Chingo De Dinero

I run into the confusion all of the time between 401ks and Mutual Funds.  Many people think they are one in the same, or at least something similar.  I hear the statements:

“I rather invest in a 401k then stocks”

“My 401k has less fees then mutual funds”

“There is less risk in a 401k then mutual funds”

Once I hear these statements, I quickly know something is wrong.  401k is not an investment, it is a tax code.  It relates to pretax investments made by workers, and many times matched by employers.  Once you put money into a 401k, it must be invested, which is usually some different choices of mutual funds, determined by your employer.  So really, then people are trying to pick between 401k and a mutual fund, they are talking apples and oranges, and usually will end up with both.

Another very similar statement I hear is about IRAs vs mutual funds, or vs stocks.  Same story, IRA (individual retirement account) is more about tax treatment, not investment type.  Inside of the IRA, you invest in mutual funds, stocks, CDs, or whatever your preference is.

Finally, I stopped screening the hard way. If you have read some of the other information I have written, I think Enterprise value is not valued as much as it should. You hear PE all of the time, but miss the cash position, either positive or negative.

I used to screen for PE and price to book, then look at individual stocks and pick out those with a ton of cash and little debt. I just noticed today, a great measure, not perfect, but good, Enterprise Value / EBITDA. If you didn’t know EBITDA, is Earnings Before Interest Tax Depreciation and Amortization. My way to interpret this, how many year will it take for the company to buy itself. For example, NCTY or The9. They have an Enterprise Value / EBITDA of roughly 3.588. To break this down, the Market Cap is 630 MUSD, they have 316 MUSD cash, 0 debt and have EBITDA of 88.18 MUSD. This means, if they did a full buyback with their cash, then used their profit to buy back shares, they could purchase the whole company in 3.588 years. Of course, this will not happen, and you need working capital, and to reinvest in the business, but man, this is a great way to tell price. Also, this is a stat Yahoo keeps, so you can run screeners off of it….so much time to be saved. Of course, you have to factor in growth, but that isn’t too hard, just look at the analyst estimates, not totally accurate, but will give a flavor.

First, let me give the definition of both:

Value Investing: involves purchasing stocks that have a market price below an assessed priced, usually found through fundamental analysis. This typically involves low price-to-book or price-to-earnings ratios, or high dividend yield.

Growth Investing: involves purchasing stocks that will have high future growth.

Now that you have definitions, you will know a little more when you are given the fund options for your 401k.

What are the benefits and drawbacks of both?

Well, if you only focus on value, you can get hit by companies that are on the decline. For example, if the company is selling for less than their book, maybe their book value is inflated (e.g. price of assets has decreased). The company may not lose money, but may fail to grow, resulting in below market returns.

If you look just at growth, you could pay way to much for a company. So, even if it does grow, the stock can still be overvalued (e.g. if you purchases a stock with a 100 p/e, it could grow at 15% year-over-year and you still could lose money, or would make very little).

My advise is to factor in both…if you use the present value of all future cash flows, while factoring the current asset position, you have done this. You factor in the current value, while at the same time factor in the growth. Be greedy, don’t settle for just one, require it all.

It is always interesting, to me, why external auditors must be used by all publicly traded companies. It all began back in the early 1930s. If you are at all familiar with American history, for the time, this is during the great depression. If you are not familiar, basically the late 1920s were high times, then everything came crashing down, the stock market, banking system, basically the economy in general. I do not want to get too much into the cause of this, but will discuss the government’s reaction.

One of the first things the government did was set up the FDIC, to insure bank deposit, thus improve trust in the banking system. Also, the wonderful Social Security program came along, to ensure our elderly are financially secure. Many other actions were taken, but to stay on track, laws were passed in 1933 and 1934 to regulate public companies (created SEC). The laws in 1933 apply to become public, what papers to file, how it must be advertised, what information must be communicated to purchasers, having the financial statements audited, etc. The laws in 1934 apply to ongoing reporting, 10k, 10q, etc. Getting back to my purpose here, the laws in the early 1930s required companies to have audited financial statements to become public, and to have their annual financial statements audited. Thus, guaranteeing business for external auditors.

This is where it began, but now the government has created Sarbanes-Oxley which requires external auditors to give their opinion on a company’s internal controls. So, basically, the external auditors require the company to prepare a ton of paper, and sign off if it is correct or not (not totally true).

The two services I described above are called attests services, which means the external auditors give their opinion, e.g.Financial Statements are correct, Internal Controls are sufficient. There are many other services, tax advise, financial system consulting, management consulting, etc. But, if the attest services, which are required by law, go away, all of the other services which the majority of money if made from is disappear quickly, or at least will be disbursed to different companies (my opinion).

So, if you couldn’t tell, I am not to fond of external auditors (even though I am an Accountant myself). The main reason is because it is government controlled. The only economic argument for them is that the borrowing cost for an audited company will be less, because they will be viewed as less risky. Maybe this is true, but the only way to see is to remove the government requirement, and let the market do its thing.

To recap, external auditors service the purpose of giving their opinion on the accuracy of a company’s financial statements.