Archive for October, 2016

2016 Election and the Stock Market

People have been calling me and cornering me at social events asking:

“What will happen to the stock market after the election”? In the short run of a day or a week there may be a bit of an adjustment. The real issue is the next four years.

Avoiding any political statements I address this strictly from an economic stand point and as a business owner. Unfortunately, I find most Americans cannot connect the dots when economic policies are presented.

Let’s examine things in light of Economics 101. What moves stock prices? Answer: Earnings (or some call it profits). As a simple example lets say we want to buy a “pizza shop.” The present owner has been earning (making a profit) of $100,000 per year. Lets say the profit equates to “cash profit.” Assume there are 100,000 shares outstanding so the pizza shop’s earnings per share are $1 each ($100,000 profit divided by 100,000 shares). A general rule of thumb is that one would pay about 4 – 5 times earnings (or profits) for a small business like the pizza shop. This is known as the PE ratio or the price earnings ratio. In our case that would equate to a selling price of $400,000 – $500,000. Thus, without changing anything and earning the same $100,000 per year, we, as the next owners, could get a return on investment in 4 – 5 years, or, in other words we are demanding a 20% – 25% annual return (simply divide the selling price $400,000 – $500,000 by the $100,000 profit to get the return number). The present owner would be selling each of the 100,000 shares to us at $4 – $5 per share ($400,000 – $500,000 sale price divided by 100,000 shares).

Now let’s assume after we buy the pizza shop we institute some changes, i.e., getting discounts for buying in larger quantities, teaching employees to be more productive or adding technology so we are able to now earn $200,000 in profit after tax in the next year.

What are some of the outcomes of our changes and hard work: (1) With higher profits more in taxes now go to the government. We see the need to begin advertising since we can now handle more business so the advertising company hires more people (who pay income taxes) to handle our account. We also hire more people to handle the anticipated new business (and the new employees pay income taxes). We ask for more products from our vendors they do the same and so forth and so on. This is known as the multiplier effect. By the way I am not advocating a love of taxes but rather showing the outcome of a growing business and economy. So, with Adam Smith’s “Invisible Hand” principal more people are working, which means they are off the Government dole, more taxes are flowing into the Treasury and more of our new customers are happy.

As a side bar, since our business is now making $200,000 per year (or $2 per share on 100,000 shares) the next buyer would be willing to pay us between $800,000 and $1 million or $8 – $10 per share under the classic 4 – 5 times price earnings multiplier. If we decide to sell the business we would owe taxes on the difference between the selling price of $1 million and what we paid originally of $500,000. So, it is the INCREASE IN EARNINGS that push up the stock prices. By the way the P/E ratio for the S&P 500 has averaged around 12 – 13 times since large companies are more stable and you would demand lower rates of return. I am using a small business example to explain the concepts. Keep in mind the companies that make up the stock market act similarly in concept to this small pizza shop.

Here is a major input to help you understand companies and the stock market. If you took all the companies in the U.S. from the small pizza shops, to grocery stores to Apple computer and added up their profits, the average profit for all the companies in the U.S. comes out around 4.8% (before tax). Yes, it is not the gigantic number people think exists. Grocery stores work on 1% profit while the “sin” companies like alcohol, tobacco etc. have much higher profit margins.

As any business owner, just like any employee, I want to maintain my income (earnings) and lifestyle. Let’s say we are able to maintain the earnings or income of $200,000 per year (or $2 per share) as noted above.

Next, let’s say my expenses skyrocket overnight because the government imposes higher income taxes on our profits, imposes costly new regulations and forces me to buy expensive health care insurance for employees. So, without any change in sales, expenses have gone up and my profits drop back down to the original $100,000. Please keep in mind it is not just our pizza shop that is hit this way. The advertising agency and all of our vendors are hit the same way plus all the other companies in the U.S.

So to maintain our lifestyles we have 3 options: (1) Raise prices, which will make us uncompetitive and is purely inflationary. (2) Cut costs by laying off employees which will restore our profits and lifestyle and make our employees miserable, or, (3) shut down the business. In all 3 options the Government will lose tax revenue and many people lose their jobs who now become a burden on society again by going back on the Government dole. How about selling the business? Well at $100,000 in profits we might get our original money back of $400,000 to $500,000 but the new potential owner has looked at our books and seen profits dropping plus costs going up, so I doubt we can get our money back in a sale.

Who loses here: The Government, employees and entrepreneurs.

Remember small businesses produce 70% of all new jobs created in the U.S. In the past year, for the first time in U.S. history, more small business are shutting down each month than are opening. Tragic!!
Small businesses are just a reflection of large businesses that make up the stock market.

Are you connecting the dots yet?

I hope you have the answer after this long winded explanation of what will happen to your wealth in the stock market after the election.

One candidate wants to (1) lower taxes on business (we have the highest corporate tax rate in the world. That is why many companies are leaving the U.S. and we lose jobs). Every time the Government reduces tax rates more tax revenue is generated. (2) This same candidate wants to reduce costly regulations that stifle the ability to start and maintain a business. (3) This same candidate wants to revamp the out of control costs to business of Obamacare. If this candidate can do this, it will lead to an explosion upward in business growth, employment, tax revenue and the stock market going through the roof which means your wealth will skyrocket.

Who wins here: The Government, employees, entrepreneurs and society as a whole.

The other candidate wants to increase taxes, regulations and health care costs.

This simple article has only covered a few policies that are on the table that separate the candidates. My desire was to answer the question on what will happen to the stock market.

Well, I hope you now can calculate and understand where the stock market will be in the next 1 – 4 years based on who wins the election.

In the great words of Mayor Daly……

“Vote early and vote often.”

Medical Power of Attorney

Most people do not think about a Medical Power of Attorney (MPOA) until it is too late. Recently a wife asked her husband, “When you get dementia, do you still want a flu shot”?

If someone has a MPOA why do they have to ask anything. **Each state has its own rules for MPOA. Check with your personal attorney. This is an example under Texas Law Chapter 166, Subchapter D of the Texas Health and Safety Code. The MPOA appoints someone to make medical decisions when you can’t. Your medical agent has no authority until the attending physician certifies in writing that you are incompetent. You may still object to your agent’s decision to give or withhold treatment. You are in charge as long as you can communicate.

Your medical agent is supposed to make the decision you prefer, not the one he or she prefers.

The American Bar Association offers a Tool Kit for Health Care Advance Planning. Tool #7, The Proxy Quiz for Family or Physician is the one to take. To get a copy start at eepurl.com/8YXVb. Take the quiz with your spouse (or your agent). You may find similarity in some of your wishes, or it may need more discussion. Start on it today. Do not wait until after the fact.

Working Longer

A recent survey by Bankrate.com found a major shift in how people extend their working lives:
70%: Those who plan to work as a long as possible during retirement
38%: Share of those who plan to work during retirement who will do so because they like to work.
35%: Share of those who plan to keep working who will do so because they need the money.
13%: Those who plan to retire in their 50’s

Coming into our office we find people are choosing to work longer mainly because they never made a plan for retirement and did not save enough.

“Beware of little expenses; a small leak will sink a great ship.” Benjamin Franklin

Money Saving Tip: Drive Safe

Having one moving violation can increase auto insurance premiums for years. Premiums can jump 33 percent for a DUI in North Carolina. The premiums in Illinois can rise 99 percent for speeding 30 miles over the limit. Try to avoid a rate hike by asking your insurer for forgiveness, taking a driving class or plea bargaining to a lesser offense.

“You can be young without money but you can’t be old without it”. Tennessee Williams