Numbers are objective and if you know they are true, you’d think they would be useful. It is deeper than that. Knowing a number and knowing what the number means are immensely different.
A George Carlin skit involves him as a sports anchor on TV reporting partial scores.
Yankees 7, Lakers 114, and Notre Dame 21. As they appear are 7, 114, and 21 of any value?
A number by itself means nothing. It must have context before it helps you. When using numbers, especially financial numbers, you should be sure you understand the context before worrying about what the numbers are.
Take $1,000 as an example. It is a cheap car, an expensive hamburger, or a poor monthly retirement income. Maybe a handsome retirement income in some countries. You don’t know what a number means until it fits with other things.
Matching the number with the context is where you find meaning. It might not be as simple as just one match. Most financial statement analysis requires finding many relationships. A fund manager might spend 10 days studying financial statements and using information from prior years, the industry as a whole, discussions with management, and the news, before deciding on a purchase
The analyst creates a value they think is objective and keeps the number up to date as long as they own or might own the stock,. They buy or sell based on what the market creates for a price. The meaning they want is the difference between their calculated value and the market’s creation. Buy low, sell high is their intention.
Few of us could do the analysis a fund manager might do, but we all use numbers. Many of them contain no meaning or sometimes the wrong meaning.
A real-life example of how the rate of return deletes rather than adds meaning if the returns are in one currency but reported in another.
On September 30 2012 the S&P 500 total return index was 2468. On 31 January 2016, it was 3627. In 40 months the index grew 47% or 12.25% annually. However, if you kept track in Canadian dollars the annual rate of return was 25.5%. 5% yields don’t come along every day so you may have invested more.
From 1 February 2016 to 1 May 2021 the American dollar index grew at 10%, not so different from the 12.25 previously. It grew at just 6.6% in Canadian dollars, far less than the 25.5% the investor may have expected.
The example is calculated to emphasize the point. It is not the only one possible to discover. In the late 80s, Japanese investments in C$ were spectacular. YOu could make 50%and feel good about it even though the investment in Yen changed by less than 5%. If you thought you could get a high yield in Japanese funds, you were sadly disappointed when the exchange rate did not work to your advantage.
Pay attention to how the return arises from commercial activity.
The flaw in the analysis is the Canadian dollar looks like a constant but it is not. At September 2012 one Canadian dollar would buy 1.02462 American dollars. On 31 January 2016, it would buy just 70.54 US cents. The 25.5% return looked like it was an investment return but about half of it came from changes in the exchange rate. Similarly, it appears lower than the US$ rate of return in the 2016 to 2021 period because the C$ rose from 70 cents to more than 83 cents.
When you have a compound yield factor, exchange rate and stock market change, You should analyze the yield in its native currency. 12.25 % versus 10% can be studied and the reasons discovered. That is what an investor should care about. The exchange rate is affected by many more factors. Few of them relate to business success or failure. Forex trading is a highly specialized area of trading and the skills don’t overlap investment skills.
If you rely on a single number, even comparatively, you must understand the complete context which in this case includes foreign exchange.
Carrying meaning to your life. Some people are more involved in foreign exchange than they think.
If you travel to Florida for the winter, you can hedge the future value of the exchange rate by having investments that produce income in US$. That also saves the cost of converting which can be substantial.
People who travel by air or on cruise ships are subject to currency variance. Most international airfares and cruise charges are based on American dollars.
You cannot derive meaning if there are variables in the context of the investment you miss or don’t fully understand.
If you act on the meaning you have better success, or at least learn something for the future.
Understand how the businesses you invest in make their money. Yield taken solely on that is more meaningful than it is after currency conversion.
It is harder to understand the native context from far away. You still should have a handle on what is different in the local economy.
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I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Business Development Bank.
Be in touch at 705-927-4770 or by email at firstname.lastname@example.org