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Stocks...a poor investment?

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February 07, 2012 – Comments (24)

When comparing buying stocks to investing in a real company that your friend owns for instant, the gains on stocks seems awful.

Friend buys a pizzeria or laundromat or car wash, invests $200k into the business, hires a small team to run the place without him even beingt there, and then earns $400k a year.  He is making 200% a year return on profit. Comparing that to the 8% a year or so in stocks makes stocks look awful.

However, the risk of running a small business like that is much higher.  But if there is a 50% failure rate, your expected value is still 100%, still 12.5x that of an investment in stock.

You have to do more work setting up the business, but if it is a friends business, or a bunch of other people are running it, it does not take much work. 

What else am I msising, I know it is something.

24 Comments – Post Your Own

#1) On February 07, 2012 at 4:59 PM, sikiliza (< 20) wrote:

The one thing you are missing is that you picked an arbitrary amount, $400K as the return on a car wash, unless that is really what your friend is making. In addition is that before or after expenses?

The second is that if you are prudent, do your research and due diligence, occasionally check on your investments, you even never have to leave the house to see if your stocks are still there....

Having said that, if you want to make money, business and entrepreneurship is one avenue that can get you there. Though Buffett still invests in stocks of some companies, the Berkshire Portfolio has a number of now privately owned companies that he has bought in the past - same as owning a business. 

 

 

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#2) On February 07, 2012 at 5:46 PM, Valyooo (99.53) wrote:

The numbers I gave are not completely arbitrary.  Also, if you invested 200k into a friends company, would you only expect $16,000 return each year?

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#3) On February 07, 2012 at 5:46 PM, Valyooo (99.53) wrote:

The numbers I gave are not completely arbitrary.  Also, if you invested 200k into a friends company, would you only expect $16,000 return each year?

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#4) On February 07, 2012 at 6:51 PM, Teacherman1 (57.76) wrote:

You could expect anything, but if you will look at the returns on the businesses behind the stocks, you will see that the $400K return you mentioned is way out in fantasy land.

Depending on how your investment was structured, you could also be stuck with a big tax bill.

If you were to get a return of $20K a year out of a $200K investment in the type of business you mentioned, and have other people do all the work, you should consider yourself lucky.

Most small businesses are run by the owner, and he or she works more hours than they would put in holding down two salaried jobs. They could make a good living out of it, but no where near the $400K you mentioned.

If it is a cash business, such as the laundromat or car wash, and you were dishonest and willing to risk going to jail for filing false income tax returns, you could make more, but they have a good idea of just what the cash flow is from that type of business.

Not sure why you picked an 8% return from the stock market. If that was all I could get, I would not even be in it.

This is from the prespective of a man in his late 60's, who spent many years in banking lending to businesses of all types and sizes, as well as a former owner of a couple of his own.

JMO and worth exactly what I am charging for it.

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#5) On February 08, 2012 at 12:18 AM, SkepticalOx (99.43) wrote:

Valyoo, you forget that the 50% chance that your friend's business fails he could end up short $200K (possibly his life savings up to now). Rebuilding that will take awhile. It is essentially a highly concentrated investment. 

You can use the same logic and apply it to any public company. You could've known that Steve Jobs was back at Apple and you studied the guy's history for who knows how long. You can take a more objective opinion of him then of your friend because your view of your friend may be biased. If you bought AAPL at $7.25/share after the dot-com bubble burst, you'd be sitting pretty at $480/share right now. What's that return over average stock return? Or your friend's hypothetical business? Exactly. 

And you are comparing apples and oranges. Picking one example vs. an average of all stock returns is silly. The more appropriate comparison would be total small business returns vs. stock returns, and even then, it wouldn't be the same thing. 

 

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#6) On February 08, 2012 at 12:32 AM, MyunderratedLife (84.54) wrote:

Well that's easy, the 200k for a car wash is somewhat low, and the "expected gain" of 400k (revenue or profit?  either way) is kind of high.

And that's even coming from a midsized texas town.  I recently got a quote from an octogenarian interested in selling me his gas station - the asking price was $450K...  He said he could provide documents to back up an average annual profit (over the last 5 years) of ~$90-95K...

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#7) On February 08, 2012 at 1:27 AM, FleaBagger (29.71) wrote:

Yeah. No one's going to sell you a business for half (or less than half, since you're taking management salary out of that $200k) its expected earnings. They would just keep the business and hire the management themselves. If you actually have anything even remotely resembling a real-life example of that, jump on it, tell us all about it, and take pictures. Then move to the Bahamas.

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#8) On February 08, 2012 at 10:04 AM, EvilEmpire (29.37) wrote:

This type of scenario only plays out in your dreams, kid. A small startup 200k businesss is not going to pull 200% ROI annually just because you say it will. Sorry kiddo, might want to do further research before spewing nonsensical garbage on a global forum such as this.

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#9) On February 08, 2012 at 11:04 AM, Valyooo (99.53) wrote:

Well I actually know 3 people who have made about the same returns...but I guess I am only looking at startups, and startup stocks probably have about the same success.

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#10) On February 08, 2012 at 12:55 PM, JaysRage (89.30) wrote:

Starting and running a business is not just a monetary investment, and it is extremely high risk endeavor.     The failure rate of businesses in year one might be 50%.   Overall failure rate of businesses is higher than that.  In addition, most businesses don't make profit in year one or even two or three, especially in the restaurant business.   It's almost unheard of for a restaurant to make money in year one.    In addition to that, your quality of life while starting a business is zero.  You eat, sleep and breath that business 24x7.    It's entirely possible that your per/hour rate is higher than than of your friend with his business.   In addition to that, he had to come up with 200K somehow.   If it's his own money and there is a 50% chance of losing everything, that's extremely high risk.   If it's borrowed and he ends up failing and going bankrupt, his next borrowing climate is going to be more difficult, especially in the current borrowing climate.  

But yes, owning your own business is the best way to make money.   It's so much more difficult than the picture you paint and about so much more than the money invested.   You need to look at the time value investment and the risk.    

I recently invested in a startup.   My projected return is 50% per year for the first two years and significantly higher after that, but I know full-well that there is a very real possibility of losing all of it.  

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#11) On February 08, 2012 at 12:57 PM, JaysRage (89.30) wrote:

Typical price for a successful small business can be as high as 3X sales.   A price of 1/2 profit is a dream.   Your friend got a great deal.    

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#12) On February 08, 2012 at 2:44 PM, ikkyu2 (99.31) wrote:

"You have to do more work setting up the business, but if it is a friends business, or a bunch of other people are running it, it does not take much work."

This is a howler that makes your whole post barely worthy of comment.  Running a business is a lot of work.  Running a business like a car wash, with high turnover of a few dozen minimum wage employees, is a huge amount of work.  Try it sometime.

Owning a stock can be done with no work at all.  If the business does well, you reap the profits after purchasing the shares regardless of how much time you put into it.  If you purchase a car wash and then take the same attitude, you will lose all your money.

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#13) On February 08, 2012 at 3:11 PM, Harold71 (22.97) wrote:

"if it is a friends business, or a bunch of other people are running it, it does not take much work."

 

It's actually dead on.   I'm running a business, doing the work, and have limited partners.  They are now getting huge returns for doing nothing.  Nothing except investing, of course.

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#14) On February 08, 2012 at 4:27 PM, Valyooo (99.53) wrote:

I am unsure why people think my friend paid 0.5x cash flow, considering I said he started the business...meaning he did not buy it.

 

Also, I am not sure why people keep mentioning all of the hard work.  I said investment...I did not say job...I never said I would be working for the company.

People keep answering questions I do not ask.  A lot of helpful comments here, but a lot of ones that missed my question entirely.

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#15) On February 08, 2012 at 5:01 PM, Valyooo (99.53) wrote:

Harold, out of curiosity, what is the pay out they get?

For instance.  Let's say your company took $100k to start, and one of the partners put in 20k of it.  Each year you make 100k PROFIT.  Now, will you give him 20k?  Do you pay yourself a salary and then give him money proportionate to his equity as a dividend?  Or do you give him a percentage of his equity as a dividend?

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#16) On February 08, 2012 at 6:01 PM, FoolWB66 (< 20) wrote:

If this is the deal than yes it is a great deal.  Much better than stocks.  Sounds elementary, but if investing in stocks was better than investing in an actual business, than a company like microsoft and Apple would be better off selling their businesses and putting their money in the stock market.  Probably not going to happen.  Good luck!

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#17) On February 08, 2012 at 6:11 PM, Wiseinvestors (99.03) wrote:

I'll gladly invest in this business this very second..I just don't think it exists.

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#18) On February 08, 2012 at 7:21 PM, hbofbyu (< 20) wrote:

Apparently your experience does not match up with the real world. 

Everyone with money is looking for a place to put it where they can get a return of 8% or better.  The higher return the more risk.  If someone guarantess above 10% consider that much increased risk.

A 50% failure rate for a new business?  Wrong.  1 in 7 start-ups survive the first 5 years.  And the ones the survive often return about 8 - 10%.  Say you buy  a McDonalds franchise.  You will work your ass off and get less than 10% yearly return on your investment.

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#19) On February 08, 2012 at 7:32 PM, Mega (99.96) wrote:

"Friend buys a pizzeria or laundromat or car wash, invests $200k into the business, hires a small team to run the place without him even being there, and then earns $400k a year."

I'm guessing the $400K "profit" is not a real accounting of all the costs including taxes, insurance, depreciation, interest, wages, paying himself wages, etc.

Yes, there have been businesses that made $400K profit on $200K invested in their first year.  But they would need to have a lot bigger competitive advantage than a car wash, pizzeria or laundromat.  I.e. an innovative technology or business model.

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#20) On February 08, 2012 at 8:51 PM, Valyooo (99.53) wrote:

hboybfu,

That doesn't make a lot of sense ot me.  Some people here are saying that people look to buy businesses for 5x earnings or so.  So if you are generating only 10% per yer, and you invest 100k, then your company is only worth 50k but you spent 100k on it.  Maybe I am missing something here but something seems off.

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#21) On February 09, 2012 at 1:35 AM, MyunderratedLife (84.54) wrote:

I don't think people should jump down your throat, but if that is the valuation (200K to start, 400K expected profits) then why wouldn't the person just take a bank loan or finance it independently?

Getting investors in on such a deal would only dilute his own interest...

That said, I still think it costs a lot more than 200K to start said business.  Of course a lot of this is geographically determined, but the plot of land within a conveinent location should run you a good chunk of the 200K without even considering developing infrastructure.  

For frame of reference, those coolers you see encircling the back walls of gas stations cost100-150K to install depending on how many of them you have/how big the cold storage is.  I find it hard to believe that the canopies for your car wash would be much cheaper than freezers...

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#22) On February 09, 2012 at 1:36 AM, MyunderratedLife (84.54) wrote:

I think the 10% per year is not considering the expected earnings growth...  maybe 5x for a mature small business...

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#23) On February 09, 2012 at 3:10 PM, Hawmps (< 20) wrote:

I know your example of your friend is very basic and "broad brush", but when you say....  

"Friend buys a pizzeria or laundromat or car wash, invests $200k into the business"

I say so what?  what's the cashflow of the business?  what is the real estate worth?  How old is the building? has it been well maintained?  does he own the property or lease a space in a strip mall?  does he own the laundr-o-mat equipment or have leases on that?  How many employees does this venture require? who is keeping the books? How are you measuring your rate of return?  What's the market for this business?  are there two other car washes going through planning and permitting in your area right now?  How are the franchise fees structured in that pizzaria business?  or are you going head to head with Papa John's?

If you (or your friend) are not answering these types of questions for yourself(s) before "investing" $200k, best of luck to you.  The $200k would be good down payment money (and working capital) for said venture but you'll be hard pressed to even get a loan without showing a detailed (and realistic) business plan to sell the banker on your ideas and show some type of experience in running the business.  This is a much higher risk venture and should have a significantly higher potential for return. If you are not careful, you just bought yourself another job.  But if you have faith in your friend's business prowess, understand how the business works, understand your risk, and you can be a silent partner that just ways in on major decisions, then by all means.

If it was that easy to earn 200% every one would do it and then it would no longer be worth 200% because everyone is doing it.

 

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#24) On February 16, 2012 at 8:16 PM, hbofbyu (< 20) wrote:

I say go for it.  The only way you'll know is after you lose your first $50K.   The money will be well spent for the lesson you learn. 

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