies. Emerging markets are generally holding to tight monetary policy, and their currencies are appreciating versus the lax developed countries who don’t have much mineral wealth.

All for now.  Have to get some sleep, or I will be no good in NYC tomorrow (today).

News: I’m planning to submit my paperwork to Maryland on Monday for registering my investment advisory.  Aside from that, I am giving a talk on the Efficient Markets Hypothesis in New York City on Wednesday to the Society of Actuaries.  Onto tonight’s topic:

Analyze financial statements to avoid companies that misuse generally accepted accounting principles and overstate earnings.

Maybe I should rephrase that to be “avoid companies that abuse their accounting, overstating earnings,” because it is perfectly possible to overreport earnings, while staying within the boundaries of GAAP accounting.  Over time, I have developed four broadbrush rules that help me detect overstated earnings. Here they are:

  1. For nonfinancials, review the difference between cash flow from operations and earnings.  Companies where cash flow from operations does not grow and  earnings grows are red flags.  Also review cash flow from financing, if it is growing more rapidly than earnings, that is a red flag.  The latter portion of that rule can be applied to financials.
  2. For nonfinancials, review net operating accruals.  Net operating accruals measures the total amount of asset accrual items on the balance sheet, net of debt and equity.    The values of assets on the balance sheet are squishier than most believe.  The accruals there are not entirely trustworthy in general.
  3. Review taxable income versus GAAP income.  Taxable income being less than GAAP income can mean two possible things: a) management is clever in managing their tax liabilities.  b) management is clever in manipulating GAAP earnings.  It is the job of the analyst to figure out which it is.
  4. Review my article “Cram and Jam.”  Does management show greater earnings than the increase in book value plus dividends?  Bad sign, usually.  Also, does management buy back stock aggressively — again, that’s a bad sign.

The idea is to see how honest and focused on the long term the management team is.  Management teams that cut corners in financial reporting will cut corners elsewhere, and deliver negative surprises to you.  That’s what I aim to avoid.

Very Good Year

Trivia question: think of the US stock market from 1900 to 1997.  Now think about the top 10 years in terms returns during that period.  Call those years  “Very good years.”  What decade had the most of those very good years?

If you’re not a fan of market history, you might be inclined to think that the 80s or 90s would be the top decade by that measure.  Perhaps some with a little bit of market history would think the 20s were the top by that measure.  But the answer is a three-way tie between the 20s, 30s, and the 50s.  The 20s had 1927 and 1928, the only pair of back-to-back very good years, fueled by the credit expansion that ended in the Great Depression.  And in the midst of the Great Depression, there were horrendous years of loss in the market and years of amazing gains.  Two years amazing gains were 1933 and 1935, 1933 being the best of all years for the century as far as market returns go.  And that was in the midst of the worst decade for market performance in the 20th Century, which would only be eclipsed by the the first decade of the 21st Century.

The 50s had 1954 and 1958.  A decade of relative calm led to some spectacular gains in the market.

Second trivia question: what decades didn’t have any “very good years?”  The answer there would be the 40s, the 60s, and the 80s.  Now with World War II, one could understand why there weren’t any very good years in the 40s.  There were the costs of fighting the war, relative scarcity of consumer goods at home, postwar inflation, and the degree of fear restrained nonmilitary economic activity.

But the 60s and 80s?  Those were good decades for stocks.  How come there were no very good years during those decades?

Take a look at this interactive graphic from the Wall Street Journal.  Very good decades do not always include very good years.  Both the 60s and 80s were long expansions that did not have a lot of macroeconomic volatility.  Okay, the 80s did have a lot of macroeconomic volatility at the start and at the end, but in general it was a period of falling interest rates, and thus it had some good years but no very good years.

One of the goals of the book is to answer the question: when do you tend to get a very good year?  The author comes to the answer that you tend to get a very good year after there are economic problems leading to depressed valuations, followed by loose monetary policy, leading to an expansion in credit.

I liked this book a lot.  I thought it was a lot of fun because he doesn’t just dwell on the markets but goes into the nature of business during each very good year.  What were the hot trends?  What was going on in terms of social trends?  What were the crises that were gripping the world?  What were politicians saying and doing?

In this book you don’t get a dry textbook that aims only to prove the thesis.  You get taken on a journey through nooks and crannies of American history of the 20th century, which gives you some of the social and political flavor of what it’s like when it is a very good year.

Now, maybe someday I’ll get to write a book.  One of the books that I would like to write would be the sister to this book: It was a very bad year.  I would be interested in your comments on the matter, because I think would be equally fascinating book.  And, are Americans more fascinated by success or failure?  I don’t have a good answer to that one, because I see books in the business and finance sections that cover both.

And so I give this book a hearty commendation.  It is well-written.  It has a good concept.  It is thorough, though light at a mere 220 to 230 pages.

Who would benefit from this book:

Any investor would benefit from this book.  Good years in the stock market are not random, but tend to follow bad years, and have the Federal Reserve running a loose monetary policy.

If you want to, you can buy it here: It Was a Very Good Year: Extraordinary Moments in Stock Market History (Wiley Investment).

Full disclosure: I bought this book with my own money.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

The Insured Portfolio

Do you have a lotta money?  Lotsa, lotsa money?  And is it liquid?  More than $5 million?  If so, I have a book that could help you, The Insured Portfolio: Your Gateway to Stress-Free Global Investments (Agora Series).

There are risks that the rich want to avoid, or at least minimize:

  • Losses from lawsuits
  • Estate taxes
  • Income taxes
  • Lack of flight capital, if things go really bad
  • Inflation, or loss of purchasing power
  • Fear of US degeneration: Do you want leave the US, renounce your citizenship, and minimize/eliminate your tax liability in the process?  It can be done, at least at present.

The first chapter describes the rise and decline of America.  It is a bit harsh, but for one following demographic trends, it is accurate.  So, why should you keep money in America, if things are so bad?  (Uh, stable politics, relative freedom…)

The second chapter introduces international investing, because diversifying internationally offers greater possibilities for profit and capital preservation, given the greater tendency of the US to inflate the currency.  To the authors, it is a panacea, and I find it somewhat unrealistic.

The third chapter goes into wills and trusts. How do you want to distribute your money after you die?  How much control do you want until then?

The fourth chapter describes insurance policies that minimize taxation, while allowing for limited asset diversification. The strategies are pretty basic, I have seen better.

The fifth chapter goes into tax havens.  Where can you minimize taxes and other costs best? I found this to be pretty boilerplate; if you pay attention, the tax havens are well-known, with their relative liabilities.

The final chapter tries to tie it all together, but it is all generalities, with little additional substance.

This book would be useful to someone who has prospered dramatically and has never considered wealth preservation.  It gives a taste of all of the tools, but does not give enough to execute the tools on their own.  You will have to hire bright  experts to protect your wealth, but at least you will know what they are  doing, and will be able to spot phonies.


I dislike Agora because of the doom-and-gloom outlook that they possess, but this book does not share in that flaw to any large degree.  All of that said, all strategies that use insurance products are very expensive, and there is no proof that you can obtain above average returns on the assets.  The authors talk a good same, but they offer little proof of superior performance.

Who would benefit from this book:

Only the very wealthy could benefit from this book, and many of them have wealth advisers already, who can help them with tax avoidance and estate protection.  But this gives a good introduction to the topic so that a person could be wiser in hiring an adviser.  He would know what the issues are.

If you want to, you can buy it here: The Insured Portfolio: Your Gateway to Stress-Free Global Investments (Agora Series).

Full disclosure: I asked the publisher for a copy, and they sent one to me.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.


I am no great fan of psychology.  When I was selected for jury duty, 20 years ago, I was the first peremptory challenge because I said that I would not take the word of the psychologist as expert testimony, but rather would consider the opinion of a man on the street as more valuable than that of a psychologist.

There is one place where make an exception, and that is the economics of risk literature.  Daniel Kahneman and Amos Tversky, great.  Richard Thaler, uh-huh.  Behavioral economics?  Yes, I am there.

The easiest way to improve the returns of average investors is to train them to think differently.  Instead of looking at whether the prices have gone up or down, and getting excited or scared, they need to begin to think in terms of what is the future cash flow yield of the investment that I am pursuing?  Past success is not a reason to buy and past failure is not a reason to sell.  Focus on maximizing future cash flow yields, and you will do well.

But that’s hard to do; training the mind to think rationally about investments and take the blood out of it is difficult for average men to do.  As for me it took 5-10 years for me to train myself not to get emotional over investing.  That’s why I don’t look down on people who make mistakes investing over their emotions – they just need better training and they don’t know where to get it.

The book MarketPsych could help them get it.  The first thing that it encourages people to do is to understand themselves.  You must understand yourself so that you can invest in a way that is consistent with your emotional makeup.  You can’t be investor, if you can’t manage fear.  You can’t be an investor, if you can’t manager greed.

Why do you do the things that you do?  The book MarketPsych has number of exercises that help an investor unravel why he thinks a certain way.

The book does not take a position on questions like value versus growth, or behavioral economics, or any of the anomalies in the market such as momentum.  Rather, it tries to get the investor in touch with himself, so that he can react rational and to invest situations rather than out of fear or greed.  It encourages investors to focus on things that are known, rather than speculation.  It urges them to consider what they need the money for, rather than always seeking for more, more, more.

MarketPsych is good at describing the mental traps and pitfalls that investors suffer.  Though I am past all of those traps and pitfalls, nonetheless, I remember what it was like to get past the, and this book would’ve helped me get past them faster.


I take issue with some of the meditation exercises in the back of book because I believe they are harmful not helpful.  I also don’t go in for visualization exercises; I don’t believe in pretending.  Rather, one should develop competence and understand the markets exceptionally well.

Who would benefit from this book:

Almost any investor who is frustrated with his performance, particularly from bad timing , would benefit from this book.  If you want to, you can buy it here: MarketPsych: How to Manage Fear and Build Your Investor Identity (Wiley Finance).

Full disclosure: I asked the publisher for a copy, and they sent one to me.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

Two notes before I begin: I will be in New York City next Wednesday, and maybe Tuesday or Thursday.  I will be meeting with potential investors.  If you would like to hear what I am up to, e-mail me, and maybe we can get together.

Also, if you have a moment, have a look at my friend Cody’s website that deals with applications for mobile devices.  He seems to have found an interesting new niche.


When I was a kid, I remember reading a story about a business that started a letter delivery service in a major American city, I think it was Philadelphia.  They undercut the US Postal Service by about 20% or so, and they began to attract a decent amount of volume, such that government came and shut them down, because USPS has a monopoly on delivering non-urgent mail.

Unfortunately for USPS, it has a much larger lower cost competitor: the Internet, which is eating into its high margin businesses, forcing prices up as it tries to maintain its subsidy to activities that lose money.

The Internet improves and destroys.  The economics of newspapers has been destroyed by the internet.  Should we be surprised that the economics of a similar business, the Post Office, is suffering similar troubles?  Delivering paper mailings to addresses seems to be populated by junk mailers and a variety of businesses that could deliver via e-mail.  I get few personal letters for my family, and many of those could go via e-mail.

This is a system that is looking for a kick to get it to move from an unstable equilibrium, perpetually asking for price increases, and service decreases, to a stable equilibrium where people receive almost all mail traffic over the internet.  So, what if we replaced the postal service two years from now?

If there were two years of lead time, older folks would be forced to adapt to e-mail, and advertisers would find new means contacting clients.  Some clever businesses would buy up post office sites, perhaps UPS and Fedex, and augment their businesses.

It would be likely that the cost of purely local mail delivery would go down in densely populated areas, but that delivery outside of major urban areas would be considerably more expensive, and would depend on the location of both the sender and the receiver.

The price differences would become similar to the price of a person traveling from one place to another.  Is it hard and costly for you to go from point A to point B?  It would be the same for mail.  Sending a piece of mail from one low density area to another would be expensive.

Now, I don’t think the postal service will go away in two years.  But ten years down the road the answer might be different.  Here are two alternative visions of the future:

Now, I think Hassett is mistaken when he says, “We need only write regulations that require firms that compete for postal business to provide universal service.”  The US is a big place, with a lot of sparsely populated areas.  The countries that have privatized are typically more compact, making it possible to have netorks that deliver everywhere at a reasonable cost.  Universal service will come with astronomical pricing for low density deliveries.

But I think the Postmaster General is mistaken when he estimates the total amount of demand over the next ten years.  I think that more and more will go online, with many businesses making people pay extra to receive paper bills, statements, etc.  Paper mail is not only costly to deliver, but costly to create.

People will also evaluate the postal service on convenience as well.  As the number of days for delivery declines to five, and local post offices and local delivery diminish in rural areas, people will begin asking for more to be delivered via e-mail.

One final note: I find it tragic/comical that USPS does with its employee benefit plans what all companies and governments should do: fully fund them.  But now they are looking to raid the funds to support current services, and push back on the  Federal government to absorb more of certain shared costs.  I think it is amazing to call funding 30% of retiree healthcare and 80% of pensions to be “fully funded,” because those are the average levels of many corporations.  Raiding the funds may help today, but ten years out, as postal workers age and retire, this will place even more expense pressure on postage rates.

Eventually the economics of a situation prevails.  The proposed move with the employee benefit plan is desperate.  Eventually a significant change will have to be made to the US Postal Service.  It would probably be better to think about an integrated plan today, than let ten years elapse, and face a larger crisis.

Given the nature of the US, and the short-termism that plagues us today, I suspect that we get the crisis.

I find myself in a different mindset, as I labor to start Aleph Investments, LLC.  I find myself both optimistic and fearful.  Optimistic, because this is what I’ve wanted to do for a long time, and I see the pieces coming together.  Fearful, well… I’m intellectually honest enough to know that even though I’ve done well over the last 10 years that may have no bearing over the next 10 years.  My greatest fear is that I start this business and I don’t do well for those who invest with me.

In the last week I’ve received confirmation from the state of Maryland that my LLC has been approved.  I have gotten my employer identification number from the IRS, and filed form 2553 to elect taxation as an S Corporation.  I have also begun filing with the state of Maryland and FINRA to register my investment advisory.

My next main task, while I am waiting for the state of Maryland to approve my filing, is to choose a clearing broker will be the custodian of funds for my clients.  I have five possible custodians that are willing to work with startup registered investment advisors.  This week I will send out some sort of RFQ to the five.

Beyond that, it’s time to get accounting and tax software for my firm, business cards, and help from someone who can help me in compliance matters, given that I would like to keep this blog not shut it down.  This blog is my greatest marketing asset, and yet my greatest compliance challenge.  Almost anything that an investment advisor might write on the web is regarded as advertising, even comments at someone else’s blog.  Part of the problem is that the rules regarding communications on the Internet for investment advisors are fuzzy to nonexistent.  If yhou have ideas, e-mail me.

To my readers: I want to keep this blog going.  Writing this blog allows me to do several things:

  • My first purpose was to give back to the general community.  If you have been given a gift, you should do some pro bono work.
  • Yes, to some degree, it does make me better known.  That is a help in attracting clients, but that wasn’t my first goal in starting this blog.
  • I like writing.  I like writing about economics, business and investments.  I enjoy being a bit of an iconoclast on economics.  I think business and investments are one of the greatest games in the world, and I like writing about it.  Even more, I enjoy playing the game.

So, I don’t want to lose the blog.  That said, if I can’t find a good compliance solution, I will sacrifice the blog for the good of the business.  My guess is that the odds are low that I will have to sacrifice the blog, so don’t worry.

Anyway, that’s what I’m up to.  If you want to talk to me about any of this, just e-mail me.


With that, here’s portfolio rule number four:

Purchase companies appropriately sized to serve their market niches.

A short rule, a simple rule – what could be better?  The basic idea here is to purchase companies that have room to grow, or have some sustainable competitive advantage that allows them to prosper in the market niche that they occupy.

Sustainable competitive advantage is an important concept.  If you read the works of Warren Buffett, he talks about a concept that he calls “a moat.”  The idea is, what does a company uniquely have that would be difficult for competitors to reverse engineer?  Granted, almost anything can be reverse engineered with enough money to do so, but that’s the game.  Is it worth a competitor’s time to spend that much money?  Will the business still be as profitable even if they do reverse engineer you?

Let me give you a more plebeian example.  The restaurant chain Applebee’s had a strategy of setting up restaurants in small towns.  They looked for places that did not have a dominant restaurant, and where the town was big enough to support one restaurant, but not two.  The size of the town was Applebee’s “moat.”

In investing, what you don’t want is a company so big in its niche that it cannot grow, unless the pricing of the equity is such that it resembles a junk-bond yield.  Also, you don’t want a small company that can’t compete against larger rivals.

Ideally, you want to find a management team that understands its competitive advantage and maximizes it.  I have found that many times in the last 20 years, and when that happens, it is a thing of beauty.

This rule is a little more squishy than the others.  There is a decent amount of qualitative judgment that must go into analyzing the competitive structure of the industry the company is in.  That doesn’t make the rule invalid.  Rather, I think that the average investor, unlike Peter Lynch, has the capacity to analyze industry trends and come to a correct decision on trends in pricing power.

Anyway, that’s rule number four, which can be otherwise summarized as pay attention to sustainable competitive advantage.

PS — for a set of articles I wrote three years ago on this topic that were a hit, please visit this page.

I am no fan of quantitative easing, as readers may know.  One aspect of the dislike comes from the one-sided view of how low interest rates benefit the economy.  They do not benefit the economy, at least not as far as the following are concerned:

  • Endowments spend less, as their spending rules lead to less spending when interest rates are low.
  • Pensions find that their liabilities are more expensive than they thought.
  • Virtually every long-term financial plan fails, because they assumed far higher return assumptions.

Does the Fed ask what entities they might be hurting through quantitative easing?  They hurt any entity that has to make payments over the long term.

Now, that might change should inflation return.  There is a huge psychological barrier to be overcome there.  Given the willingness of almost all of the central banks to inflate, inflation will probably return.  The question is when?

Aside from that, banks aren’t lending.  In order for inflation to return, bank lending has to recover.

Quantitative easing requires the central bank to buy longer-duration fixed-income assets than is prudent for a central bank to buy.  That crowds out other natural buyers, like endowments, pension plans, and life insurance companies.  Flattening the yield curve is not costless.  It affects those that need to fund long duration obligations.

Capitalism is complex.  There are many nooks and crannies that central bankers ignore.  They are focused on the short-term.  Do central bankers realize that they are making life tough for endowments and pension plans?  Do they care?

To the extent that central bankers lend long to the US government, I would tell them that they are in a long-term bad bargain, though the short run might be different.

I don’t know the future, but I favor ideas that favor effort over passivity.

Financial statements encourage us to look at the bottom line.  The bottom line indicates the purpose of financial statement.  With an income statement, the purpose is to show us how much the company has profited.  With a balance sheet, the purpose is to show us how much the company is worth on a book value basis.  Now, book value is nowhere near perfect, but neither is it to be neglected, so neglect book value, particularly tangible book value at your peril.

Then there is the cash flow statement.  The main idea that there is to look at the change in net cash of the corporation.  But the subordinate goals of the cash flow statement are to show us how much cash has been generated from operations, how much has been used in investing, and how much has been acquired through financing.  There are many scams with the cash flow statement most of which try to recharacterize cash flows from financing or investing into operations if they are positive.

Finally, there’s the statement of shareholder equity.  This forgotten statement helps to clarify who owns what and clarify where book value comes from.  What is the effect on book value from new shares and their equivalents?  How was book value increased or decreased various corporate actions and why?

That said, the financial statements each have one major purpose, unless they can be adjusted for other purposes.  A stock investor will want to understand earnings per share and how it is changing.  But a bond investor will want to look at EBITDA, which shows how much cash is available to service debt.  To the stock investor, EBITDA is not very useful, except in the situation where the company might be a takeover target.  In that case, the acquirers may be looking at EBITDA because they will be financing the acquisition with a large slug of debt.

Someone doing an analysis of the industry on the whole is going to abstract from interest, taxes, depreciation, amortization, and will focus on gross revenues or maybe even revenues.  It all depends on the type of analysis that you are doing.  In one sense, every analyst must adjust the statements that they look at in order to reflect the claim priority of the investor for which they are analyzing.

Common stockholders should view statements differently than preferred stockholders who should view statements differently than junior debtholders who should view statements differently than senior debtholders. (Need I mention the bank debt holders or trade claimants? Nah, but they have different goals as well, and use the statements differently.)

Existing income statements and balance sheets and cash flow statements are designed for equity investors, because they run the calculations for the residual income claimant, the equity investor.  Bond investors, bank debt investors, have to think in these terms: what type of revenue or operating income is necessary for me to get paid dollar one, and for me to get paid in full?  And how likely are each of those events?  The same set of questions can be applied to the balance sheet where the debt investor asks what it would take for his claim to be impaired in bankruptcy, or wiped out in full.  And then the debt investor can ask how likely those events could be.

The boundary line answers for these questions may be easily calculated, but the probabilities will be more subjective, and depend on estimates of the likelihood of future revenue or operating earnings.

I don’t have a lot more to say here.  Just be aware of what question you’re trying to ask of financial statements, and if you’re other than the equity investor, make the necessary adjustments so that you get the answer that is tailored to your questions.