Sunday, November 9, 2008

Augmented Unemployment Report Leads to Augmented Balance Sheets

The world being circular, when you begin going in one direction you eventually come back to where you started. This circumnavigation also applies to words. Recently on Bloomberg radio I heard a cogent discussion of the impact of unemployment statistics on the domestic economy. The speakers very quickly blew past the Department of Labor’s official unemployment number of 6%+, focusing instead on what the department calls “an alternative measure of total unemployment.” This “augmented unemployment” statistic takes into consideration part time workers who want to work full time, those who have dropped out of looking for employment, and a portion of the “self employed” who would prefer to be on someone else’s payroll. This augmented number is over 11%, possibly 11.8% for November.

From the standpoint of an analyst or policy-maker, the difference between 6% and 11% is huge. Basing decisions upon misleading data can have serious consequences to a national economy or to an individual’s wealth.

In the investment world, we see something of a contrary relationship. Simplistic “value” investors often feel a stock is “cheap” relative to its book value as presented in balance sheets. A careful analysis of what makes up book value, particularly for a company that has grown by acquisitions, include a number of items generated by acquisitions such as the value of customer lists, an updated value of real estate (useful for an acquisition, but not for an acquirer) plus the remaining net difference between the price paid and all other assets which is labeled “goodwill.” This is not the first time that accounting rules and investment usage differs.

The accounting book value is measured against price to determine whether a stock or a market is currently attractive. On this basis, many investors believe much of today’s stock prices are attractive compared to history. Those of us who have grown up in the financial community prefer to rely on “tangible book value” which is lower than reported book. I often advocate reconstructing a balance sheet to determine true value under varying assumptions. Many accountants and investors have accepted that an augmented book value is more useful than a book value generated by hard assets.

Then why is it so difficult for wealthy individuals, particularly ultra high net worth (UHNW), to develop their own augmented personal balance sheet?

One of the elements of an augmented personal balance sheet would be what someone would pay for his/her home less the expenses of the sale, including taxes, less the cost of replacement living accommodations. This figure should be modified by the difference between the mortgage on the old dwelling and the new. Another example of an asset to be added to your balance sheet is the value of your business-related mailing lists. (If you do any significant amount of fund raising for any non-profit or political organization your personal mailing list could be quite valuable to another fund-raiser.) There are other assets that could and perhaps should be added, such as a portfolio of unexploited patents, sale of a brand name, current ownership of debt selling well below maturity value, etc. The augmented personal balance sheet should a complete list of actual and potential liabilities or commitments.

The augmented personal balance sheet can make the difference between an estate that accomplishes the grantor’s desires and one that produces just the opposite. In one specific example, a rather extensive list of specific dollar commitments to personal or charitable beneficiaries was designed both to meet those obligations and to reduce the residual estate so that a bunch of spoiled trust fund babies were not created. But, in this case, because little or no value was placed on various intellectual properties-patents, brand names or badly out dated valuations of real property, the residual estate was many times the expected amount, creating just the situation and resulting behavior pattern the grantor wanted to avoid.

The same result might occur if the grantor, while alive, used too small a valuation on his/her assets relative to liabilities and thus had reserves too large for future payments. This type of discussion and analysis should be done privately and often with other professional advisers present.

Traditionally when the Marines have landed their basic units; platoons, companies, battalions, regiments and divisions, are augmented with additional specialists and firepower. Thus, I am quite comfortable with the process of augmentation as it is often needed to accomplish the mission.

I discuss these principles in my book, Money Wise, and in my recent interview with Steve Forbes on's Intelligent Investing site. I hope you find it as interesting an experience as I did.

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