Investing strategies: used by billionaires to amass their fortunes

There are many investing strategies, which investors use. Value investing, contrarian investing and growth investing are mostly used investing strategies. Let’s briefly study them.

Value investing is the most successful investing strategy. It was founded by Benjamin Graham, mentor of Warren Buffet. In this strategy investors see for underpriced securities based on some formula other than market price. This formula for ascertaining the value of the security is generally some multiple of income of the corporation. Value investors usually have to wait for longer in order to realize the full value of their assets.

Along with Warren Buffet many other successful investors follow the value investing strategy of investing. According to researches value investing proved to be the most successful way of investing.  Many billionaire investors favor value investing over other forms of investing. Warren Buffet, Howard Marks, Seth Andrew Klarman, Charles Brandes, Walter J. Schloss, Irving Kahn, Mario Joseph Gabelli, Michael F. Price   are some of most successful value investors.     

Another strategy is contrarian investing. Contrarian investing is buying when other people are selling and selling when other people are buying. Every up and down in the overall stock market or some specific share price offers opportunity of selling and buying to these contrarians respectively.  Warren Buffet is also sometimes referred to as contrarian investor, owing to the obvious reason of many similarities between contrarian and value investing strategy. Other famous proponents of contrarian investing are Michael F. Price, James Beeland Rogers, Marc Faber, David Dreman, Mark E. Ripple, and William Albert Ackman.

Growth investing is another strategy which many successful investors use.  Those who follow growth investing strategy invest in companies that show above average growth even when their shares seem to be highly priced. Unlike value investors, growth investors buy stock in companies that are trading higher than their intrinsic value-assuming that the intrinsic value would grow eventually exceeding current valuations. These investors focus on capital appreciation. Venture capital funds can be classified as growth investors.   

Provident funds and Gratuity funds

According to Pakistani law provident fund and gratuity funds are two distinct things.  Provident funds are paid to regular employees and gratuity payments are made to contract employees. Gratuity is a tip for good services and therefore its payment is contingent on successful completion of contract. Employees who are removed on disciplinary basis are not entitled to gratuity payments.

Permanent employees are to be paid provident fund at the end of service irrespective of quality of their services. Hence, removal of permanent employee from employment on disciplinary basis doesn’t disqualify him/her for receiving provident fund.

How these funds work

Employer makes regular payment to these funds and these funds are then invested in variety of securities. The returns generated on these funds are reinvested and generally paid to employees at the end of their term.

Employers register these funds as trusts and appoint the trustee who oversee and invest these funds for the ultimate benefit of beneficiaries.

Tax treatment

These funds are exempt from taxes provided they are registered. Any unregistered fund is to be taxed at reduced rate.

Where these funds are invested

These funds are invested in variety of securities. Generally Govt. securities are preferred for the investment as these are secure and there is smaller risk of default. A small portion of fund can also be invested in equity to generate increased return. The problem faced by the managers of the fund is to strike a balance between return and risk.

Federal Govt provident fund

Federal Govt maintains provident fund for its employees. Finance Ministry has notified new rates for minimum subscription to GP fund. Employees in grade 1 has to pay at least 3% of their average salaries in the fund. From BPS 2 to BPS 11 employees has to subscribe atleasat 5% of their mean salaries into the fund whereas BPS 12 and above will have to contribute on minimum 8% of their mean salaries to the fund.

Govt. pays 11.30 % per annum mark up on the fund to civilian employees serving under ministries other than defense and railway ministry.

Challenges for provident funds/gratuity funds

These funds must earn huge returns to pay off the accruing liabilities. This present a challenge to fund manager (trustee), who has to invest these funds in venues where returns outweigh the risk. With one wrong decision, the fund manager risks millions of workers’ hard earned money. To find a right balance between risk and reward a manager employees the services of financial analysts. These professionals make sure that workers’ hard earned money doesn’t wipe away in market crashes.

Baby shark method: the secret of many successful retailing giants

Albert Gubay, the late billionaire, from humble beginning established United Kingdom’s most successful supermarket chain Kwik Save.

It started, in 1959, when he founded value foods. His aggressive price cuttings lead many distributors and suppliers to refuse him.

In 1964, he visited United States learning from there a technique which helped him built his retailing chain. Sooner his Value Foods changed to Kwik Save, a discount retailer chain boosting more than 1000 stores. The growth of his business was a direct result of his use of baby shark method.

In this method the retailer purchases goods on good payment terms, say for example, 60 or 90 days and then sell these items at or below costs. The interest on cash generated by the sale is then used to expand retailing business.

The interest on trade credit is received in form of discount. By selling these items he generated cash for expansion at the same time being able to pay suppliers when the payments became due. This method is a sort of OPM, other people’s money.

The use of baby shark method, along with other cost cutting methods learnt from West German retailing giant ALDI, he founded the empire consisting of hundreds of outlets. In 1973, he sold Kwik Save for £14 million, the first step to amass his £500 million fortune.

ALDI, the giant German retailer was using this method much before Gubay copied it. In fact, ALDI was where this method of retailing was perfected. Today ALDI owns more than 10000 stores in 18 countries, with total turnover of 50 billion €.

Growth of Islamic Finance in Pakistan

Assets of Islamic banks have doubled in the last four years and SECP is now considering amending laws and giving tax relief to enable them to issue sukkuk bonds and real estate investment trust.

“The assets in Islamic banking (in Pakistan) have doubled, jumping from Rs837 billion to Rs1.6 trillion, from 2012 to 2016, now accounting for 11.7% of the total banking assets,” said Securities and Exchange Commission of Pakistan (SECP) in a handout on Saturday.

Read more about Islamic Finance

Non-banking financial institutions (NBFI) enjoy more support in religious classes of the country than Islamic banks. This is evidenced by stronger growth of assets in Sharia-compliant NBFI. The market share of assets in Islamic NBFI has grown from 14%, in 2002, to 33% now.

 “The SECP has recently conducted two consultation sessions with market participants to facilitate issuance of sukuk and real estate investment trust (REIT),” said Usman Hayat, head of the Islamic Finance Department at the SECP.

“The SECP is analyzing industry proposals and it shall consider making appropriate amendments to the relevant regulations, further reducing the cost and hassle for both issuers and investors. The industry proposals pertaining to tax issues regarding sukuk and REIT are being referred to the FBR,” he added.

At present 21 banking organizations are offering Islamic banking services in the country through 2,322 branches in 112 districts across the country.  “The SBP has a holistic approach to the promotion of Islamic banking and is providing enabling policy environment, Sharia governance, risk management, and capacity building,” says Ghulam Muhammad Abbasi, head of the Islamic Banking Department at SBP.

The assets of Islamic financial institutions are growing at a rapid pace but it is yet to be seen as how Islamic is the Islamic finance.

Using customers' money for your startup

Beijing has the world’s costliest rental housing, according to a survey of 15 global cities, with average prices more than 1.2 times average salaries, says a report by the Global Cities Business Alliance, a UK-based not-for-profit organization. The rise in rent, in developing countries like China, India, and Pakistan, has provided developers an opportunity to make money out of thin air.

What they do is to purchase a piece of land and then announce construction of residential plaza or shopping mall over it. Advance booking is announced for residential and commercial units. The advance money collected is then used for completing the project. Unheard in many developed countries, realty development is one of the most lucrative areas for investors.

The use of customers’ money for growth isn’t limited to realty sector only; entrepreneurs can use this method to grow their startups in other areas as well. Take the example of TutorVista, which successfully leveraged this customers’ money model of financing. It started when Krishnan Ganesh hired three teachers and provided them with VoIP internet connection, PC displaying a digital whiteboard along with webcam. It quickly became a 100$ per month tuition service.

Dell is another example of customer funded business. Michael Dell, founder of Dell, started by selling customized PCs to small businesses. The core percept in his business was to collect cash before having to lay out money on chips and computers to be sold. 

Customer funding provides many benefits to the startups. Usually, startups receive higher valuations if they performed successfully for an extended period of time, without external funding. Additionally, strong cash inflows, from customers, allow entrepreneurs to focus on proving business model rather than wooing investors.

In this model of business funding, balance sheet shows more current liabilities than current assets. In accounting term it is called negative working capital. Ironically positive working capital is assumed to be good as it poses less insolvency risk to the business.

Not every startup can be run using customers’ funding. Capital intensive projects need to rely on traditional way of financing. 

Islamic mode of financing

Islamic finance is sharia compliant way of financing.  Sharia, on one hand, prohibits any transaction involving undue uncertainty and on the other hand, it requires avoidance of receiving interest. Sharia defines interest as any income derived in excess of loan. Loans involve personal guarantee of debtor and therefore any such benefit would amount to injustice to debtor. In other words, you can only make profit when you don’t enjoy guaranteed return of the principal amount.

Islamic finance is Sharia compliant way of raising funds

Another important aspect of sharia financing is use of money for ethically healthy projects e.g. you cannot invest in projects involving alcohol manufacturing.  

Sharia compliant financial institutions have developed many sharia compliant products including modaraba, musharika, sukkuk, murabaha etc. Let’s discuss them one by one

Modaraba

Modaraba is financing mode in which one person provides financial resources and other labour and skills to carry out business. Both share profit, in pre-determined ratio, while losses would accrue to one who invested financial resources.

Musharaka

Musharka is mode of financing in which both partners contribute capital and divide profits/losses according to pre-agreed ratio.

Sukkuk

Sukkuk is a bond which gives right of ownership, of some tangible asset, to its holders. The holder of instrument then collects profit as rent of the asset.  Three elements of sukkuk as outlined by Taqi Usmani are

·         Sukuk must represent ownership shares in assets or commercial or industrial enterprises that bring profits or revenues

·         Payments to Sukuk-holders should be the share of profits (after costs) of the assets or enterprise

·         The value payable to the Sukuk-holder on maturity should be the current market value of the assets or enterprise and not the principal originally invested,

Murabaha

Murabaha is sharia compliant form of leasing. In this form no amount is charged for late payment as it would constitute interest (Riba). Murabaha has become the most prevalent form of Islamic financing.

How leveraging works

Leveraging (Other People’s Money) is one of the techniques, most used by billionaires to amass fortune. Sam Walton, Donald Trump, Aristotle Onassis, W. Clement Stone, Daniel Ludwig and number of other tycoons applied this principal to set up their empires.

Financial leverage is using borrowed funds to invest in an industry. Say, for example, an investor borrows 1000$ and invest it along with his own 1000$. Now, if the industry generates 20% returns he would be able to produce 33% return on equity as compared to 20% returns he would have generated without leveraging.

The most famous example of application is Aristotle Onassis who borrowed funds from banks, using future cash flow from his already owned ships as collateral, to build more ships. Although Daniel Ludwig was the founder of this technique but Aristotle Onassis is more famous for its application.

W. Clement Stone also used other people’s money to buy other insurance companies. E.g. he bought the Pennsylvania Casualty Company using funds borrowed from the Commercial Credit Company of Baltimore, which owned the company he was buying.

Financial leverage is a double edged sword. Using it can generate super normal profits in good days but it can play against you, as well, by generating extra losses during recession.

Leveraging may help you to be extra vigilant regarding your business expenses. The liability you have under taken in form of funds and interest would pressurize you to be extra careful in your expenditure and you would move towards cost cutting. It may provide impetus for you to work hard. Fed chairman Ben Bernanke, has compared, adding debt to firm’s capital structure, to putting a dagger to steering wheel of your car.   Dagger- which points towards your stomach- would motivate you to drive carefully but at the same time the risk of damaging yourself is very serious when someone else hits you- even if you are driving carefully.

15 Ways to Finance Your Start-up

Not all small businesses need financing. Accurately gauge the need for financing because usually entrepreneurs make mistakes in assessing the need for financing.

There are number of ways in which small entrepreneurs can arrange financing. Some of them are listed below along with brief description.

1.       Bootstrapping is when you reinvest the profits of your business. Growth is slow, when you work your way up, but business decisions are under your control.

2.       Friend and family loans Arab Americans prefer to get loans from family rather than bank. Getting financed from family is easy in strong families as they are more willing to trust you. Regular meetings and communication is important in order to avoid misunderstanding with friends and family.

3.       Savings Utilizing your own saving is one of the most common methods to grow and simultaneously have control over the business decision.

4.       Home-equity Home equity may serve as collateral for a home equity loan or home equity line of credit (HELOC).

5.     Angel investors These are wealthy individuals who fulfill financing needs of start-ups against convertible securities or ownership equity.

6.       Venture capital Getting financed from venture capital is another option. Usually venture capital funds take ownership interest in young companies. They also take part in management of your business.

7.       Crowd funding Crowd funding is pooling funds from large number of people, often using internet. Many websites help you in arranging crowd funding for your venture. Some of the sites are Kickstarter, Indiegogo, etc. The highest amount raised from Crowdfunding is USD$70,000,000. This amount was raised by Star citizen, upcoming video game.

8.       Rotating saving and credit association In this arrangement members of the association meet and every member pay fixed amount. The total amount is than paid to one member. Same cycle is repeated to pay lump sum amount to every member of the society. When every member has received lump sum amount the association is disbanded.

9.       Factoring It is selling your account receivable to financer.

10.   Applying for small business loan Akuwat, and Grameen bank are some of the institutions in developing countries for aspiring entrepreneurs.

11.   Sale and leaseback transaction A company sells some of its equipment to a lessor, such as a bank or another financial institution, which leases the equipment back to the company. Thus the company is no longer the owner of the equipment but keeps the use of it. This commercial transaction allows to companies to have at their immediate disposal the cash to make investments in new business opportunities.

12.  Keep your financing requirement to minimum. Squandering your cash will play havoc with your business. Efficient management is most important thing in keeping your finances under control.

13.  Efficient management Keep your debtors’ collection day to minimum.

14.     Buying on credit. Buying on credit is another means of financing with added advantage that it is interest free. The down-side is that relationship with client can deteriorate if you fail to pay within stipulated time.

15.      Merchant cash advances. It is selling your future credit sales against a lump sum amount. For example if you get 10,000 Rupees lump sum than you have to sell 13000 rupees worth of future sale to the lender.