Yes, it helps a lot, it was very instructive. So, selling can be very advantageous given that certain conditions exist. For example 1) the tax implications won`t be crippling, 2) the asset is overvalued and there`s no way it`s earnings will present a solid return. In both cases we have to take our cash and re-invest it in an asset that will earn higher yields for it to make sense to sell.
In any case scenario, the one factor that can really accelerate earnings or destroy a person is leverage. Lehman Brothers was leveraged 150 to 1 and no longer exists. Berkshire Hathaway essentially carries no corporate debt but uses their massive cash holdings (produced by unbelievable cash flow) to buy at the most opportune moment. Being over-leveraged might be a very compelling reason to sell when our asset is overvalued so as to avoid Lehman`s fate.
Thanks for the post.
QUOTE (gwasser @ Nov 18 2008, 10:20 AM) Most investments make money in two ways: cash flow and appreciation. To explain this lets start with a government bond. Say you buy the bond for $100 with an interest rate of 6% or cash flow of 6 dollars per year. The 6% rate is called the coupon rate. Now say that the Bank of Canada rate increases and therefore the coupon rate of bonds increases. New bonds will now be sold at a coupon rate of 7% or cash flow of $7.00 per year.
How much is now the government bond that you bought with a coupon rate of 6% or $6 per year cash flow worth? If you want to sell the bond, it needs to `yield` the same as the new bonds with coupon rate of 7%. Thus, your bond is no longer worth $100 (it`s original face value) but now it is worth $6/7 percent = $6/0.07 = $85.71 The bond trader would now say that you own a $100 face value government bond with coupon rate of 6% worth $85.71 and a yield of 7%.
If you bought $100 worth of shares with a dividend yield of 6% it would also cash flow $6 dollars a year. If the government bond yield rises from 6% to 7%, these shares would also lose value. If all things between the stock and the bond were the same, the share value would also drop to $85.71. However, shares are different from bonds in that they represent ownership in a company. Companies grow and thus do often their profit per share. While the bond is a loan whose principal does not increase or decrease in value, shares are ownership in a company whose value can increase or decrease depending on its profitability. Dividend is that portion of the company`s profit that is paid out to its owners; the remainder of the profit (retained earnings) is re-invested in the company with the hope to generate more profits.
People such as Warren Buffet look at a company`s net income per share and divide that income by the share price. This is kind of like interest, but now it is the amount of net income each share yields; it is called earnings yield. According to Warren, this earnings yield is theoretically a bond yield with build-in inflation protection plus compensation for business risk. You can value the business by comparing it to say the bond yield (a benchmark).
Now the share price with its earnings yield can rise in value when interest rates fall just like bonds (yield). It can also rise when profits increase because the earnings yield rises compared to the bond yield and that allows investors to pay more for the shares. If the economic outlook is stable and the company`s earnings are easy to predict, business risk is low and the earnings yield would be nearly the same as the bond yield. When the economy is turning sour, the earnings become more difficult to predict and the business risk increases, i.e. the share price falls. If the economy is expected to boom, business risk drops; the share price will go up. Of course, whether the economy will boom or crash, whether the business will remain competitive or not are all `judgments`. Often these judgments are skewed with emotions, hence the stock market is often not quite rational and shares are overpriced or on sale (cheap) in regards to its real earnings yield.
Traditionally, instead of earnings yield (earnings per share divided by share price), share valuations are expressed by the inverse, as a price to earnings ratio (i.e. share price divided by earnings per share). The price-earnings ratio (P/E) can also be seen as the number of years it takes for net income to earn back the price you paid for the stock. In economic investment evaluations this is called `payout time`. Thus a stock with earnings yield of 10% or a P/E of 10 needs ten years of earnings to pay for the share. A stock with an earnings yield of 5% has a P/E of 20 and it takes 20 years of earnings to pay back that share`s purchase price, compared to a 7% bond yield that would be a pretty expensive stock. If you have an earnings yield of 1% or a P/E of 100 such as a hi-tech company sometimes has, it would take about 100 years of stable earnings to pay for that company`s share price. This would be clearly overpriced and if I had a stock with P/E of 100 I would cash in and run to the bank. There are other aspects involved in valuating shares but it would go too far to discuss those here.
In real estate you can have a similar logic to value your property. In fact Don is doing that with his score cards and so is the REMA software. It combines rental yield, expenditures and property appreciation to determine the rate of return. By evaluating your existing properties using current market value, rents and expenditures, you can determine whether your rate of return is comparable to government bond yield (your benchmark) or whether it yields more (i.e. it is undervalued) or whether it yields much less (i.e. it is severely overvalued). In the latter case, you may want to lock in your profits and sell, looking for another undervalued investment opportunity, which may be well another piece of real estate.
Hope this helps
