Buy Low, Sell High

Good luck trying to find anyone in the United States who hasn’t heard the advice to “buy low, sell high,” yet it’s becoming more and more difficult to find people who are actually willing to follow that advice.  That’s why I appreciate this editorial by Warren Buffet.  Read it — there’s a reason why Berkshire-Hathaway stock sells for over $100,000 per share and Buffet is considered to be the wealthiest man in the world.

An excerpt:

I’ve been buying American stocks…

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors…But most major companies will be setting new profit records 5, 10 and 20 years from now.

Something Buffet does not point out here that I will is another big reason to buy U.S. stock right now: it’s one thing that anyone can do to help the economy.  As you invest, the stock you buy becomes more scarce, and therefore more valuable.  The company you have invested in has more money for new projects and new products, which in turn generate more revenue which also increases the value of the stock.  As the value of the stock increases, other investors are attracted to buy it and the cycle repeats.  It’s what keeps the market healthy and gets you the earnings that Buffet forecasts in his opinion piece.

Once again, I can’t tell you what to do with your money and you should always seek out a financial advisor before investing.  If you want my opinion, however, it’s this: buy low, buy now, buy American.

SEC Eases Mark to Market Restrictions

The SEC and FASB issued a statement yesterday easing restrictions on mark to market accounting.

Via the Washington Post:

“When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable.”

So what does this mean? Previously, a firm was forced to value an asset based on what that asset would currently sell for. This can create problems on a firm’s financial statements by making the firm appear more or less valuable than it really is.

The first situation is best illustrated by the example of Enron. Using mark to market accounting, Enron recognized revenues that would not actually be realized for several years, making the company’s assets appear much greater than they actually were. Warren Buffet referred to this kind of abuse of the mark to market concept as “mark to myth,” deliberately inflating the earnings of a company based on highly speculative future values of current assets.

The second situation is one currently being experienced by banks and other mortgage lenders throughout the United States: because no one is willing to buy mortgages and mortgage-backed securities, their values are basically zero, even if based on a loan that is in good shape and currently generating revenue. For example, if a family has a $300,000 loan for their home, both parents work and make their mortgage payments on time every month, the loan is still counted as worthless under mark to market even though the bank who issued the loan is earning interest income. This significantly reduces the net worth of the bank and has contributed to bank failures in the last few months.

The statement from the SEC and FASB above is meant to alleviate the second situation. It allows mortgage loans and mortgage-backed securities to be valued based on the income currently being generated, taking into account the time value of money. It helps keep banks from failing, and it doesn’t take $700 billion dollars to do it.