How banks make their money and why we should learn from them?

When we play the game monopoly, we know that the bank is rich and everyone pays to the bank when they buy a deed of land. In our real world, we know that banks are rich as almost everyone deposits money in the bank. So how do banks make money?  Banks lend out money and earn from the interest. This is the primary business of a bank.

The business of the bank

Banks do the same thing over and over again. Take the money they have, lend it out with interest, get back the money with interest and lend it out with interest again. This creates a consistent cash flow for them. Of course banks do other things with the money the have for example investing it in bonds etc. But come to think of it, isn't investing in bonds lending out money with interest too?


How we can be like the bank?

Lending out is a good business. We can also be like the bank and create consistent cash flows for ourselves. Take the money we have, lend it out with interest, get back the money with interest and lend it out with interest again. So who do we lend it to? The answer is we can lend it out to the financial markets.

The financial market is created to facilitate the transactions between lenders and borrowers. With the financial market, borrowers can seek funding from lenders and lenders can lend out money to borrowers in a fast and efficient manner. The stock market and the bond market are part of the financial market.

In the bond market, corporations or the government can borrow money through the issuing of bonds. When we buy a bond, we are lending money to the corporation or government who issued the bond. By lending money to them through bonds, we are paid interest for it. We become like the bank who lend money out to others. However, before investing in bonds, you should know how it works and how interest is paid out etc. Read: 4 things you should know before investing into bonds

In the stock market, companies who need more money to expand their business can seek for people to invest in their companies. When we invest in a company through the stock market, we effectively own a part of the company. This is even better than lending out money only. Owning a part of the company entitles you to dividends that the company pays. This is like the company paying you a share of their profits. As the company earns more money, dividends are expected to increase. Of course sometimes it does not increase and that's where we have to look out for.


How to choose who to lend out to?

Choosing who we lend our money to is important. Choose the wrong person and you may lose all your money. We can learn from the bank on how to choose the correct person to lend out to.

Banks do a detailed report of a person before deciding if they will lend to an individual. Some deciding factors are:

1. Does the person have a stable income and how much income?
2. Does he have many other outstanding loans?
3. Is that person over leveraged on debt?
4. Does he have any assets?
5. Does he have any prior bad financial report ie. failure to repay loans or bankruptcy

I'm sure there are other factors but well i hope you get a rough idea. Using the above profile, we can do a detailed profile of the company we want to invest in too. Some factors to look out for in a company are:

1. How much profit does the company have and is it consistent?
2. Does the company have huge debt? Is it manageable?
3. Does the company have any assets?
4. Does the company allocate capital efficiently?

These are just some simple factors to consider. This is not enough when evaluating a company as companies are more complicated than individual persons. I have written a series of post on how to pick stocks. You can read it up to learn more here. 

A risk to take note

Banks have collapsed before and the most famous one is Lehman Brothers which collapsed during the 2007/08 global financial crisis. Why did it fall? The answer is that it was over leveraged. To say it simply, it actually lend out more money than it had. Reports say that Lehman Brothers has a leverage ratio of 44:1. This means that every $44 it lend out, only $1 was from its own pocket. 

When we invest, do not invest using money which you do not have. Using borrowed money to invest is dangerous. In stricter sense, do not even invest money which you will need for paying bills or for emergency. 

Conclusion 

By learning from the bank, we can be like the bank. Use the money we have, lend it out or invest it with interest or dividend yield, get back the money with interest and dividends then lend it out or invest it again. Repeat the process correctly and you will become rich one day. We may not have people depositing money with us but we can deposit money into ourselves. This is the art of savings. Using this money we deposited into ourselves, lend it out or invest it. Put it in the correct place and see it grow. However, put it in the wrong place and it will wither away.

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Related Posts:
1. Buying the company on the streets (Part 1) - Discovery stage
2. Investing is like water that flows out
3. How to pick stocks (Part 2) - The profitability of a business

Teens in Singapore to Learn How to Manage Finances

Teens learning to manage finances early in life will be a revolutionary shift as far as Singapore’s growth in the areas of education and economics is concerned. Read on to know what the program is about and how it’ll operate!

Even though Singapore already has a high literacy rate and is already the international hub of education, the Government of Singapore is keen to educate its young generation on how to better manage finances. As a practical step ahead in this direction, ‘teens studying finances’ will be a definite part of MoneySense, the country’s national financial education program.

What Does the Move Aim At?

The move will address a range of grave financial issues every person faces in life at one point in time or the other. This will help ultimately future Singaporean adults become more efficient at managing their finances!

Educationalists and social workers from across Singapore are likely to be involved with a single goal - spreading financial literacy among people, especially the youth.

Teachers will also be trained and prepared to impart quality financial education to students.

How Will the Program Be Brought into Practice?  

All Secondary 1 and 2 scholars will get a chance to develop finance management skills through this program initiated by the Ministry of Education, Singapore. 

The Ministry is all set to prepare teachers for this challenging responsibility by equipping them with all essential skills and information, so that they can make lessons both relevant and interesting for the young minds. 

Interestingly, it will not be a compulsion for the students to take exams for getting admission in the program, for the ultimate purpose of this initiative is to instill certain confidence and impart practical skills that can be utilized in future. 

Future Perspective and Scope of Success 

The idea is to make teenagers comprehend an otherwise complex subject - finance management early in life - so that they face no difficulty in developing the right attitude and approach during their formative years towards saving and spending money. 

The program also focuses on using social service networks to make more helpful ways and opportunities available to those going through financial problems. This is the reason a pilot program has been specially designed to coach social workers on financial literacy. Once properly trained, these counselors will be able to offer help to households with low income. 

Author Bio: Lim Chuwei is a Teacher in Singapore at ChampionTutor and highly advocates the use of cloud based application for teaching and learning.

Related Posts:

1. Lower secondary students to learn about financial literacy from next year

Croesus Retail trust 2nd Quarter results beats forecast. DPU 3.1% higher than forecast

Croesus retail trust has another quarter of DPU which is higher than its forecast. Final DPU is 5.24cents which will be payable in march. This is good news for shareholders of this trust. I've initiated a long position in November last year at a price of 0.875. After the announcement of good earnings, the stock price closed at 0.915 today. Another good news for shareholders.

Credit: http://www.croesusretailtrust.com/html/portfolio_moriya.php

Fundamentals wise, this trust remains strong and outlook remains positive. They have 4 shopping malls under them and all have approximately 100% occupancy rate. 100% of their total debt has been swapped to fixed rate which will minimize their risk in case of interest rates spikes. At least 80% of their debt has also been hedged against currency fluctuations. Gearing ratio is currently at 41.8% and they have also issued S$100million of fixed rate notes to be due in 2017. I hope they will make some good acquisitions to include more properties in their portfolio using the debts they have and this will increase DPU as well. It is written in their Quarter 2 financial statement that the S$100Million notes will be used by:

"CRT and its subsidiaries for the purpose of financing or refinancing its acquisitions and/or investments, financing any development and asset enhancement works on the properties in which it has an interest and general corporate purposes." 

Uniqlo was recently one of the new tenants in their Aeon town Moriya shopping centre. Having big and branded tenants in their shopping malls will certainly attract more customers as well as other tenants to set up their retail outlets with them. NAV per share has risen slightly from JPY72.40 to JPY74.09. This is about 91.7 cents when converted back to Singapore dollars. At the current price of 91.5 cents. it is still at fair value. Investors who buy now will still enjoy a annual dividend yield of about 8.9% if DPU is maintained. Those who bought at 87.5 cents would have enjoyed a dividend yield of 9.3% p.a.

It was reported today that Japan is moving to speed up the impact of a US$50 billion stimulus package aimed at countering any slowdown from a looming sales tax hike. They really seem to be doing whatever they can to bring their economy out of the decade long depression. Prices will start to increase in Japan which will boost consumer spending. Previously, due to deflation, consumers hold back their purchases as they keep thinking if I don't buy now, i will be able to buy at a cheaper price later. Japanese people have became savers over the past few years. Now when prices start increasing, they will want to buy now for fear that prices will keep rising in the future. CRT which owns shopping malls will stand to benefit as more tenants look for space to set up their shops.

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Related Posts:
1. Croesus Retail Trust - First Quarter results released and initiated long position
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Investing is like water that flows out

Water that flows is constantly renewed with fresh water. Water that doesn't flows will become stale after awhile and the colour will change. Why am i talking about water here? The reason is I think water represents our money.

Some time ago, there was one news reported where people feedback that one of the private swimming pools in a residential unit has not been changed for a very long time. Algae has started to grow in it and the water is no longer clear. It was later found out that the owner was not staying there and had turned off the outlet where the water could flow resulting in the water turning stale.

Money that doesn't flow will also become stale. What I mean is money that you save which is not invested will become stale. We all know that inflation decreases the value of our money. The higher the inflation, the lesser the value of your savings is worth year after year. It is wise to put your money in a place where it can flow. Investing for income creates that flow where your money generates income in terms of dividends from stocks or rental from properties. This flows back to you creating a constantly cash flow for yourself.

Rich people become rich because they know where to put their money. Their money is constantly flowing like fresh water that is always renewed. If you do not let your money flow, it will become stale and worth less and less overtime. Then again, make sure you put your money at the right place. Placing it in the wrong place may lead to drying up. There must be water flowing back as well.

Giving is also be a form where your money can flow. It adds purpose and meaning to what you have. Treat your family or friends for a good meal? Surprise your spouse with something special? Giving back to your parents who have raised you up over the years? Donating for a good cause in society? These are some things which adds value to our money. Creating cash flow will  make you wealthier while giving back will make you a better person. This will certainly make our lives more worthwhile to live. Don't let your money become stale and smelly.

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Buying the company on the streets (Part 2) - When to buy?

In the previous post, the companies on the streets were discovered in our everyday lives. I have said that even though we have discovered them, we should not buy them immediately. In this post, I'll touch on some simple ways we can value a company.

Knowing the nature of a business is important before anything else. What business does the company engage in? How much does that product contribute to the company's profits? For example, we know G2000 is partly owned by Wing Tai. Wing Tai has a retail business but they also engage in building properties. G2000 is an established brand with good sales record. However, Wing Tai only owns 45% of G2000 and this only contributes to a small portion of its income. The main income comes from its property business. So no matter how successful G2000 may be or how long the queues you see outside G2000, the impact on Wing Tai's profit is very minimal.

Now, even before you start investing, i would suggest you forget about the stock price. The stock price the company is trading at now does not mean anything. You are not buying the stock price but buying a part of the business. Look at the company with the eyes of a business owner.

When to buy?

This is a question a lot of people ask. To be honest, there is no perfect entry point to buy a stock. In fact, most of the time when investors buy the stock, its price will most likely go down. Does it sound shocking to you? Of course you do not want to be buying at the high also and don't want to be paying a high price for what the company is actually worth. It'll be good if you can buy the company at a discount of its fair value.

Now, to determine the value of the company, we can look at 2 things:

1. Intrinsic value
2. Assets the company owns

Intrinsic Value

You might have heard of this term called the intrinsic value. Investopedia defines intrinsic value as "The actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors". So how do we calculate the intrinsic value of a company?

Cash flow can be used in the calculation of intrinsic value. Cash flow is a more accurate measure of a company's worth than earnings. It is the real cash that the company generates every year. To know more about cash flow, read: Understanding Financial Statements (Part 3) - The Cash Flow Statement

The most common valuation that investors use to calculate intrinsic value is called the discounted cash flow model. It factors in the estimated future cash flow growth rate of the company and discount it to the present value. Intrinsic value is therefore the present value of all expected future net cash flows to the company. This will give a rough gauge of how much value the company is worth today based on the predicted cash flow growth. 

Not to worry if you do not understand what i wrote above. I know sometimes it is not easy to understand the finance concepts if you're not a finance student. There is a free intrinsic value calculator you can use provided free by Bigfatpurse.com. You can download the free intrinsic value calculator here. 

Assets the company own

Assets have value and this is especially important for companies that deal with or own properties. We can do a simple valuation of property stocks using the Price to Book(PB) ratio. Book value is similar to what we call Net asset value(NAV). The NAV of a stock is derived by taking the total Assets minus the total liabilities. The NAV shows us the total net assets the company has. The PB ratio is derived by taking the stock price per share divided by the NAV per share. A PB ratio of less than 1 means the stock is trading less than its NAV per share.

Let's say Capitaland stock price is now at $2.50. Assuming it's NAV per share is $5, the PB ratio would be 0.5 ($2.50 divided by $5). If you buy its stock at $2.50 now, you would have bought at less than it's actual value based on its assets. Isn't that a good value that you have found?

Margin of Safety(MOS)

Buying a company below its intrinsic value gives us a margin of safety. This will somewhat limit the downside risk if the market turns bearish. Buying 25% below the company's intrinsic value is a safe margin. However, the stock price can fall even lower and when that happens, it should be good news for value investors like us. This also means that we should always have extra money on reserve no matter what. This is to take advantage to buy at lower prices when Mr market decides to have a bad mood. Unless if i can find many stocks trading at more than 50% lower than it's intrinsic value, then maybe i will be invested fully. When the crash comes it takes courage to invest. Will you be in the game when it happens?

Conclusion

This ends the 2 part series on buying the company on the streets. Next time when you go shopping, remember to look around to find companies which you can potentially buy. Then, research on the company based on its economic moats, profitability of its business, strong balance sheet, intrinsic value and assets. This is what Warren Buffet says to buy good companies at undervalued prices.

It's bad to go to bed at night thinking about the price of a stock. We think about the value and company results; The stock market is there to serve you, not instruct you. -Warren Buffet, 2003 

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Related Posts:
1. Buying the company on the streets (Part 1) - Discovery stage
2. Understanding financial statements (Part 1) - The income statement

100,000 page views!

My blog has surpassed 100,000 page views right after Chinese new year! An auspicious time for an achievement indeed. Thank you all my readers for your support and i will definitely write more quality articles this year.

A peek at the top all time traffic source for my blog. As a finance blog, the top post should be something to do with investment but surprisingly it is not. The top all time posts was the post on my Taiwan trip which i manage to spend only $702 for 8 days. I discovered that various searches on Google ranked my Taiwan trip post as the top search result. You can try searching "Taiwan trip blog" or "taiwan trip itinerary" and both searches show my site as the first result. So, that's where the traffic is coming from. People love to travel and the most number of searches that come in was during the November and December holidays. That's when i know people are planning for their holiday trips. Well, till now there are still searches coming in so i guess there are people travelling throughout the year.

Some other financial bloggers will agree that we have a very small audience compared to lifestyle or travel bloggers. Indeed my travelling post become number 1 in page views. The second top page views post is on WhyMoolah which is a life simulation app to help young adults make wise financial choices. This was something interesting which i have also tried the app personally myself. You can try it if you had not done so. The third most page views is the post on POSB invest saver. I hope that post has helped more people in making better investment decisions.

For the readers who visited my blog, most are from Singapore. Next is followed by United States as the second, Malaysia as the third. There are people from many other countries including Europe, Russia, Australia, UK, Ukraine and other parts of Asia too. This is something interesting to me to have readers from all over the world.

Also, the Facebook page that i started with 0 Likes has already garnered 122 Likes as of now. Thanks to everyone who liked my page. Once again, thank you all of you for your support. Stay tune for more exciting post coming soon.

Buying a car with 100% cash and no debt

It's the second day of Chinese new year and I hope all of you had a wonderful time with your loved ones especially your family members. The past few days I've been hanging out with my family and relatives. Its a good time to catch up and every Chinese New Year, it always seems to be a family gathering event.

My relatives seem to be getting richer every year. Recently, one of my uncles bought a new car paying $140k in cash. Its a higher end car but well they are rich enough to afford it. I also had the chance to ride in it. Most of my relatives have been paying full cash for their cars ever since many years ago. I am not very familiar with the interest rates of car loans in Singapore as i do not own a car but I did a rough check online for car loan rates. UOB indicated that they are offering an effective interest rate of 6.31% p.a for a five year loan tenure for new cars. Wow, 6.31% p.a is rather high. Am I seeing it correctly? Maybe those who have experience in buying a car can advice?

If interest rates are indeed at the 6% range p.a, then it makes sense to pay for the car in cash. If not, the interest that is compounded can amount to quite a substantial amount. It looks like what my uncle did was a wiser choice.

This brings me to the point that if you cannot afford a car, do not buy one. Period. Why succumb yourself to massive debt just to own a car? Paying monthly petrol, parking, insurance,  road tax is already taxing enough. With monthly loans to service also, it'll be an even greater burden. Think wisely before buying one. Are you rich enough to pay for the car? After paying, are you still able to live your life indefinitely? A wrong choice will lead to misery afterwards.

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