Hey friends, today’s menu:

Thank you

Eddie

It’s useful to be aware of inherent emotional tendencies we have.

One such is Present Bias: the tendency to prioritize short-term satisfaction over long-term goals, leading to insufficient saving and excessive spending.

Everyone has some level of this. It’s not just in saving and spending. It’s reaches every part of our lives.

It’s why people who want to get fit buy gym memberships but rarely use them. It’s why people that want to learn a language download Duolingo but hardly use it.

Excessive risk taking for the slim prospect of quick riches is a further example (gambling, shady deals, even crime - ps Greg Martel the infamous $140 million Ponzi scheme criminal from my home town may have finally been found and arrested in Turkey)

It’s so easy to start thinking, maybe I’ll just sell all the SP500 and go 200% levered long energy.

These are completely and utterly stupid ideas, because the risk is too great - especially with a young family to take care of.

At a certain age, things reach a point where you realize things can’t go on like this, and you make an executive decision to do something worthwhile, which also includes doing nothing at all.

Challenge for today: take a pen and paper and write down some of the things you’ve always wanted to do (or stop) and haven’t followed through on. Then write down why you think that is.

Lastly, please watch this 3 minute video my Dad sent to me, from a guy called Don Fernando - a self made billionaire - on his money psychology.

For all the doomslayers out there, I’m going to paint you a picture of how the S&P can double in 5 years (credit Jim Thorne for the simple tweet that inspired today’s entry).

A common way to value the stock market is the Price to Earnings ratio.

Price ÷ Earnings = P/E Multiple.

Today the SP500 index is trading at a price level of ~$7,500 with approximatley $336 earnings per share.

$7,500 ÷ $336 = 22.3x P/E multiple.

Let’s assume earnings per share grow at a 15% compound annual rate.

Using the Rule of 72: 72 ÷ 15% = 4.8 years, that means earnings per share of $336 doubles to $672 in 4.8 years.

Slap a 22.3x multiple on $672/share in 5 years time = $672 × 22.3 = $14,985.

There’s your double on the stock market.

People will go nuts and say there’s no way earnings can grow like that!

Excuse me, of course they can. The average ROE on the SP500 today is 29%. Stock markets broadly follow business performance.

People will yell about elevated valuations. I can’t argue there. So along the way I expect there will be some major pullbacks. It happened in 2018, 2020, 2022, 2024, and it will happen again (just don’t ask me precisely when).

You should welcome that if you are young and continuing to contribute. That means you can buy more shares at lower prices along the way.

The other thing people will flag is the concentration risk with the top 10 companies representing ~40% of the index. Another good point!

But the thing about the future, is it is really hard to know what it will look like and far harder to pick which individual companies are going to excel.

Personally, I put a significant part of our networth into the index that represents the capitalist machine of all the companies that have the capital, the innovation, developing new products and markets, and are leading the AI race, etc.

By doing this I get to participate in the darwinian growth engine that is the SP500.

The capitalization rate, or "cap rate," is one of the most common valuation metrics in commercial real estate.

It is the net operating income (NOI) of a property (rents minus operating expenses) divided by the purchase price.

In other words, if you buy a property for $1,000,000 and it has an NOI of $50,000, it has a cap rate of 5%.

(1) Cap Rate = Income ÷ Property Value

5% = $50,000 ÷ $1,000,000

Think of it like a dividend yield in stocks; essentially the cash flow you get as the owner.

Cap rates are widely used in the industry and with some easy algebra, can help you evaluate key metrics of a property:

(2) Property Value = Income ÷ Cap Rate

$1,000,000 = $50,000 ÷ 5%

(3) Income = Property Value x Cap Rate

$50,000 = $1,000,000 × 5%

Some people might confuse the level of cap rates and impact on value. They might suggest if a property has a higher cap rate, that makes it worth more. Not quite…

Let’s use a transaction scenario to explain futher.

Someone owns a property, it earns $1,000,000 income per year. They want to sell it. They notice similar properties were selling at 4% cap rates last year. Meaning, for every dollar of income, the value ascribed was 1/.04 = 25x.

So they list the property this year at a 4% cap; $1,000,000 ÷ 4% = $25,000,000 - this is the price the seller wants to get paid and based on those real transactions done last year.

But last year is not this year. Interest rates were 3.5%. Today, they are 4.5%.

A buyer comes along and says, nope, that’s too expensive. Since interest rates are 4.50%, and I need to make a bit of profit, I’ll pay a 5% cap rate. $1,000,000 ÷ 5% = $20,000,000. The buyer demands a higher “yield” because they determine 4% cash flow isn’t enough to cover the higher interest payment and other associated risks (i.e. slow economy, low tenant demand, etc).

You can see here, property prices go down when cap rates go up; vice versa, property prices go up when cap rates go down.

It also depends on perspective. For the buyer, there might be more value in buying a higher cap rate property - more dollars of income per dollars invested. For the seller, it’s the opposite, because they are getting paid less.

One final and easy way to think about it is using the residential market. Most of you would agree with the statement that residential prices go up when interest rates go down. When interest rates sky rocket, prices go down.

A whole paper could be written on the cap rate, but hopefully this is a good intro to how changes in cap rates impact prices.

“Lack of discipline leads to lack of opportunity”

—Don Fernando

Where is one area of lack of discipline for you?

Eating habits are one for me. I go through seasons of it. One day I’m eating chicken and rice. The next I’m eating a 2,000 calorie lunch at Five Guys.

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