Prelude:
I will be analyzing sample individuals and evaluate their finances as if they were a company. How do they stack up if their finances were publicly available? Would investors “buy” their shares?
Name: Francis Collins
Age: 26
Income: $46,000
Monthly After Tax Income: $3000
Monthly Expenses: $1475
Home: No, renting at $400 per month.
Summary:
Francis Collins is a young professional who has 2 years of industry experience. He is 26 and is currently living frugally by renting a house with several roommates and aggressively investing in the equities market. He was lucky to have his parents fund his college degree and thus graduated with no student debt. Throughout college, he interned at various companies and agencies which enabled him to save a decent chunk of change. However, he is currently taking on heavy load of margin debt and line of credit debt to pursue his dreams of financial freedom. Is his strategy way too risky given his circumstances or is it manageable?
He owns a 2001 Toyota Corolla which was gifted to him from his parents. He has no plans to upgrade to a new car until this one breaks down.
Monthly Expenses:
His monthly expenses are as follows:
Rent: $400
Utilities & Internet: $50 (shared between roommates)
Eating Out: $100
Groceries: $150
Automotive Gas: $150
Automotive Insurance: $125
Automotive Misc: $100
Misc: $400
Total: $1475
What is his balance sheet like?
| Balance Sheet Statement | |
|---|---|
| Current Assets | |
| Cash, Checking & Savings Account | $5,000 (Checking & Savings) |
| Monthly Income | $3,000 |
| Short Term GICS | |
| Money Owed By Friends & Family | |
| Non-Current Assets | |
| All Stocks & Mutual funds | $190,000 |
| Total Real Estate | $0 |
| Cars | $1,000 (2001 Toyota Corolla) |
| Total Other Investments | $2,000 (Coins) |
| Total Assets | $201,000 |
| Current Liabilities | |
| Credit Card Debt | $18,000 (at 1%) |
| Average Monthly Expenses | $1500 |
| Money Owed to Friends & Family | |
| Long Term Liabilities | |
| Mortgage Remaining | |
| Line of Credit | $36,000 (at 3%) |
| Home Equity Line of Credit | |
| Other Long Term Loans | $22,000 (at 4%) |
| Total Liabilities | $77,500 |
| Shareholder’s Equity (Networth): $123,500 | |
What is his cash flow statement like?
| Annual Cashflow Statement | |
|---|---|
| Revenue: | |
| Net Employment Income: | $36,000 |
| Dividends (at 1%): | $1,900 |
| Capital Gain (at 7.5%): | $14,250 |
| Expenses: | |
| Monthly Expenses: | $17,700 |
| Loan Interest: | $2,140 |
| Other Debt: | |
| Net Income/Net Annual Savings: $32,310 | |
Analysis:
Profitability: His Profit Margin (Net Income / Net Revenue) is 32,310 / 52,150 = 62% which is extremely high. Being able to save over 60% of your income from all sources is a pretty stunning feat. Just as a perspective, Apple Corp, who commands one of the highest profit margins in the industry, only has a 40% profit margin.
Evaluation: 10/10
Return on Equity: His Return on Equity (Net Income / Net worth) is 32.31 / 123.5 = 26.1%. His ROE is very good. As many investors demand minimum 15% ROE, his numbers blows the requirement out of the water. However, do note that this is achieved because of very frugal savings alongside aggressive investing.
Evaluation: 9/10
Debt to Equity: His Debt to Equity (Liabilities / Net worth) is 0.62. Although industry standard is 1 and 0.62 puts him well below the industry average in terms of debt, alongside oil and gas (0.64) and computer manufacturing (0.63), this is where the numbers don’t actually tell you everything. The majority of his debt is line of credit and margin debt, both which are callable by the debtor at any time. Thus, if the equities market suffers a major downturn, Francis may be forced to liquidate at the bottom of the market, which would be catastrophic to his financial goals.
Evaluation: 6/10
Quick Ratio: His quick ratio (Current Assets / Current Liabilities) is 8000 / 19,500 = 0.41. This is where we see the cracks on his investment strategy. As industry average is 1 and Francis is well below that, he needs to keep in mind that if the markets do head south, he may not be able to cover his debt liabilities and be forced to sell off his shares to finance his debt, thus being forced to sell at the bottom.
Evaluation: 3/10
*Note: I put his stock portfolio as long term assets because I am going by the assumption that he is investing for the long term and won’t sell to finance his debt obligations.
Conclusion:
I am giving Francis an overall score of 7/10. He has managed an impressive 62% profit margin which may very well offset his high investment debt obligations. And as a young professional making $46,000 per year, I do expect his income to increase with time and decrease his overall risk. However, he does need to be well aware that as of this instance, he is undergoing a very risky strategy that majority of investors shy away from.