June 04, 2005

Financial Industry Terms

Prime Brokerage: A brokerage offering to customers who need specialized services - such as hedge funds

Fixed Income: Typically another way of saying bonds.

Equities: Security (Stock)

prime brokerage

Posted at 06:33 PM

December 25, 2004

December 24, 2004

Why I won't be a financial engineer

Monte Carlo Simulation

Posted at 05:19 PM

August 25, 2003

My kind of company


Posted at 09:49 AM

August 15, 2003


Meetings don't solve problems. People do -- me

I am tired of people scheduling meetings in the assumption that problems will be solved by the presence of a few people in a room. Meetings are great to make sure everybody agrees on what we have to do. But on the whole people just need to go out there and work on the problem to solve it.

Posted at 12:49 PM

June 23, 2003

April 15, 2003


Kaizen is the Japanese management system based on continuous improvement. Kaizen works on the principle of :

1. Process creates result. Change the process. Results will not occur without changes and improvements to the process
2. Focus on the bigger picture
3. Do not focus on the person. Do not blame.

The implementation works around PDCA (Pick, Do, Check, Act)
Pick the project; do; check results; standardize the new process

Seiri, Seiton, Seiso, Seiketsu, Shitsuke (Sort, Straighten, Scrub, Spread, Standardization)

Posted at 11:47 PM

December 15, 2002

Newspaper boy problem

There exists a concept in Operations Research, called "Newspaper boy problem". Every day the newspaper boy must make a decision on how many newspaper to take into inventory. If he takes too many then he's left with inventory that goes to waste immediately (nobody wants yesterdays newspaper). If he takes too few then he leaves customers unsatisfied. Why is this problem different from regular inventory problems? The inventory in this case is highly time sensitive.

One application apparently is airlines. When a plane leaves the gate the inventory is frozen. If there are empty seats then thats like having too many newspapers. If there are passengers at the gate who couldn't get on then thats too few newspapers. Thats all I know. Maybe Mr. CFO can shed more light?

Posted at 01:36 PM | Comments (5)

November 07, 2002

Record Sales

When a record sells more than 500,000 copies it becomes a Gold Record.
When a record sells more than a million copies its a Platinum record
Then multiples of millions become multi-platinum.
Finally when more than 10 million copies are sold it becomes a diamond.

The most all-time successful band is the beatles with 102 million copies sold.

Other Definitions

Posted at 09:42 PM

October 24, 2002

A few ratios

Dividend Payout Ratio = Divident / Earnings

Divident Yield = Annualized Dividend/share price

Dividends are a tax disadvantage. Stock holders have to pay normal tax for dividends distributed. However capital gains is given a better tax treatment. Does this incent companies to re-invest dividends in capital appreciation projects?

sidebar: REIT's have to distribute 70% or so of their earnings.

Posted at 11:23 AM

October 20, 2002

October 14, 2002

Basic Technical Analysis Terminology

Technical Analysis is the art of keeping your job on wall street when stock prices make no sense. The claim is that stocks (not companies) trade within certain 'technical' parameters.

Support: - the price below which the demand for the stock will prop the price up
Resistance: - the price at which the supply will increase, keeping the stock price constrained

Short Interest ratio: ratio of total short sales positions to average daily exchange volume. It ranges from 2.0 (bearish) to 5.0 (bullish).

Contrary Opinion rule: Whenever 60% or more of the recommendations are bearish then expect the stock to go up. Whenever 15% or less are bearish then expect the stock to go down. This is the anti-portfolio!

Breadth indicator: NetAdvanceorDeclines/Number of issues traded gives you an idea of if the market overall is moving upward or downwards

Posted at 10:52 AM

Fisher theory of interest rates

The Fisher theory states

(1+nr) = (1+i)(1+r)

The nominal interest rate is propotional to the product of inflation and the real interest rate. Interest rate is the 'rental' price of money. If you rent a sofa you pay for the use of the sofa. The sofa undergoes wear and tear and reduction in value due to passage of time. The rental rate usually takes this into account. When you rent money there is no wear and tear but there is a reduction in value due to inflation. Therefore the interest rate takes inflation into account. The standard way to look at real interest rate is to look at it as the increase in consumption. I will give you $100 today if that means I will get $105 next week. This means the real interest rate is 5% per week. However if inflation is running at 2% per week then I need to factor that in. This is what the Fisher theory solves. The nominal interest rate (the rate I charge you) is a combination of my real interest rate (5%) and the inflation (2%). Hence

nr = (1+.05)(1+.02)-1 = 7.1%

Read more

What else did Fisher say?

Quantity Theory of Money
M = money
V = velocity
P = prices
T = level of transactions

Essentially means that as money supply increases prices will increase as well implying expanding the money supply causes inflation. This is the basis for the Fed increasing interest rates to combat inflation in the 80's.

Lot more info at the history of economic thought

Posted at 10:17 AM

October 04, 2002


Interesting blog entry on Investment banking. The summary:

When companies merge they have two options when managing the accounting. Straightforward purchasing (involving transfer of assets to the acquirer's balance sheet) or pooling of assets. In the former case the excess value paid over book value is treated as goodwill.

The pooling option has been eliminated. Now goodwill no longer has to be depreciated over 40 years. Instead its subject to impairment every year based on valuation. (Remember AOL Time Warner's whopping loss this past year due to impairment of goodwill!)

Posted at 11:14 AM

September 17, 2002

Stock market spoofing

IP Spoofing is no longer the only method of masquerading in my vocabulary. It is possible to spoof the stock market. This weakness is due to the way market makers set their bid/ask prices.

Market makers set their bid/ask prices. (Bid is the price the dealer will pay for your stock and ask is the price at which the dealer will sell you the stock). The SEC has a Limit Order Display Rule which requires that limit orders for 100 shares or more is displayed on the system (NBBO - National Best Bid and Offer). The display of the limit order influences the dealers bid/ask price (because the dealer knows of an outstanding order for a higher price). This weakness is exploited by a trader sending in a limit order at a higher bid price and then selling his shares when the dealer honors the higher price. The immediately the trader cancels his limit order leaving the dealer with the stock.

An example:

the Commissionís complaint against Alexander Pomper alleges that Pomper placed a limit order to buy 300 shares of Gumtech International (ďGUMMĒ) at $11.375 per share when the best bid side of the NBBO was $11.0625 per share and the best offer side was $11.4375 per share. Due to the Limit Order Display Rule, Pomperís $11.375 per share buy order became the new best bid price. Pomper then placed an order to sell 2000 shares of GUMM at $11.375 per share through another market making firm. Pomper obtained immediate execution at $11.375 per share (rather than $11.0625 per share) because the other market maker honored the $11.375 best bid price created by Pomperís buy order. After Pomper obtained his price improvement of $.3125 per share, or $625.00, he canceled his order to buy at $11.375. Pomperís conduct was deceptive because he improved the NBBO with a limit order he did not actually want filled.
Posted at 09:07 PM

September 03, 2002

Hayek Reader

This entry will remain a place holder for my future forays into Hayek country.
While the name Hayek commonly evokes memories of a sultry Latina actress from Veracruz, a distinguished pupil of Ludwig Von Mises, Friedrich Hayek is the subject of this entry. There is however a less than serious discussion of a Hayek-Hayek showdown.

One of Friedrich Hayek's major contributions (via The Road to Serfdom) is that he predicted that a socialist system will lead to totalitarianism. He reasoned that a centrally planned society such as in a socialist country will require a "Central Planning Board" that will eventually have to make decisions and trade-offs in the absence of market data. This structure will lend itself to domination by a strong personality that will use it for his (this appears to be an exclusively male pursuit) pleasure. Evidence: Stalin, Lenin, Mao, Pol Pot

Hayek Pages
Economics and Knowledge

Posted at 11:04 PM | Comments (1)

August 19, 2002

Value Investing my @#^%

Exponents of value investing repeatedly stress the benefits of "buy and hold". However I seem to have mastered the art of "buy and hold till the stock is delisted". @#*&%#$

Posted at 11:00 AM

August 12, 2002

Principles of Economics

The principles of Economics is available online at Drexel University

Posted at 08:03 AM

July 02, 2002

McKinsey and Enron

Business week examines the McKinsey angle in the whole Enron debacle. Over all Business week explores the decisions of McKinsey during the big dot-com bubble. It would be hard to fault any manager who decided to enter the dot-com stock option craze. At that point in time if you were'nt singing praises of the bubble you would have been derided as a dinosaur. I think I prefer not going back to those times. I'd rather wish the world rewarded hardwork, decent idea and unrelenting passion. Even in today's market there are some companies that are doing quite well. It just so happens they're not in the limelight (and sigh! not in my portfolio). Take Limited (LTD) for example. Since Sept they've gone up 40%. NCEN (New Century Financial) has gone up 3x since Sept.

Posted at 09:24 AM

May 24, 2002

Accounting charges and goodwill

Recently companies have been writing down their goodwill in lump some amounts shocking the world with the losses they've accumulated. AOL recently reported the greatest lost in the history of business at $54 billion. The company broke even on a cash flow basis but was forced to write down the good will acquired (via the TimeWarner-AOL deal) in one quarter.

Geoffrey Colvin in his article explains how the new accounting rule has required that goodwill no longer be amortized over 40 years (as was previously the case) but be evaluated and written down each quarter.

An excerpt:

The rule change is simple in concept. When a company buys another company, the price it pays in excess of the target company's book value is deemed goodwill. Under the old rule, it had to be amortized over a period of up to 40 years; that is, every year a little bit of it had to be deducted from the company's profits and also from the "goodwill" asset on its balance sheet. But this rule assumed unjustifiably that goodwill is a so-called wasting asset, like a machine that inevitably wears out. In reality it may not lose value at all, and sometimes it even gains value.

So the new rule requires companies to evaluate their operating units at least annually and ask if their fair value to an outside buyer today is greater than their recorded value, including goodwill. If so, all is well. But if not, the company must take a charge for the difference, all at once. The companies that have taken the hugest charges all made major acquisitions near the height of the stock market insanity. The charges are in effect their confession of being terrible investors.

The positive side of this write down is that we no longer have to suspiciously watch the assets of a company as they carry a ton of good will. The Return on Capital calculations also work out favorably for companies.

Posted at 02:02 PM

May 16, 2002

Support chain issues

I've heard the parable of the supply chain and the green car several times, finally I have the rest of the details. In the 1990's Volvo manufactured cars in green and they didnt sell. To clear out inventories they offered hefty rebates to consumers. However, someone forgot to tell the Supply Chain Automation system. It noted the increase in the sales of lime-green cars and assumed this demand best be met with increased production of cars.

The Economist has an article on Supply chain automation/forecasting which mentions Rapt ( a software company that is trying to solve this problem). Hau Lee from Stanford is acknowledged to be an expert in this field. CIO magazine has 5 key steps to improve/implement supply chain management.

Posted at 12:55 PM

May 06, 2002

Present Value of Money

It ofcourse makes sense that money in hand today is more valuable to money available at a later date. The value of money available in the future decreases its present value relative to the interest rate and the period of time you have to wait for the money. In this entry we'll look at the calculations behind calculating the present value of money.

PV = future amount / (1 + rate)term
For example say you'd like to purchase a $30,000 car in 3 years. The interest rate is 6%. Then the present value of the $30,000 amount in 3 years is:
PV = 30,000 x 1/(1.06)3 = $25,188.57
So your $25,200 will become $30,000 in 3 years. The simplifying assumptions presume interest rates to remain constant. (you could lock down the rates in a CD I suppose). The expression 1/(1+r)t is called the discount factor. Lets look at this problem a different way. Every so often furniture stores offer a promotion. No payments, no interest until 2004. So lets assume you buy a $1000 sofa (the current interest rate is still 6%). You have 24 months to pay off the sofa and incur no interest charges. What is the Present Value of your purchase?
PV = 1000 x 1/(1.06)2 = 1000 x 0.88996 = $889.96
So if a competing store is offering you $150 off the same sofa you are better off taking that deal. Otherwise you are better off taking the no payment deal.

The final permutation of this equation is to calculate the interest rate from the present value of an asset. Suppose you are given a promisory note for $750 that promises to pay $1000 in two years what is your effective interest rate?

PV = amount/(1+rate)term = (1+rate)t = amount/PV = rate = (amount/PV)1/t - 1
rate = (1000/750)1/2 -1 = 1.154 -1 = .15 = 15%

Thats a pretty decent interest rate. I suggest you take up the offer!

To add: perpetuities, annuities, PV = C/r (for annuities) and PV = C[1/r - 1/(r(1+r)t)], amortization, net present value. Opportunity cost of capital

Posted at 07:07 PM

Finance Koan

If you borrow $1 million from a bank and you can't pay it back, you are in trouble. If you borrow $1 billion from a bank and can't pay it back, the bank is in trouble.
-- Steven Saltman
Posted at 04:14 PM

May 05, 2002

APR's and the truth

Credit card companies today beseech gullible consumers by offering incredibly low introductory APR rates. The rates revert back to their higher counterparts upon expiration of the offer period.

But what does APR mean besides Annual Percentage Rate?

When a credit card company loans you money (like when you dont pay the full balance at the end of the month) it charges you interest for it. The interest charged is not computed annually. It's charge periodically, usually every month.

Truth in lending laws require companies diclose the APR. The APR is supposed to tell you the annualized rate, but it is not the effective rate. The APR is:

number of periods x interest rate

Thus an APR of 12% if calculated monthly would indicate a 1% interest per month.
Unfortunately interest is not charges only on the principal during each period. Interest is charge on the principal plus unpaid interest. (thus, if you owe $100 at 1% a month, the first month you owe $101 but the second month the interest is charges on $101 resulting in your owing $102.01 the third month). So while the APR might say 12% the effective interest rate when charged 1% every month is
(1+(interest rate))^12 = (1.01)^12 = 1.1268 = 12.68%

So given an APR you can calculate the effective interest rate by:

(1 + APR/term)^term = (1 + .12/12)^12 = 1.1268 = 12.68%

Posted at 11:51 PM

May 03, 2002

Motivating your employees

The following is a summary of the article One more time: How do you motivate employees? pulbished in the Jan, 1968 issue of the Harvard Business Review by Frederick Herzberg.

Herzberg argues that KITA (Kick in the Ass) is not a sustainable form of motivation. Given that a physcial KITA is not a normal form of interaction in society today the manager has to apply KITA in a different manner. Psychological KITA is the method that seems to be used more often to deliver the motivation. The other method of motivation employed by management is positive KITA. Essentially, "you do this for me and I'll give you this". Herzberg claims in this case the motivation remains with the employer. Where KITA was a push, positive KITA is a pull. His quote:

..negative KITA is rape, and positive KITA is seducation. But it is infinitely worse to be seduced than to be raped; the latter is an unfortunate occurence ,while the former signifies that you were a party to your own downfall...

The main reason why KITA is not motivation is because it needs to be applied serially to cause an action. Herzberg reviews common mechanisms used to motivate people and dispels all myths that they harbor:

reducing time at work The claim is that spending less time at work will improve employee morale and contribute to a motivated employee. Herzberg points out that a motivated employee would want to spend more time at work.

spiraling wages. Increase the wage and the employees will seek a greater increase. Herzberg claims out shrinking wages motivate people better.

Fringe benefits Companies have introduced all sorts of perks to improve employee life. Herzberg states that the cost of fringe benefits has reached 25% of the wage dollar today. He says that employee instinct has been deadened to the point the bar has to continually be raised for an employee to be motivated. From medical benefits to stock options things have continually gotten better without much improvement in employee motivation to show for it.

Human relations training The attack of sensitivity training, claims Herzberg has changed the office dynamic. The onus has been transferred to the employer that proper attitude has been demonstrated in requesting a change in bad behavior.

Other attempts at boosting motivation include Sensitivity training, Communications, two-way communications, job participation (the attempt to convey to the solitary wrench tightener on the assembly line that his efforts lead to the construction of great cars, essentially conveying job sense and the big picture) and employee counseling.

Hygiene vs Motivators
Herzberg proposes his motivation-hygiene theory. The theory states that the factors leading to job satisfaction are different from the factors leading to job dissatisfaction. The normal human thought is to consider the opposite of job satisfaction to be job dissatisfaction. The theory refutes this.

Posted at 01:54 PM | Comments (0)

April 30, 2002

Stock valuation

A company's stock is evaluated using many different criteria. If there were one fail-safe mechanism the stock market wouldnt be the big game it is. Here we consider some of the things to look for in a company.

Financial Health: The financial health of a company is not that different from the financial health of an individual. The D-word is key. How much debt a person has indicates the financial well being of a person. For example people prop up their debt with the help of collateral or income. People take second mortgages on their house to increase their debt levels. Credit card companies extend lines of credit based on your income. A company is not different. Financial leverage is:


It reveals how much of the assets is backed by equity as opposed to debt. Look at companies that have low debt and high free cash flow. WCOM (Worldcom) has $37 billion as debt on its books. Its market capitalization is about $10 billion.

Profitability: Essentially when you buy a share you are investing in the company. You do this because you believe the company will give you a positive return on investment. If the return on investment was 3% you'd be better off leaving it in your savings account and stay safe without weathering the risk. ROE (Return on Equity) is a crucial measure of a companies profitability (and as a consequence your return on investment). Depending on the business several factors are needed to increase profitability. When times are rought management boosts profitability by reducing expenses (read: layoffs, stop coffee, employee perks). In order to increase revenue Chilli's would have to do one of the two:

1. open new stores
2. increase sales at existing locations

Growth: A stock's price in theory reflects the value of the company. GE is worth close to $200 billion because investors believe that if the company were taken apart it would yield $200 billion dollars. However, in the next year if GE's revenues increased then it would be worth more. In reality a stock's price reflects where investors think the company is going to go.

Valuation check: A stock's valuation is checked using calculations such as P/E (price per earnings), P/S (price per sales) or P/B (price per book value).

Earnings as discussed previously is the profits of the company. P/S marks a company's price against its sales. In the hey day of the internet craze the stock market placed all its bets on increasing sales with no focus on the profitability. As a result companies were urged to grow as fast as they could with little or no focus paid to the bottom line. Book value of a stock is what its worth in hard assets. This is a very pessimistic way of looking at a stock since you then believe that the company is worth no more than what cash it has in the bank and the buildings it owns.

Right before PC Order (PCOR) was bought by Trilogy its valuation was $65 million. PC Order had $66 million in the bank!. But if a stock is totally undervalued then book value is a great indicator of whether it's worth investing in that company. Currently Worldcom (WCOM) has a market capitalization of less that $10 billion with a share price of ~$2.50. It has a book value of ~$18. So why is Wall Street hurting this stock so badly? In my personal opinion all companies with substantial debt on their balance sheets ($37 billion in wcom's case) are tainted with the Enron syndrome; investors do not trust their books.

The factors we discussed above all work well until we encounter debt. P/E ratio's do not consider the debt burden of the company. Apply these terms to the financial health of an individual we find the example of Joe Schmoe making $50,000 a year (revenue) with savings (earnings) of $20,000. The P/E for Joe Schmoe (assuming he is incorporated with 10,000 shares trading at $10) would be well placed (5). However if Joe were carrying $100,000 of student loans we'd be unduly optimistic of Joe's potential.

Enterprise multiple takes into account the debt burden of a company. The enterprise multiple is calculated as follows:

Company market cap
+ liabilities (debt, etc)
- cash, inventory, assets

total cost to buyer (enterprise value)

Now to get enterprise multiple

enterprise value/Operating Income

Operating income is (revenues - cost of revenue - Operating expenses)

When the Enterprise value for a company is more than its P/E then its a tip that the company has sizeable debt. Learn more about enterprise multiples at Forbes

coming soon....
Barrier to Entry, Price Elasticity, Capital Intensive, Substitute, Regulation

Posted at 08:58 PM

Economic solution to mundane problems

Free markets are great at solving lots of resource consumption problems. Sometimes, even when problems dont appear to fit the economic model the solution lies in free markets.

At one point in my past I was involved in building a distributed computer system which would replicate servers (resources) to locations with closer geographical proximity to the client. The system was designed to enforce a certain QoS (Quality of Service) and would replicate whenever the load on a server exceeded a threshold. However in order to prevent the rampant spawning of services around the server farm we built an economic model to constrain the replication. The load manager would enter an auction to buy time. Periodically a servers balance would be refreshed. The server would enter auctions with these tokens and would relinquish tokens when it won the auction. A server had rules that would help it decide how much to bid on an auction (based on load). This prevented a server from replicating out of control (since the tokens would be exhausted till the next refresh).

We think of phones, bandwith etc in terms of resources. We are prepared to pay more for broadband than dialup internet connections. We stay off the phone during the peak hours because we have limited tokens (minutes) during the peak hours. There are other resources that we dont think of in the same way. Roads are examples of a resource that we use without regard to the cost since the cost is pre-factored into our registration fees.

However if we were to consider roads as resources which require payment based on need and congestion it would alter our behavior. I am not sure it makes sense to make all roads and lanes toll based. I would prefer to have a few lanes toll based that I can use if the urgency of getting to my destination makes it worth my while to pay for it.

In Mexico the government has allowed private companies to build toll roads across the country. These roads are clean, well-maintained and expensive. The govt still has free roads which can be used who'd prefer to rough it out rather than pay for the good roads.

Forbes magazine has a good article on the free market solution to traffic congestion

Posted at 02:24 PM | Comments (0)

April 28, 2002

stock market indices

The DJIA (Dow Jones Industrial Average) is a group of 30 stocks picked by the editors of the Wall Street Journal. Unlike most other averages like the S&P etc, the DJIA (Dow Jones Industrial Average) is not weighted by market capitalization.

The DJIA is calculated by totalling the price of the 30 stocks and dividing by a divisor. The divisor has changed over time (starting at 1) to something like 0.20 today. The divisor has changed to counter the effect of a stock split. If say WMT were to split tomorrow the DJIA would also be changed to counter the effect of the drop in price of each share of WMT.

The Standard and Poor's index by contrast is weighted by market capitalization. The S&P 500 was first published in 1957. A committee at S&P meets to decide the constituents of the index each month. New companies are added when old ones are removed because of mergers or faltering business. Entrance into the S&P is important to most companies since there are index funds that invest in the S&P 500 and this brings a lot of attention to the companies in the fund. Holding companies and REIT's are excluded from the 500.

Posted at 08:19 PM

April 25, 2002

India's economic future

An article on India's economic future. (Courtesty Sapta-Sindhu).

Posted at 09:10 AM

April 24, 2002

Balance sheets

Overview of basic balance sheet terminology:

Revenue: Quite simply the inflow of money into a company

Cost of Sales/Cost of goods sold: represents the cost of creating the revenue. For a company that manufactures bread this will include the cost of wheat, yeast, labor, electricity, etc (all the raw materials and labor needed to produce the product). For a software company the cost of CD/documentation production is minimal compared to the cost of the software. However companies that employ professional services personnel to deploy the software include the cost of the personnel in the cost of goods/cost of sales entry. (note: software companies do not include the cost of developing the software. That will come later).

Gross Profit: This is the difference between revenue and cost of goods. Quite simply put this is the number you get by subtracting the cost of producing the good from the revenues. For our bread company most of the expenses are included in the cost of goods, but for our software company the cost of goods is minimal.

Selling, General and Administrative Expenses (SG&A). Also known as Operating Expenses. This includes all the expenses involved in the running of a business. This number sometimes includes Research and Development and Marketing Expenses. For our bread company this will include the secretarial and administrative expenses. The R&D entry will include the financial effort exerted in developing new types of bread.

Depreciation and Amortization: When a business buys a resource it intends to use over a period of time it does not include its expense entirely in the period it execute the purchase. For example if the bread company buys a warehouse for $2 million it will not include the cost of the warehouse in regular expense since it intends to use the warehouse for say 20 years. It will instead amortize the cost of the warehouse as $100K every year.

Non-recurring charges/gains: A one-time action will trigger a non-recurring charge sometime. For example if a company laid off employees in a quarter then the cost of their severance packages etc will figure in the one-time charge. Sometimes companies include this number in their operating expense (SG&A).

Interest Income/expense: can be the interest the company pays to service its debt. It can also be income earned from cash in hand.

Taxes: the tax liability of the company.

Net Income: The profits after all expenses have been paid out. In the case of most companies these days its negative ... sigh.

Preferred Dividends: Companies also issue different types of stocks. Preferred stocks get their dividend at a higher rate than common stock holders (usually they dont have voting rights either).

EPS: diluted vs basic. After reporting the number of shares outstanding in a company the diluted number of shares are also reported. For example software companies issue a lot of stock options. These options are not shares themselves but have the option of being converted to shares (after vesting etc). The diluted number of shares includes the number of options outstanding. The basic EPS (earnings per share) is simply the earnings / number of shares. The diluted EPS performs the calculation on the diluted number of shares and is hence lower. The diluted EPS is a good reflection of the cost of stock options.

More information:

The most essential equation in Accounting is

Assets - Liabilities = Equity

A company uses financial leverage to finance its operation. For example to increase its sales (assuming the demand exists) our bread company might desire to build a new factory. It might not possess the capital to make such an expansion. It uses financial leverage (takes on more liabilites) to make the capital commitment today. Financial leverage is:


Current Assets: are defined as those likely to be converted into cash and consumed in the next business cycle (usually defined to be one year). Current Assets include:

1. Cash. Money in the bank.
2. Marketable securities. Any investments etc that a company might have its money in for the short term.
3. Current Accounts Receivable. This is the money a company expects to receive from its customers (via collection). Usually it's a given that all the accounts receivable will be collected but this might not necessarily be the case. For example phone companies have a number of their's go to collection agencies. In that case they are unlikely to achieve full collection.
4. Inventories. Simplicistically this refers to the products manufactured but not yet sold. But can include raw materials on hand to manufacture. If a company has high inventories levels then it implies that a large percentage of its assets are locked till the goods can be sold. Another problem with large inventories is that they have to be cleared. For the bread company the inventory will rot and be useless. Retailers like the Gap have to mark down inventory and move it out in order to make room for new arrivals.

Non Current Assets:

1. Property, plant and equipment are examples. Depreciation is used to cover the lower value of equipment over time.
2. Intangible. The most notorious intangible is good will. This is the euphemism used to make accountable the extra money paid for an acquisition. For example if our bread company were to buy a pastry company as part of its acquisition and made 500K over the asking price of 1million then a goodwill of 500K has to be included into the account books.


Current Liabilities: Similar to Current Assets these are the bills the company expects to pay during the following business cycle. If a business borrows money then short term debt is part of this entry. Current Accounts payable are the monies owed by this company to its suppliers. Our bread company needs to pay the wheat supplier.

Non Current Liabilities are the monies the company owes over a longer period of time.

Cash Flow Statements:

The cash flow statement is a new requirement for companies submitting their balance sheets to the SEC (since 1988). Cash flow statements are on 3 areas:

Cash flow from Operating Activities:

Net Income (Revenues - cost of sales) is calculated as discussed above
Depreciation and Amortization: Since this is a non-cash charge (i.e. this was paid off in a previous time period and does not affect the cash flow for this period it is removed from consideration) and is added. Deferred taxes are also added. Inventory/Account Receivable. When either of these two go up it implies that a company's cash is tied up in a warehouse (in the case of inventories) or in collections (in the case of accounts receivable). Both of these cases results in a lower cash flow for a company. One time charges are added back to the cash flow statement.

Net Cash from Operating Activities (or operating cash flow) is the sum/subtraction of the entries above.

Cash flow from Investing Activities:
This includes capital expenditures made by the company. In the case of our bread company it is buying a plant etc.

Investment Proceeds: the returns from any investment activities of a company. During the dot-com boom companies like Dell, Microsoft invested in start-ups with their extra cash.

Purchases or spin-offs. Costs associated with these activities are factored in.

Cash flow from Financing activities:

Dividends paid: Any dividends paid out to share holders have to be included
Issuance/re-purchase of stock: When things are going well, and the company believes that the stock price is below what the company is worth, then the company starts re-purchasing shares. This has the effect of increasing the price of the stock (higher demand) and the company increases its value. During growth period the opposite occurs. Companies conduct secondary offerings to increase the amount of free cash they have.
Payment of debt is also included.

Posted at 08:58 PM

SEC filings and the public company

The SEC requires several documents to be filed by public companies each year.

Once a year companies publish a high-gloss, we-are-going-to-conquer-the-world annual report. This report paints a rosy picture of the companies activities and future potential and is distributed to all share holders.

The company also files a 10-K with the SEC. The 10-K contains a description of the companies business and a geographical breakdown of its performance for the year. All legal proceedings, execution compensation, risks, and by-laws have to be listed in this document. The company's audited financial statements are also present in this document.

The company files a 10-Q in every quarter that a 10-K hasnt been filed. A 10-Q contains the unaudited financial statements of the company for that quarter. Any spin-offs, acquisitions are listed in this document. All 8-K's filed in that quarter are listed.

An 8-K is filed whenever a material change occurs in a company during the quarter. Spinoffs, mergers, preliminary financial results are all disclosed as 8-K's.

S-1 is a prospectus of a company. It details the nature of the business, future outlook, reason for raising money etc.

Posted at 08:35 PM

SEC and the markets

The roaring twenties culminated the great stock market crash of 1929. In a bid to clean up the system Congress passed the Securities Act of 1933. This also led to the estabilishment of the Securities Exchange Commission in 1934. The SEC has 5 commissioners appointed by the president who server 5 year terms (that expire in separate years).

The SEC is made up of several divisions:

The Division of Corporate Finance: is responsible for making sure public companies file their 10-K (annual reports) and 10-Q (Quarterly reports). It also reviews S-1's (applications to go public).

The Division of Investment Management: is responsible for governing the compliance of mutual funds. It also oversees public utilities.

The Division of Market Regulation: liasons with Self Regulation Organizations (SRO) such as NASD to ensure that their constitutions and practices adhere to the rules of federal securities acts.

The Division of Enforcement: investigates and prosecutes violations of securities fraud and crime. For example this division tracked down several instances of touting (making outlandish claims of stock performance without disclosing the financial incentive being paid for making said claims).

The General Counsel and office of compliance inspections support the SEC divisions.

Posted at 08:21 PM

Stock Markets

A quick overview of the different markets and what they cater to.

The NYSE is the oldest stock exchange in the country. It started, when a group of traders exchanged stocks under a buttonwood tree on Broad Street N.Y. The NYSE then moved to its current location on 18. Broad Street.

In order to be listed on the NYSE a company needs to have:

1. atleast $40 million in tangible assets
2. atleast 2 outside directors (and an audit committee)
3. atleast 2 years of positive earnings (this is a flexible requirement).

Trades at the NYSE are performed via the public out-cry method where the traders quote prices till parties are in agreement. Traders meet at a trading post for a stock on the exchange floor. Current chief Dick Grasso is often credited with the resurgence of the NYSE in recent years.

The National Association of Securities Dealers Automated Quotation System NASDAQ was then formally founded in 1971. It originally began as an agreement to exchange trades over the telephone. Now all trades are performed electronically with no physical trading floor. There two NASDAQ levels. The National Market trades about 4,000 premium stocks with many qualifying to trade at the NYSE but choosing to remain with the NASDAQ. The Small Cap markets provides the prestige of trading at a regulated exchange for smaller companies.

The American Stock Exchange or AMEX began as an informal gathering of brokers meeting outside the NYSE to trade stocks that could not gain entry to the NYSE. The National Association of Securities Dealers then bought Amex and combined the two markets into NASDAQ-Amex market group. Amex now plays a role in trading derivatives and options.

Regional Exchanges: The US also has several regiional exchanges (Boston Stock Exchange, Philadelphia stock exchange, etc) to handle smaller companies at the local scene. However these exchanges also tend to deal with options and derivatives.

Finally stocks that once listed at the premier exchanges and fell out of favor and ended up no longer meeting the minimum requirements end up trading OTC (Over the Counter). These stocks also go by the name pink-sheet stocks. A vestige of the days when OTC stocks were listed on a pink piece of paper.

Posted at 08:06 PM

Taxes and Income.

A new bookMyth of Ownership claims that we are wrong in griping about the govt taking some of our income away. The New York Times and the Cato institute have reviewed this book.

Posted at 04:16 PM | Comments (0)

April 23, 2002

fuel economy. supply vs demand side

I read a quote recently that very clearly identified the problem behind the proliferation of gas guzzling monstrosities distributed under the abbreviation S.U.V.

First a background. The U.S. government attempts to regulate and limit the production of high gas consumption vehicles through a mechanism called CAFE (Corporate Average Fuel Economy). The fuel economy rating for a manufacturers fleet of passenger cars must average atleast 27.5 mpg. Failure to meet this results in a fine of $5.00 per 0.1 mpg that it falls behind.

The quote I read said something to the effect:

trying to control gas consumption by forcing manufacturers to adhere to CAFE is like trying to reduce obesity in America by reducing the manufacture of XL shirt sizes.

Posted at 02:52 PM | Comments (0)

April 03, 2002

Shoes, Socks and Business Tricks

The Kingdom of Saudi Arabia, the bastion for Wahabi conservatism denies its female citizens several basic freedoms and rights. The intrinsic female instinct to care for one's appearance cannot be supressed. A Saudi woman can shop for clothes but cannot try them out at her Jeddah mall. To circumvent this problem she has until now visited the centers of haute-coutré in the west.

Prince Alwaleed Bin Talal the intrepid Saudi investor has participated in the opening of a female-only mall in Riyadh. Staffed exclusively by women, the mall prohibits the entrance of men during the hours of operation. Saudi gals can let down their hair and charge up a storm (whoa! vortex of clichés) at this exclusive shopping area.

This is another fine example of how the free market economy is all about meeting the needs of the people at the price the people decide. Enough demand will eventually be satisfied with an increase in supply.

Read more at Forbes.com

Posted at 09:06 PM | Comments (0)

April 02, 2002

All good things come to an end

Over the last 3-4 years the insane enthusiasm of venture capitalists (Its the new economy stupid!) has brought a plethora of neat, ill conceived, totally unsustainable ideas to the internet. Now, in total desperation as the falling bank balances extinguish their aspirations these companies start charging for their services. The End of Free chronicles these efforts at survival.

Posted at 10:36 AM

March 13, 2002

Accounting issues

Under that deal, E.D.S. agreed to buy as much as $8.5 billion of communications services from WorldCom over 10 years. WorldCom, in turn, said it would hire E.D.S. to oversee its billing and other basic services, agreeing to pay E.D.S. as much as $7 billion in the same period. E.D.S. also agreed to buy a WorldCom unit for $1.6 billion, taking on more than 12,000 WorldCom employees. The question for analysts is how each company booked the nearly equal amounts of revenue from the deal.

- Nytimes

Posted at 05:08 PM | Comments (0)

Stock market scams


Posted at 11:35 AM | Comments (0)

March 11, 2002

Corporate Culture and Strategy

Mr. Gerstner argues that strategy and corporate culture are intimately linked. "You can't talk a culture into changing," he said. "You can't just exhort people to be different. You've got to point to fundamental strategic changes you're going to implement in a company and then drive the execution of that strategy. And it is in the execution of the strategy that the culture begins to change."

-- New York Times.

Posted at 11:23 AM | Comments (0)

March 04, 2002

Infini band. Infinite Bandwith?

The infiniband architecture is a high throughput I/O interface. Its speed is in the order of Gigabits/sec and blows the antiquated PCI architecture out of the water. There are a plethora of companies jumping into the market around Infiniband.

Vieo provides the software stack to build on top of Infiniband. Banderacom builds a infiniband chip. Surgient builds high performance application servers on top of Infiniband technology.

Posted at 11:58 PM | Comments (0)

February 26, 2002

Irrational exuberance. over a tulip?

During the tulip bubble in 1637, the irrational exuberance of buyers drove up the value of each tulip to several thousand dollars. A single Semper Augustus tulip was then three times as valuable as the most expensive estate in Amsterdam.

One Analysis that I found interesting took the position that the tulipmania of the 17th century was not an example of speculation or preferences of the rich. The rare tulip represented the DNA for a future generation of tulips that could be acquired by winning the auction for that single tulip. Over time, as the tulip propogated and became less of a rare avis the price dropped.

Another article on tulipmania is on Andrew Tobias's site.

Posted at 10:04 PM

February 17, 2002

Staying in the game

Sometimes, its too easy to put your hands up and resign from life. Jack Welch didnt want to quit.

As she tells the story, at one point at 4 A.M. in the hospital,
I turned to her and said, "If something goes wrong, don't let them pull the plug.
Even if they can't tell, I want you to know I'll be fighting like hell in here."
-- Jack Welch, jack: straight from the gut.

Posted at 05:22 PM | Comments (0)

February 07, 2002

How many Starbucks are there in Utah?

Mormons are apparently denied the use the primary vehicle of caffeine delivery, coffee. Ex-mormons or apostates as they are referred to by the mormons will help you figure out the real mormon faith? The Economist has something to say about the spread of Mormonism.

Quick facts
Joseph Smith founder of Mormon religion
accused of multiple sexual liasons
claimed received golden tablets from angel. Translated tablets into book of mormon
only approved pass holders may enter church
coffee, tea, alcohol not allowed
10% of income is tithed.
must perform out of church assignments

Posted at 04:58 PM | Comments (0)

February 06, 2002

Nick Leeson

Nick Leeson gambled $1.17 billion on foreign exchange trades in Singapore and set off the collapse of England's historic Barings Bank.

Posted at 11:05 AM

January 31, 2002

Make-up tips from PeopleSoft: How to make your earnings prettier than they are

You are a new CEO at a enterprise software company thats heading South. You'd like to hear turn-around king mentioned in the same breath as your name. You have your developers re-write the product. However R&D costs money. You spin off a company called Momentum Business Applications with a one time charge of $250 million. Most analysts just gloss over the charge as part of re-structuring.

Momentum turns around and hires you to develop the new application. You bill Momentum for the cost of developing the software. On your profit and loss statement you're spending no money on development. When the software is developed you start selling it. You buy Momentum back.

Now traditionally for sales of $471 million (9 months ending Sept. 2001) you would have netted $151 million (with expenses for R&D). However, since Momentum absorbed your R&D costs you ride up to Wall Street with $279 million in earnings. apresente le genius. Your earnings growth is headed to the moon.

Peoplesoft's turnaround was covered by atleast two magazines.Forbes presented the story above in all its nasty detail. Business2 however was content playing blushing school girl to Conway's tale of rescue and romance.

To be fair, on Jan 28th Business 2 faithfully toed the fuzzy accounting line with regards to PeopleSoft.

Posted at 07:59 PM | Comments (0)

Recipe of the day: Enron earnings soup

How to make earnings out of nothing: First make a deal with a major player like Blockbuster to launch an exciting new service. Drum up buzz. Spin a new corporation to make the deal viable. Let the corporation pay you (Enron) for the rights to undertake the partnership. The corporation needs to pay you $110 million. The corporation borrows money from a bank. You guarantee the corporations loan with Enron stock. The corporation borrows $115 million and pays you $110 million. You immediately book it as earnings for the quarter.

The deal with Blockbuster goes South. Your stock starts to dip. Print more stock to keep the bank at bay. voila serve with a unrepentent CEO and garnish with political contributions.

Posted at 07:40 PM | Comments (0)

January 28, 2002

The economic human - not rational

The Washington Post (via aldaily) has one of the best articles on economics I've ever read. Analysis coming.

Posted at 05:39 PM | Comments (0)

January 20, 2002

Dell is a retailer not an innovator?

I read an interesting editorial in a leading business magazine where the author noted that when he met with Michael Dell he was told that Michael wanted Dell to be the IBM of the 21st century. The author observed that Dell struck him more of a Walmart than an IBM.

Walmart is one of the most remarkable businesses of the 20th century. Walmart's success lies in its superior distribution management technology and prices. They are supposed to have some of the most advanced information technology systems. Their warehouses are apparently extremely automated and efficient. Dell, has probably the best supply chain system in the computer industry. Their inventory levels are measured in hours and not days. This is achieved, because they dont make a machine until its ordered. However once its been ordered to be built, any change in the order results in a new machine being built. The machine that was originally configured continues through the process and ends up in the Dell Factory Outlet. Dell, squeezes down on its suppliers and is known to be ruthless with partners and suppliers.

IBM is one of those companies that has innovated on technology and not just on process. What other companies fit this mould? in other industries? The essential diffrentiation appears to be one of innovation vs process engineering. The retail industry is essentially limited to process engineering, marketing, brand loyalty and price diffrentiation.

As a side note: Dell did briefly enter the retail sales of computers. However that didnt work and they exited the reail sales channel promising to never return. Dell made Direct the theme in its business. Dell currently predicts that 30 million pcs are on their 3rd year and will require replacing in 2002. However, the counter argument is that computer no longer need to be upgraded every 3 years. The Mhz sapping applications are currently limited by bandwith not CPU cycles (thanks to the webification of almost all software applications). However, software vendors like Microsoft are hard at work to squeeze every cycle possible out of silicon.

Posted at 07:19 PM | Comments (0)

January 15, 2002

The intertwined world of business

KMart is contemplating declaring bankruptcy (Chapter 11) which would allow it to restructure its operations. (As an aside, KMart is sitting on a decent amount of cash which might prevent it from getting approval for declaring bankruptcy). If KMart were to go bankrupt what other businesses might be affected? Well, KMart requires retail space. Kimco Realty's portfolio has KMart as a major tenant (~13%). So Kimco was dowgraded by Salomon Smith Barney. If KMart were not around some other brands would suffer. For example Martha Stewart has primarily worked with KMart to peddle her wares. So you'd anticipate a drop in her market value as well.

Lets snapshot this time

Date: Jan 15th, 2002


We'll revisit this in a few weeks.
Update Jan 22nd Just heard that Kmart filed for bankruptcy (chapter 11).


The rational I can offer is that MSO's shareholders now realize that Martha Stewart can move to another retailer (breaking a contract that was otherwise set to expire in 2008). KIM's stock price probably already incorporated the dismal outlook of an economy that did not require more retail rental space. KIM's P/E stands at 15. With a book value of $18 (per share) I'd say it's looking attractive. But then again I've never been a fan of REIT's or any other business requiring land as capital.

Factoid: When New York was still New Amsterdam, the Dutch govt appointee built a wall in New York to defend against the British attacking from Canada (Unfortunately for him, the British attacked by sea). The street next to the wall was called Wall St. The original traders used to trade with coins which were in 1/8ths? hence when the stock market was estabilished prices were quoted in 1/8th untill the decimalization in 2002.(the last fact needs some research)

Posted at 10:55 AM | Comments (0)

January 03, 2002

branding. what does it mean?

Charles Revson started Revlon during the great depression. Why? because he believed that depression was a stronger indication of people's sentiment than the economic reality and that a luxury item such as nail polish will be popular as it would alleviate people's mood. He detached price from cost of product. hence branding. Coca Cola sells sugar water? Yes. But what business is it in? the business of teaching people to sing together (barf!). Other info: "Hope in a Jar" book on the cosmetics industry.

Revson appears to be a ceo of the same mettle as Bill Gates (arrogant, rude to employees). Revlon went public in 1955.

Sam Walton: Started Walmart in Benton, Arkansas. Arkansas joke: We're glad Mississipi is around so that we are not the last in everything

William Levitt (promoted the creation of single family houses in large scale production). Levitt town New York. Huge affect on the landscape of America and how Americans live. Levitt pointed out that a man with his own plot of ground was too busy to become a communist.

Rockerfeller, J.P.Morgan. Henry J. Kaizer.

gleaned from theconnection.org presentation on titans


Hope in a Jar
Time magazine's list of builders

Posted at 01:48 PM | Comments (0)

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