Three Investing Patterns That You Should Know
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Three Investing Patterns That You Should Know
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Re: Three Investing Patterns That You Should Know
#2When economists say "_net present value_ of future returns", are they exclusively wanting to discount the inflation effects? Or is there anything else?
Re: Three Investing Patterns That You Should Know
#3When economists say "_net present value_ of future returns", are they exclusively wanting to discount the inflation effects? Or is there anything else?
Your discount rate is generally the rate you can borrow at, so it differs for everyone.
To see why, consider a really simple case: you can buy a contract to receive C cash at some time T in the future. Call X how much you'd pay today to enter that contract. You can borrow X today and agree to repay it using the payout from your contract. If you can borrow at a fixed, continuously compounded rate R, then the amount you repay is X exp(RT). So your breakeven (or "fair") price would have X exp(RT) = C, i.e. X = C exp(-RT). NB, the rate you use to discount a future value to know its present value to you is R, which is _your_ rate to borrow that much money for that length of time.
There are various models that aim to recover R from other values, but ultimately it's determined by market activity. Lenders either will or will not loan you X for T time at a rate of R.
What kinds of things might impact their willingness? Definitely their perception of present and future inflation rates, but also their ability to loan at a higher rate to someone else with a similar risk profile (i.e. the "rates market" as a whole) and also specifics of your own credit risk to them. If they think you might default on the loan, they'll charge you more for that added risk.
Re: Three Investing Patterns That You Should Know
#4When economists say "_net present value_ of future returns", are they exclusively wanting to discount the inflation effects? Or is there anything else?
Depends; economists talk about real returns meaning returns over inflation. So discounted future real returns take inflation into account.
Re: Three Investing Patterns That You Should Know
#5When economists say "_net present value_ of future returns", are they exclusively wanting to discount the inflation effects? Or is there anything else?
This one confused me as well when I learnt about it.
For valuing an investment, you have to take into account the inflation that will happen, as well as the opportunity cost.
So if you can earn 5% on your money, but inflation is 4%, you can turn $100 into $101 today-dollars in one year.
Re: Three Investing Patterns That You Should Know
#6When economists say "_net present value_ of future returns", are they exclusively wanting to discount the inflation effects? Or is there anything else?
This one confused me as well when I learnt about it. For valuing an investment, you have to take into account the inflation that will happen, as well as the opportunity cost. So if you can earn 5% on your money, but inflation is 4%, you can turn $100 into $101 today-dollars in one year.
But why? If you don't invest then you turn the $100 into 96 today dollars. It seems to me that information is pretty much irrelevant.
Re: Three Investing Patterns That You Should Know
#7When economists say "_net present value_ of future returns", are they exclusively wanting to discount the inflation effects? Or is there anything else?
It depends on your view point and the model you are making.
Generally it will be your cost of capital to be used as a discount rate. Say if you borrow at 10%, then you need account for that every year you need to wait for that return.
A company with access to cheap capital can use a lower discount rate, and come up with higher net present value based on distant cash flows compared to a company that needs to pay a lot.
Net present value is a normalization measure.
Re: Three Investing Patterns That You Should Know
#8Earlier quoted context omitted.
This one confused me as well when I learnt about it. For valuing an investment, you have to take into account the inflation that will happen, as well as the opportunity cost. So if you can earn 5% on your money, but inflation is 4%, you can turn $100 into $101 today-dollars in one year.
But why? If you don't invest then you turn the $100 into 96 today dollars. It seems to me that information is pretty much irrelevant.
Well it is an important factor.
Average bond yield is around 4% over a decade, that means that investing in a business you need to discount the growth it will have in it's cash flow by 4%.
Imagine you conclude Coca Cola can grow it's cash flow and earnings per share by 6% annually, is it an appealing investment when you get right now almost 5 on bonds? I's not really, but you would probably come to a different conclusion if Coca Cola's price felt by 15% in some market conditions.
Re: Three Investing Patterns That You Should Know
#9One of the most important realizations I've had recently is the investing motto: "You can't beat the market, but you can beat the tax man".
Don't try to be smart about your investments from the point of view of share pricing, P/E ratios, EBITDA, etc, etc. The legions of Harvard and MIT quants working on Wall Street are going to be better than you at figuring out what the stock price should be.
Instead, get smart about how the tax code works. Figure out the difference between long-term and short-term capital gains. Figure out how to do tax loss harvesting. Figure out what a back-door IRA is. Figure out how to take out a loan on your 401(k). The benefits from those investigations are going to be much more reliably beneficial than trying to be smart about pricing and timing the market.
Re: Three Investing Patterns That You Should Know
#10When economists say "_net present value_ of future returns", are they exclusively wanting to discount the inflation effects? Or is there anything else?
They discount average historical 10Y US bonds.