Value Investing 2021 Security Analysis Questions and Discussion Thread |
| 2021 Security Analysis Questions and Discussion Thread Posted: 01 Jan 2021 02:05 PM PST Question and answer thread for SecurityAnalysis subreddit. We want to keep low quality questions out of the reddit feed, so we ask you to put your questions here. Thank you [link] [comments]  |
| Posted: 01 Jan 2021 06:49 PM PST Perhaps the largest threat to the survivorship and stability (read existence) of the global financial system is that of non-productivity. The United States, is the most advanced country by way of financial services; American banking is incredibly complex and far-reaching in its influence, is but a system that is built upon inefficiency. When you take out a loan, there are many things you can do: you can create a business (SBA loan), a productive use for this, such as making a restaurant and creating jobs and foodstuffs, or you can take a loan for investment; however, not investment in a non existent business (a pre-business), such as a restaurant (by providing capital to your friend's new proposed restaurant) but rather in a business whose shares have already been issued, or a business that is already extant. The problem with the second one is the extent to which it's been done; the dilemma of more money chasing the same assets is the reason why capitalism feels so faulty and inefficient. I am not proposing socialism nor am I a socialist, but I want to bring to your attention that the current system of economics is not capitalism but rather some sort of bankism; a system in which there is no regard for the productive usage of credit, but rather just the creation of more wealth. This is something the reader has heard many, many times and a topic almost beaten to death, but to actually internalize it is complex and requires an understanding of how modern banking functions. When you go out to take a loan, you are not actually taking out a loan but rather creating a security for the bank; the bank is 'investing' and then repackaging and flipping out the loan to some other financial entity, whether it be another commercial bank or an endowment (through packaging it in a form of SPV), or perhaps that loan is for a house, so it is placed in a REMIC and is being incorporated into an MBS, either way, it is being moved into another financial entity which is moving it into another one, and so on and so forth. This oversecuritization is the reason why there are so many problems with the economy or why the stock market is overvalued or wrongly assessed; but to be fair, by definition the stock market is always overvalued (or undervalued, better yet, granted it is a forward looking mechanism, it is always mis-priced). Credit is a tool, a tremendous one at that; the United States is privileged in that it has effectively managed to make credit available to the common person and allowed them to employ the payment (of almost everything) of current items with future money. Even when people (or corporations) cannot afford to make the payments to cover the interest and debt from what they assumed to be money that they would have (future money) the country lets them refinance at a higher interest, or in the case of companies, with a different capital structure (if they have to restructure their loan and issue preferred shares or create PIK). Regardless, it always just gets pushed off towards later in the future, seldom is the goal to actually wipe the debt. In this sense, the only true cure is that of a complete reset of the system, a debt jubilee if you will, however, this has its own problems. If you wonder how deep this culture of pushing off payments is embedded within the financial system simply look at VCs or at any youthful technology company; they are expected to lose money and most go public while still losing money. There is a video of Aswath Damodaran explaining how someone once asked him how much they should pay for a business that will have negative cash flows for(ever) a long time, and he reacts simply flabbergasted, because it would make no sense to pay for such a business. This is the case with many technology companies who focus so much on high growth that, on paper, it would seem that they forgot to actually make money. This is a problem that Damodaran has also tackled, explaining how the best predictor of tech company valuations are user-base and not revenue nor EBITDA, etc. This is a fundamental problem, because it has encouraged a behavior that might have, a distant time ago, only been an exception that was excusable because the wholistic business was that much better than its (temporary) negative cash flow; this exception has now become a rule. From a more practical standpoint, it is important to fund companies that lose money because otherwise innovation is completely stifled. However, there is no way that this can be the standard because it is simply unintuitive and counterproductive to have so many companies that are only in existence because they have a blank check behind them. There should only be two or three Ubers, not fifty, or really, an entire sector full of Ubers; this might sound hyperbolized, but cash flow negative tech companies that IPO are actually the majority. One might wonder how many Uber-like companies (read companies that only exist because a third party consistently funds them at a loss) fund the B2B contracts of other Uber-like companies (how many companies who lose money at Uber's pace provide business to other companies that lose money at an Uber's pace?), because upon collapse of one large tech company, this could be very dangerous for many enterprise serving companies that depend very much on the Ubers of the market. In a true free market all companies would die, as they should, but we cannot pretend that we live in a free market, as America is not capitalistic in this regard, but rather a convenience operating economy; it would like find a way to salvage Uber and let its helpers die. None of what has been said I mean as social commentary nor do I care to bring political awareness, I am like most people who will read this, in it to get wealthy and want only to understand the entire machine's operations for financial benefit; it is why having an understanding for this bankism is so important. I have a strange but telling figure that helps explain this over-financialization in the world (which stems from the American financial industry): There are 54 pages of financial companies on FINVIZ, to contrast the next most popular industry group is healthcare with the same amount of pages, 54; however, if I count ETFs in the grouping, I get 170 pages, which is over 3 times more than healthcare's 54. ETFs, which are simply holding vehicles, are amalgamations of previously issued stocks; some are representative of commodities and currencies, in this sense they act as proxy instruments, but however which way you view it, they are artificial in that they are non-productive. I.e. Coca Cola makes soda and an ETF for gold simply holds gold. The over-financialization of everything is what has led to such a large bubble; we are always in bubbles, just never to this extent. But I remind you that being right does not mean that you will be paid, as markets are reflexive in this manner and if out of 100 participants, only 1 holds the correct view but only 9 people agree with him, the other 90 will overtake his perspective, simply because he does not have enough support. The markets do not respect reality, but rather popularity; and the truth is seldom popular. There is a lot of evidence of this over-financialization and it is even to blame for the mistakes of employment in the finance sector. These mistakes arise partly because of bureaucracy and partly because of inefficient structure; I invite you to take a trip to your local commercial bank and count the number of people who seem to be doing nothing, I promise you will find at least one. Many of the services offered in finance seem redundant and bureaucratic in their structure. Take a hypothetical scenario for creating credit-linked notes, for instance, a variant of derivative: JP Morgan issues a loan to Texas Instruments. As this happens, JP Morgan issues a note to a set of investors that is linked to Texas Instruments's credit quality (making the note a credit-linked note). The interest rate on the issued note is tied to Texas Instruments's credit quality (rating). Using the funds from the note, JP Morgan purchases 10 year U.S. treasuries. After this happens, one of two scenarios occurs; If Texas Instruments is solvent, the bank must pay back the notes in full, if it goes bankrupt then the investors become the creditor of the loan given to Texas Instruments and receive their loan (originally credited to JP Morgan). JP Morgan gets compensated by the (risk-less) money generated from the U.S. treasuries using the note funds. This makes perfect sense to industry participants. But to anyone else, it doesn't make any sense, as most over-the-counter derivative transactions don't make any sense. Without thinking about this, the first assumption you probably have is that the involved parties are trying to bypass some form of regulation or credit-restraint; and they are. The omnipresence of this is what is so problematic; the financial industry is at a point where it has so much dry powder and so little yield that it is being artificially forced to create more and more intricate structures. That credit-linked note example is a simplified one and has iterations that become much more intricate. The point being, the overfinancialization can even delve into employment; imagine how many fictitious and counter-productive jobs this type of event creates. Again, not social commentary, but it is a genuine concern because it increments the fragility of the financial system. Imagine if Congress created new tax provisions just so the Big 4 would be (artificially) forced to open up new tax departments in Bermuda; this happens more often than not. Credit was designed for productive use, and its unproductive use is the prime reason why many, many markets are overinflated. If you made it this far, I appreciate you taking the time to read this. Excuse the rambling on some parts of this writing, I will be fixing this post and attempting to make it more cohesive and legible. [link] [comments]  |
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