Business 1O1 Podcast: Investing 1O1 with Stephen McKeon

Overview

Investing 1O1 with Stephen McKeon

This episode starts with the time value of money and quickly becomes an exploration of the time value of everything. Finance professor Stephen McKeon takes us through his past working at a winery, starting a drone company, to his current outlook of always choosing a happy versus wealthy life. The episode bounces between balances sheets and the purpose of life—and how the basics of all those scary words like stocks, bonds, and annuities aren’t so scary. McKeon uses some wonderful examples to illustrate the concept of investing, including how to invest in outer space asteroid mining, judging a company by how risky the CEO is (hint: see if the CEO has pilot’s license), and of course, cryptocurrencies—something that keeps getting him in the news constantly. As always, host Troy Campbell and editor Alec Cowan drop in some additional research and stories. The episode grows in complexity and subject matter as it progresses, but everything is always sewn together by the simple concept that a dollar today is worth more than a dollar tomorrow.

What We Learned

101 Everywhere: Time Value of Investing

101 Everywhere: Time Value of Investing

This episode is subtitled “Time Value” because it is based on the simple idea that if you invest in something today—be that a stock or a skill—it is likely the case that you gain more from that investment over time. That’s a finance principle, but it is also a great principle for life.

In Romance … Invest in something that will continually pay out over time, such as dance lessons.

In Friendship … Spend time checking in with friends in different cities. This is a simple act that is often overlooked.

In School … Take that extra class because the more you learn now, the more future you will have to earn the dividends of those skills.

In Work … Make sure you are automatically investing in a savings account if you can afford it.

In Public Policy … Think about how to build infrastructure that doesn’t just fix a problem but that will create a sustainable future.

In Health … Invest in learning health behaviors and facts, so you will be better prepared in the future to make health decisions—especially when you are not as young as you are today.

Misconceptions

The Balance Sheet

The Balance Sheet

At the center of investing is the balance sheet. A balance sheet is just a spreadsheet that calculates the point at which your idea is profitable and how profitable it is.

Here are the three basic steps for creating a balance sheet.

Step 1: Write It All Out

Just write out all the cash inflows and outflows from a project, which are all the different ways you will be spending and bringing in money, such as investors, sales, and costs of products.

McKeon elaborated on step one through the example of investing in a new corporate project: “There’s usually large outflow in the beginning in order to get the project going, and then, as you begin to sell whatever the good is—maybe that’s precious metals from an asteroid or maybe it’s tickets on your hyperloop, whatever revenue stream you have—those would be inflows that happen later in your project. So, the first step is you line those things up, and that usually requires a spreadsheet.”

Step 2: Apply Discount Rates

Once you have all your cash flows on the spreadsheet, you must discount them, which means to value them in accordance with how much they are worth today. So, here is where that popular term “discount rate” comes in. Luckily, there are lots of established metrics you can use to think about inflation and other factors.

McKeon explained further: “The second component is once you’ve analyzed the amount and the timing of these inflows and outflows, you need to discount them. So if it’s five years away, it’s not as valuable as if it’s three years away. And so, you need some sort of discount rate to discount everything back to today.”

McKeon then further elaborated on how to discount the project number you have for the future earnings of a company by comparing “something like GE, a very large stable company with stable cash flows and stable projects” or a company like “a startup drone software firm, [with] lots of uncertainly about future cash flows.” He explained that, “You’re pretty sure GE is going to make that amount, so you wouldn’t discount it. There’s still some uncertainty. But with the drone software company, it could be a 1,000—or it could be 5,000—or it could be zero. So in that case you’re going to discount it more heavily, so the cash flows from the software company are worth less to you today than those from a company like GE because you’ve got more uncertainty revolving around the software firm.”

Step 3: See What It Says

“Then it’s simple,” McKeon said. For step three, “You take all the different streams of things that are happening over different years and discount them back to today and add them up. And if it’s positive, we call that a positive net value project, and that’s something that you want to pursue.”

Firms and Risky CEOs

Firms and Risky CEOs

McKeon looks at factors that affect firm success. Investing at the firm level is all about understanding these factors. In a fun project with some serious science underneath it all, Steve and colleagues looked at CEOs who pilot private planes (a generally risky activity). They found that these CEOs take more risks in their businesses. This shows up in demonstrations of how the company is performing, such as the amount or volatility of their stock returns.

McKeon explained, “The thing we found was piloting small aircraft. So, then what we did was we took the pilots and said how do they run their companies? It came through in virtually every policy we looked at. So, they took on higher leverage, they acquired more companies, and they had more volatile stock returns . . . . The CEO’s risk tolerance, so how comfortable they were with taking risks, really impacted the way their businesses were run.”