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?
In this segment, I am re-evaluating the financial situation from chatelaine.com and comparing my results with their financial experts.
Name: Gerry and Fiona
Age: 41 & 36
Income: $62,000 & $22,000
Monthly After Tax Income: $4916 ($59,000/year)
Monthly Expenses: $3750 ($45,000/year)
Home: Yes, and 2 additional rental properties with mortgages
Gary and Fiona have stock investments valued at $1.2 million and 2 rental properties. Their debts are as follows: $195,000 mortgage for primary home (LOC), $410,000 mortgage for 2 rental properties, and $313,000 margin debt (at 3%). The article states their net-worth is well over $1 million, which I will assume the value of their 3 homes totals $900,000, which puts their total net-worth at $1.2 million.
I have calculated their after tax income to be $59,000 based on the data given that they squirrel away $14,000 per year.
What is their balance sheet like?
|Balance Sheet Statement|
|Cash, Checking & Savings Account|
|Short Term GICS|
|Money Owed By Friends & Family|
|All Stocks & Mutual funds||$1,200,000|
|Total Real Estate||$900,000|
|Total Other Investments|
|Credit Card Debt|
|Average Monthly Expenses||$3,750|
|Money Owed to Friends & Family|
|Long Term Liabilities|
|Mortgage Remaining||$410,000 (at 2.7%)|
|Line of Credit||$195,000 (at 3%)|
|Home Equity Line of Credit|
|Other Long Term Loans||$313,000 (at 3%)|
|Shareholder’s Equity (Networth): $1,188,250|
What is their cash flow statement like?
|Annual Cashflow Statement|
|Net Employment Income:||$59,000|
|Dividends (at 3%):||$36,000|
|Capital Gain (at 5%):||$60,000|
|Net Income/Net Annual Savings: $81,620|
Profitability: Their Profit Margin (Net Income / Net Revenue) is 81,620 / 155,000 = 52%. This number is really high due to the fact that they have amounted a massive $1.2 mil stock portfolio to accommodate their above average $82,000 per year household income.
Return on Equity: Their Return on Equity (Net Income / Net worth) is $81,620 / $1,188,250 = 6.8%. Corporate investors usually look for 15% ROE to be considered a healthy company. However, this can easily be explained because their employment income isn’t very high and a nearly half of their net-worth is tied up to real estate.
Debt to Equity: Their Debt to Equity (Liabilities / Net worth) is $921,750 / $1,188,250 = 0.77. Gerry and Fiona and well within “industry” standards in terms of debt. In fact, over two thirds of their debt is non-callable secured debt and only a third of it is the riskier margin debt. Even if equities were to fall 50%, they would NOT get a margin call. Therefore, they are at a pretty good margin of safety, pun intended.
Quick Ratio: His quick ratio (Current Assets / Current Liabilities) is $4916 / $3750 = 1.31. This puts them slightly above industry average of 1.1. However, the story doesn’t tell all. They may have a few thousand sitting around in their checking accounts and I haven’t taken into account their rental income either.
I am giving them an overall rating of 7/10. Their portfolio size is 4 times their margin debt, which is more than sufficient to protect against any future equity crashes. I suspect that aggressive margin investing was the main reason they managed to accumulate over $1 million net-worth on a mere $82,000 household income. I also presume they are very sophisticated investors who are investing tax efficiently and wisely if they are able to tackle on margin debt.
I disagree with the financial planner Jim Otar’s advice to de-leverage, because they are obviously intelligent enough to use margin debt wisely. I doubt they will take his advice either since they clearly know what they are doing. Otar notes that markets crashed 40% in 2008-09. What he failed to note is that markets also recovered in 5 years as well. If the couple is willing to stay the course, which I believe they are, they will get out of the next stock market crash unscathed.
Savvy Buck’s Advice:
It really depends on whether if they want to leave any assets for their kids or not. As it stands, they are able to retire this instant if they wanted to. Should there be a stock market crash, I believe they are able to temporarily cut some expenses to weather through the crash.
Unless both rental properties provide some sort of sentimental value (e.g. family asset), I would recommend selling one of the properties and using the proceeds to invest more in the stock market. Half of their net worth in real estate is a little over concentrated.
As a side note: This article was posted in 2012, since then the stock market has gone up 40%. Their portfolio should now be at $1.68 million, which means they can definitely retire now. I hope they didn’t de-leverage as per the recommendation!