William Ackman: Everything You Need to Know About Finance and Investing in Under an Hour | Big Think

William Ackman: Everything You Need to Know About Finance and Investing in Under an Hour | Big Think

The FLOATING UNIVERSITY (00:00:09)

  • CEO of Pershing Square Capital Management discusses finance and investing essentials.
  • Illustrates starting a business using the example of "Bill's Lemonade Stand".
  • Discusses raising capital through issuing shares and borrowing money.
  • Emphasizes keeping a larger share of the business by borrowing rather than selling more stock.

STARTING A BUSINESS (00:02:18)

  • Introduces the concept of a balance sheet showing company's assets, liabilities, and shareholder equity.
  • Details initial company setup with $500 raised through stock, $250 borrowed, and $1000 of goodwill for the idea.
  • Explains the purchase of fixed assets and inventory for lemonade stand operation.
  • Describes creating an income statement showing revenue, expenses, and profit/loss.
  • The initial business operations lead to a slight loss, prompting evaluation of business viability.

GROWING THE BUSINESS (00:05:49)

  • Discusses reinvestment strategy for business growth and price increase assumptions.
  • Projects expansion to multiple lemonade stands with growth in revenue and profits.
  • Outlines cost management and eventual profitability increase.
  • Explains tax implications on profit and the positive outcome for investors.

CASH FLOW (00:08:08)

  • Analyzes cash flow implications as the business becomes profitable.
  • Highlights accumulation of cash within the company and increase in shareholder equity.
  • Suggests that, based on projections, the lemonade stand could be a viable and potentially successful business.

BILL'S LEMONADE STAND GOOD OR BAD BUSINESS? (00:08:52)

  • The business had an initial valuation of $1,500 and generated over $1,500 in earnings by year five, indicating a high return.
  • Return on capital was over 100%, as $2,100 was invested in capital and generated $2,336 in earnings.
  • Earnings growth was rapid at 155% per annum and profitability increased significantly from 1.3% to 28.6% by year five.
  • An equity investor earned a 100% return, much higher than the lender's 10% interest.
  • Equity investors took on more risk, but received higher returns whereas the lender had lower risk with secured returns and priority in liquidation.

DEBT AND EQUITY: RISK AND REWARD (00:11:10)

  • Debt is safer than equity with a senior claim on company assets, varying from secured loans like mortgages to mezzanine and convertible debt.
  • Debt prioritization affects interest rates, with safer investments earning lower rates.
  • Equity, such as preferred or common stock, offers a residual claim on assets after debts are paid.
  • Equity holders are entitled to dividends rather than fixed interest and assume the risk of business failure.
  • Risk should be evaluated by the potential for permanent loss rather than short-term stock volatility.
  • Investments are compared to low-risk options, like government bonds, to determine expected returns.
  • Higher business risk warrants higher expected returns from investors whether lending or buying equity.
  • Growth opportunities may be pursued instead of immediate dividends for profitability.

VALUATION: DETERMINING A COMPANY'S WORTH (00:17:37)

  • A company's worth is critical when considering payouts or selling interests.
  • Business owners must balance growing the business against personal liquidity needs.
  • Options include paying dividends, selling the company, or selling a portion of the business either privately or publicly.

COMPARING COMPANIES TO DETERMINE VALUE (00:17:52)

  • An IPO (Initial Public Offering) allows a business owner to sell shares to the public and get listed on an exchange, such as the New York Stock Exchange.
  • The IPO process involves significant disclosure of information to the public through a prospectus, prepared with lawyers and investment banks.
  • The prospectus outlines the company's history, financial statements, risks, and opportunities, and needs approval from the Securities and Exchange Commission (SEC).
  • During an IPO, owners typically sell only a small percentage of the company, retaining control while raising capital.
  • Business valuation can be determined by comparing with similar companies in the stock market, using earnings multiples to estimate worth.
  • Example: if comparable lemonade stands trade at 20 times earnings and your company earns $1 per share, the company could be valued at $20 per share.
  • Selling a portion of the business through shares can raise capital while reducing the owner's stake, though maintaining majority control.
  • Post-IPO, the business becomes liquid with shares traded on public markets, facilitating further investments or owner exit strategies.

HOW TO VALUATION WORKS

  • To value a business, look at similar businesses on the stock market for comparison.
  • Stock price times the number of shares outstanding gives the equity value of a company.
  • Use earnings multiples from comparable companies to estimate a business's worth.
  • The value of a company can increase significantly from its inception to the time of an IPO based on earnings and market comparables.
  • Selling shares reduces owner's percentage but can raise necessary funds and provide liquidity.

IMPORTANCE TO INDIVIDUAL INVESTORS

  • Understanding company operations, profits, and financial reporting is crucial for investors.
  • This knowledge aids in making informed decisions when investing in businesses, from small ventures like a lemonade stand to larger, publicly traded companies.

KEYS TO SUCCESSFUL INVESTING (00:24:56)

  • Starting to invest early in life can significantly boost future returns due to compounding interest.
  • An initial investment of $10,000 at a 10% return can grow to $600,000 in 43 years, whereas starting 10 years later would yield only $232,000.
  • Higher returns, such as 15% or 20%, drastically increase the compounded amount over the same period.
  • Consistently investing more than the initial amount, like $10,000 annually, increases wealth exponentially.
  • Avoiding significant losses is as important as generating returns to ensure the preservation and growth of investments.
  • Following Warren Buffett's advice to never lose money is critical for long-term investment success.

WHEN TO INVEST (00:33:28)

  • Invest in publicly traded, established companies that are easy to understand and have a track record of profitability.
  • Choose investments that are priced reasonably and have potential for longevity. Examples include Coca Cola and McDonald's.
  • Invest in companies offering unique products or services with strong customer loyalty and brand preference, like Hershey's chocolate.
  • Avoid businesses with excessive debt which may struggle during tough times.
  • Seek companies with barriers to entry that protect them from new competitors threatening their market position.

THE PSYCHOLOGY OF INVESTING (00:34:40) & HOW TO WITHSTAND MARKET VOLATILITY (00:35:44)

  • Seek businesses resistant to external factors, such as commodity price changes, interest rates, and currency fluctuations.
  • Companies that consistently perform well through various global events, like Coca-Cola, which has been profitable over 120 years despite wars and economic changes, are ideal.
  • Prefer businesses that don't require significant reinvestment of capital for growth.
  • Low capital intensity businesses are more attractive, unlike high capital intensity ones like the auto industry, which requires large investments in factories and equipment.
  • Companies like Coca-Cola and American Express, which earn royalties or a percentage of sales without owning production facilities or funding customer purchases, are considered high-quality investments.

MUTUAL FUNDS (00:38:03)

  • Investing in companies that are not controlled by a major shareholder is safer, as controlled companies can pose a risk due to the potential for decisions that don't favor minority investors.
  • Trust in the controlling shareholder is crucial, and there's no guarantee that the current, trustworthy controlling shareholder will not sell to someone less supportive of minority interests in the future.
  • Evaluation of a company should also consider management and control to ensure that minority shareholders' interests are protected.
  • Investment readiness is addressed, suggesting that one should be free of high-interest debt, such as student loans or credit card debt, before investing.

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