THE VALUE OF A MEDICAL DEGREE

Here’s Buffett on how to calculate the intrinsic value of a college education:

“Book value is the cost of the college education plus foregone earnings one didn’t receive for those 4 years.  Intrinsic value is the earnings over a lifetime less what would have been made without college discount to grad day at appropriate risk rate.”

Let’s see how getting a medical degree looks in terms of its book value versus its intrinsic value.

Is Medical School Worth It?

First, let’s have our subject attend an Ivy League school to maximize the overall odds of getting into medical school.  The cost of a four-year Ivy League education is approximately $250,000 in hard costs.  Buffett adds in the value of the earning not received, another $100,000, but I’m not going to include that.  I’m going to assume our student goes to a good college.    Total book value of the undergrad education is $250,000.

Now our student attends a wonderful medical school, again to maximize future earnings.  These four years cost about $80,000 per year for a total hard cost of $320,000.  In addition, we now forego a significant income.

Let’s assume we have a smart kid here who, instead of choosing biology, picks finance, graduates near the top of her class and goes on to a career in finance.  This Ivy Leaguer begins her finance career at about $60,000 a year in earnings, with that amount rising quickly.  At the end of four years, she will have taken home (after tax) about $300,000.

Our student’s book value (invested capital) now has an additional $300,000 invested, a new total of $620,000.

Our student is a doctor but the investing is not yet complete.  She now begins a 5-year residency program where she will earn about $50,000 a year while working 80 or more hours a week.  This apprenticeship adds to the investment cost of her career choice.  The alternate choice of a career in finance would have provided our superstar with an income of $100,000 a year after four years in the field and the next five years will deliver another $500,000 in after-tax income.  We have to add to the investment in this career the difference between the $40,000 a year after tax income for five years, i.e., $200,000, she will receive and the $500,000 she would have made in finance.  That is another $300,000 invested.  She now has invested $920,000.

Calculating the Sticker Price

Five years after medical school our doctor begins her career and starts making serious money as a return on her equity (aka book value, aka invested capital).  Now we can calculate the Sticker Price or intrinsic value (aka ‘what it’s worth’) of this ‘business’.

Doctor’s incomes vary widely depending on their specialty and how hard they are working, not to mention the impact of the quasi-nationalization of their profession but let’s assume this five-year residency produces a great surgeon who makes average money in one of the higher paid specialties like orthopedics or urology.  The expected income for that surgeon is about $470,000 a year; after taxes let’s call it $300,000 in current dollars.  Assuming her income will increase at the rate of inflation, we’ll keep that $300,000 as a constant.  In addition, she can probably sell her practice for 3 years of net income in current dollars when she retires in 30 years so in the last year we’ll add an additional $900,000.

Now we can do a calculation that tells us if we should pay $920,000 for this stream of cash.  This is a discount rate calculation and the result is what we call the ‘Sticker Price’ of the business.  Once we know the dollars invested ($920,000) and the dollars coming out ($300,000 for 30 years with a $900,000 payoff at the end), we need to determine a critical number, the Minimum Acceptable Rate of Return (MARR) which the rest of the world calls the ‘Discount Rate’.

We discount future cash flow because common sense says that it is better to receive $300,000 today than $300,000  thirty years from today.  The key question to ask is ‘how much better?’.  Well, the answer to that depends on:

  1. The risk you have of never receiving the $300,000 in 2044
  2. Some reasonable return for waiting for the money instead of getting it today.

Essentially the question becomes this: If I gave you a choice between #1: get $300,000 dollars today or #2: get Y dollars in 30 years, which one do you want, #1 or #2?  Our job is to figure out Y, a number that makes the result of either choice financially the same.

The first step to an answer is to recognize that this is just the inverse of another question: What is my rate of return on a risk-free investment where I won’t get my money back for 30 years?

The answer to that question is the current 30-year Treasury bond interest rate, currently a bit less than 3%.    This is assumed to be the minimum return anyone would accept since every other investment has more risk associated with it.

Since this is an alternate investment to the ‘risk-free’ Treasury bond, the second step is to figure out how much risk there is and then assign that risk a premium return.  In essence what we need to know is what the chances are that the $300,000 a year won’t come in.  As risk goes, a doctor’s income is low on the list but still, there is risk; she could decide she doesn’t like medicine, the US government could nationalize all the doctors and reduce her income, she could get hurt and be unable to do surgery, surgeons might be replaced by robots, etc.

Whole Foods…

Whole Foods faces this sort of problem on a regular basis when considering whether to open a new store.  They can make a good estimate of the after-tax cash flow for the next 30 years, the investment in the new store and the risk of not making the cash flow they projected.  Their standard risk adjustment is to discount the future cash at 9%; this is their MARR, this is the amount they require as a repayment of capital and to account for risk.  Let’s use that 9% for our MARR and see how the Whole Foods discount rate plays out for a surgeon:

Excel Formula: Calculate the Present Value of a Stream of Equal Payments

The excel formula to calculate the present value of a stream of equal payments is:

=PV(rate, nper, pmt, fv) where

rate = 9%,

nper = 30,

pmt = 300000 and

fv= 900000

We do the calculation and here are the results:

Present Value (aka Sticker Price) = $3,150,000.

MOS (50%) = $1,575,000.

Investment in surgeon business = $950,000

Now we compare the present value or Sticker of a career as a surgeon with the price being charged in the market to have that career and we see that $3 million is quite a lot higher than the nearly $1 million it will cost.

There is a nice Margin of Safety that protects the investment from much of the risk.  Therefore, becoming a surgeon still potentially pays well enough to choose it.

By comparison, an Obstetrics doctor will average $257,000 pre-tax and $166,000 after tax.  The residency for OB-Gyn practice is four years.  The shorter time in training reduces the investment from $920,000 to $860,000.  This career has a Sticker of  $1,740,000.  The present value of an Obstetrics doctor’s income does justify the investment and it still has a good MOS.

The lowest paid doctors are the family practice physicians; $178,000 pre-tax, $110,000 after tax.  The Sticker on this practice is $1,150,000 and, with three years of residency required, the investment is $800,000.  It’s still a buy but the recommended margin of safety is gone.  This might at least partially explain why it is getting harder and harder to find residents for primary and family practice.  Kids might not know about doing this financial analysis but their gut tells them something is wrong with investing $800,000 to make $110,000 a year.

This analysis is interesting from an investor’s point of view in that it indicates that the income paid to some doctors is only marginally enough to make sense of the financial investment, not to mention the time and effort it takes to succeed.  It occurs to me that some students who have the ability to become doctors will realize that it might make more sense from both a financial and labor perspective, to simply, for example, become a high school teacher who, after 20 years, can make $110,000 a year, working only 9 months a year, an equivalent income of over $100,000 a year after tax.

One must wonder at the wisdom of a system that pays experienced family physicians and tenured high school teachers an equivalent income despite the vast difference in the minimum work ethic, IQ, and investment required to succeed.

On that point, the 50th percentile IQ of high school teachers estimated by a University of Wisconsin 2002 study of IQs by profession, is 107.   The 50th percentile IQ for doctors according to the same study is 120.  This is also the highest average IQ of all professions.  But by all accounts it isn’t enough to be smarter to get to be a practicing physician; it takes a huge amount of work and sacrifice, an effort that only a very small portion of the population is willing to exert.

Conclusion

My conclusion is that if a high IQ and a great work ethic is the essence of what makes for a financially successful life, doctors should be at or near the top of the pile.  The fact that doctor’s income is dropping while teacher’s income is rising to the same level is a prescription for a disaster in medicine in the future. I’ve created calculators that you can use for free to tell if a business is worth investing in. Click the button below to learn more.

Leave a comment below on your thoughts and join the conversation!

Now go play.

About Phil Town – Phil Town is an investment advisor, hedge fund manager, two-time NY Times best-selling author, ex-Grand Canyon river guide and a former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence. You can follow him on google+, facebook, and twitter.

  • Luis G. Fernandez, MD

    PHIL:

    Great analysis for the MOS and sticker price for the medical student to be. I just went through your recent Live Seminar in Atlanta this past April 2015 and I had to shake my head and open my eyes. I a now in the process of doing my due diligence to understand what it means to be a value investor. I finished Medical School in 1997 and luckily did not have undergrad debt, and “only” came out owing $156,000 after medical school, which I finally paid OFF in 2006. It seemed a daunting process then, so I can imagine what it seems like now almost 19 years later for the new Physicians coming out of training. Thank you for your wise teachings, and look forward to more!
    I will go and PLAY NOW!

  • http://www.etecconsulting.com Keith Jackson

    Great analysis on value of medical school. I know a number of people in the medical professions, and the one in my view with the best financial prospects is my Dentist friend, who has multiple locations. My MD friends are unable to start a practice on their own. A couple are part of group practices. None are surgeons, however. My daughter has talked about becoming a doctor since elementary school. I persuaded her to take the more challenging path of majoring in engineering, to provide more options. She is at her first year at U Dayton, and thinks she will opt out of med school, but still work in medical industry. She will major in Chemical or Mechanical Engineering, then possibly get a MS in Biomedical Engineering, with emphasis on medical appliances and prosthetics for the body.

    I earned BS/MS degrees in Engineering form ILLINOIS and MBA in Finance and Statistics from U of Chicago. I have owned an Engineering consulting practice for 20 years. I share with kids the importance of choosing a career that allows them versatility and growth opportunities. How can they know what they want to do with their life at 18 years old. I encourage them to co-op or wok internships every summer, even if they have to work for free.

    I agree with Garrett’s comments about the student loan disaster. In 1976 when I started at ILLINOIS, it cost about $1200 per semester. Grant it, ILLINOIS is a land grant public school. Total tuition, room and board, and fees for an out of state student is about $45k. Scandalous. Most of the private schools are over $50k. You can get loans to meet your expenses. However, leaving college with even $100k in loans is a formula for disaster.

  • Garrett

    Rulers,
    Quick fact:
    It took our nation 216 years to rack up the first $8.5 trillion in debt… then just 8 more years to more than double that amount.
    http://www.usdebtclock.org

    Yet, Mr. Market is up, commodities are down, cost of energy and oil is down. There is $2.00 gas at the pumps, US Dollar is actually strengthening against other currencies, yet 50% of Americans are on some sort of gov’t handout. This is not normal or rational. Something is out of whack with reality and common sense.

    Again, from the May 2014 Berkshire shareholders meeting, Warren and Charlie had this to share – so if they can’t figure it out then there’s little hope in my trying to predict what happens or when it happens:

    Warren: This is an interesting movie; we haven’t seen it before and don’t know how it ends. I think [Ben] Bernanke was a hero at the time of the crash and panic, and subsequently. A very smart man and handles things very well. When the Fed minutes came out then, it was interesting to me how the members of the Fed weren’t getting it, some didn’t understand just how serious things were. So I give particular credit to Bernanke since he wasn’t getting unanimous view and went ahead with necessary moves. I feel the same about [Janet] Yellen, but do not know the answers to what happens if you keep rates close to zero for so long. I’ll be interested to hear Charlie’s thoughts.

    Charlie: Well, nobody, for instance in Japan, would ever have anticipated interest rates would go way down, and stay low for 20 years. And no one would have anticipated that stocks can go way down, and stay low for 20 years. And if you think you understand, you’re not paying attention.

    Warren: In 2008, I wrote an article saying cash is king if you use it, but dumb if you weren’t. People cling to cash at the wrong time. Zero rates have had a huge effect on rejuvenating economy and asset prices. –

    …And I guess that’s really it …..”Zero rates have had a huge effect on rejuvenating the economy and asset prices.”

    Eventually, Mr. Market will get bid back up to a high PE or something will happen in the world that will create a huge sell off. In the meantime, I’m staying 50% cash or more and staying invested in the few companies I own that either have very little market risk since I bought them a long time ago or in other companies I’m still waiting for Mr. Market to realize their full potential as “The Story” hasn’t changed and I’m waiting on Management to finish doing what they said they were going to do that would unlock the value of why I bought it. Ie…like built a new factory to lower cost etc…Those things take time but as long as we’re on schedule without any huge obstacles, then we just wait – kind of like if you were building an apartment complex. It’s not worth much half finished…so you don’t sell in the middle of the project – you wait. And that’s what I’m doing in some companies.

    IBM is an interesting company and has some huge potential to lower market risk with their share buybacks. You can learn all you need to know about IBM by reading hours and hours worth of Seeking Alpha commentary. Buffet is still “all in” on IBM.

    To Your Wealth!
    Garrett

  • Garrett

    Noel,
    Well, thank you sir for you kind post. I’m in Dallas today and instead of reading Phil’s blog I should probably be reviewing my study cards for tomorrow’s flight simulator. Next two days it’s all flight simulator training for Southwest Airlines.

    I’ve often used Phil’s blog as my own form of therapy! Most of the time I’m just writing out my thoughts to clarify things – did that a ton a few years ago – It was how I ended up meeting Phil. I had lost over half a million in various investments and I just kind of typed those thoughts out his blog – people around the world seemed to relate so I just kept typing and sharing. All those posts are buried deep over the years now on Phil’s old blog site. I just paid off one of my bad real estate deals from years ago that cost me a few hundred thousand. I’m the proud owner of a piece of real estate in North Carolina near the ocean that I’ll probably never build on nor be able to sell for what I paid for it.

    The bottom line is life happens – I made some investments that didn’t work out. And I made a few that did. But I’d rather lose big money than have some serious health issues. We’ve never been in bankruptcy – we just worked really hard and we never made an investment that would put us on the street – My wife and I have recovered because we’ve saved what we can as working professionals.

    All those very hard lessons learned led me to Rule #1. That’s the only thing that makes sense. And Rule #1 is the same whether you’re buying real estate or Panera stock. I have a few investments in real estate with my wife’s IRA and a non-retirement account (some people don’t know they can use an IRA to buy real estate) and of course we have some investments in equities.

    Getting late and need to be on my game for tomorrow’s fight simulators!

    To Your Wealth!
    Garrett

  • Garrett

    Rulers,

    I found a great un-official transcript of Buffett’s May 2014 Annual Shareholder Meeting. Here’s a few pithy statements from Buffett and Munger that I’m pasting here as I’m reading it:
    —–
    You said in 2009 if you had to invest your wealth in just one company, it’d be Wells Fargo. What would you say today?

    Warren: I would’ve answered Berkshire (if allowed). I wouldn’t quarrel with Wells Fargo. That’s a great question, but it’s not going to get an answer.

    Charlie: No, I think you gave exactly the right answer.
    —–
    Do you and Charlie ever fight or argue? How do you manage your partnership?

    Warren: Charlie and I have never had an argument. We met when I was 29 and he was 35. We have disagreed on a lot of things, but it never has and never will lead to an argument. We argue with other people. It just never has occurred. I called Charlie about the [Coca-Cola] proxy statement.

    Charlie: That’s one of the problems. Most the time we think alike. If one us misses, the other one will too.

    Warren: No question. If you look at the really bad mistakes, I’ve made them. I’m a little more inclined toward action. would you say that’s true, Charlie?

    Charlie: Well, you once called me the “abominable no-man.”
    ——
    See’s has provided us with lots of cash for acquisitions and opened my eyes to the power of brands. We made a lot in Coca-Cola partly because of See’s. There’s something about owning one [a brand] to educate yourself about things you might do in the future. I wouldn’t be at all surprised that if we hadn’t owned See’s, we wouldn’t have bought Coca-Cola.

    Charlie: There’s no question about the fact that See’s main contribution to Berkshire was ignorance removal. One of the benefits of removing our ignorance is that we grew into what we are today. At the beginning, we knew nothing. We were stupid. If there’s any secret to Berkshire, it’s that we’re pretty good at ignorance removal.
    ——–
    In recent times, prolonged periods of low rates have cause problems. If you were running the Fed, what would be your policy on rates?

    Warren: Who would have guessed five years ago you’d have rates this low this long. I am surprised how well it’s going, I wouldn’t do much differently, and I would like to say I’d have done the same since it’s going so well. This is an interesting movie; we haven’t seen it before and don’t know how it ends. I think [Ben] Bernanke was a hero at the time of the crash and panic, and subsequently. A very smart man and handles things very well. When the Fed minutes came out then, it was interesting to me how the members of the Fed weren’t getting it, some didn’t understand just how serious things were. So I give particular credit to Bernanke since he wasn’t getting unanimous view and went ahead with necessary moves. I feel the same about [Janet] Yellen, but do not know the answers to what happens if you keep rates close to zero for so long. I’ll be interested to hear Charlie’s thoughts.

    Charlie: Well, nobody, for instance in Japan, would ever have anticipated interest rates would go way down, and stay low for 20 years. And no one would have anticipated that stocks can go way down, and stay low for 20 years. And if you think you understand, you’re not paying attention.

    Warren: In 2008, I wrote an article saying cash is king if you use it, but dumb if you weren’t. People cling to cash at the wrong time. Zero rates have had a huge effect on rejuvenating economy and asset prices. We are not in a bubble situation at all right now, but it is an unusual situation.
    —–
    Can you please share your views on the oil sands industry and the impact on Berkshire?

    Warren: We have a crane business at Marmon that does a lot of business in oil sands. We will soon have a transmission business that will cover part of Alberta — 8,000 miles of transmission lines. We are moving 700,000 gallons of crude oil on our railroad.

    Oil has flexibility in where you take, to take advantage of spreads. Oil gushes through pipelines, but railroads are twice as fast at moving oil. We recently bought a company from Phillips 66 that has chemical additive that allows oil to move faster through pipelines. Oil sands are an important asset for mankind over the centuries. But I don’t think it will dramatically change things at Berkshire.

    Charlie: A lot of the oil sand production uses natural gas to produce the heavy oil. So, it’s a very peculiar thing. It’s economic only if oil prices remain very high, and natural gas prices remain relatively low. So, I think it’s good for mankind. But I don’t know about the investment merits.
    ———-
    You have said that people should operate within their circle of competence? How should we figure out what our circle of competence is?
    Warren: Good question! Some of the people in the audience identify with it (laughs). Be self-realistic. That applies outside of business as well. Charlie and I are reasonably good at knowing the perimeter of our circle of competence.

    Being realistic when realizing you own shortcomings is important. There are a number of CEOs who don’t know where their circle begins and ends!

    The best really know when they are playing the game that they’re going to win. The ultimate was Mrs. B at Nebraska Furniture Mart. She told me she wanted cash, not stock. It might seem like a bad decision, but it wasn’t. She didn’t know stocks. She knew cash, property and retail, so it was a good decision.

    When you’re playing the game, versus playing outside the game, knowing the difference is a huge asset. I can’t tell you how to do that yourself. Asking your friends who know you may help. Charlie’s helped me, telling me, “What the hell do you know about that?”

    Charlie: I don’t think it’s as difficult to figure out competence as it may appear. If you’re 5-foot-2, you don’t have much future in the NBA, and if you weigh 350 pounds, you shouldn’t dance ballet. If you can’t hardly count cards at all, you shouldn’t try playing blackjack. But competency is a relative concept. What I need to get ahead is to be better than idiots, and lucky for me there was a lot of them.
    ——–
    Why do you annually compare growth in Berkshire book value per share (BVPS) to the S&P 500?

    Charlie: Warren wants to make it extremely difficult for himself. So if you don’t understand why people want to wear hair shirts, then you’ll never understand this. It’s insane, you’re right. It’s a way for Warren to make the comparison extremely difficult on himself.

    Warren: Normally when he goes wishy-washy like that I like to clarify, but I think I won’t.
    ———-
    Being a young person without an ability to code or build robots, I don’t know technology. If you were 23 years old, what non-tech industry would you start a business in?

    Warren: I’d probably do just what I did at 23, I would go into the investment business and I would look at lots of companies, talk to lots of people and learn what I could about different industries. One thing I did when I was 23: If I got interested in a coal business, I’d go and see the bosses of eight or 10 coal companies. I’d ask a lot of questions.

    One question I would always ask: If they had to put all their money in a company in the industry and go away for 10 years, which would it be. And if they had to sell short under the same conditions, which company would it be and why? And, if I talked to everyone in the industry like that, I would know more about the industry than anybody.

    There’s lots of ways to learn about the economic characteristics of companies, such as reading, personal contact, etc… But, you need a real curiosity about it. It really has to turn you on. And, what could turn you on more than asking questions about, for instance, coal companies? (laughs) And in my case, the insurance industry was particularly interesting, and perhaps you could become well equipped to run such a business some day. If you just keep learning things, something will come along that will be very useful. But you have to be open to it.

    Charlie: Try the trick that Larry Bird used when he wanted a new contract, he asked all agents what agent he should hire if he didn’t hire that agent, and when they all came up with the same second choice he went with that second choice.

    Warren: We did the same thing for Salomon. I called in eight or 10 of the managers. We had to open for business, and I had to have someone to run the place. I said “Who besides you would be ideal and why?” And one guy told me no one could compare to him. He was gone within a few months (laughter), but it’s not a bad system to use. You could really learn a lot just by asking (sounds like a Yogi Berra quote, but it’s true).

    People like to talk. You just have to be open to it, and you will find your spot. You may not find it the first day of the week, but you’ll find what fascinates you. I found it when I was 7 or 8. Sometimes it’ll take a while, but you’ll find it.

    Charlie: It’s a very competitive business. When I was at Cal Tech and studied thermodynamics, there was a guy who was tremendously talented at thermodynamics. I realized that I’d never be as smart as him in that field. I tried other industries with the same results, so I just kept doing that until I ended up here.

    Warren: I had a similar experience with athletics (laughs).
    —-
    Berkshire paid $8.9 billion in taxes. Pfizer is considering a move offshore to reduce taxes. Would Berkshire consider that?

    Warren: I think the answer is no, what do you say Charlie?

    Charlie: I think it would be crazy to be as profitable as Berkshire and get off that easy on taxes.

    Warren: We could not have done Berkshire in any other country other than the U.S.A… America is in a very, very good way. Charlie and I have become very, very rich…

    Charlie: I’ve got no complaints. And I look around at these people, they seem like very happy people. I don’t see them gnashing their teeth.

    Warren: But I don’t want to make it holier than thou. When we get all through the 20,000-page tax return, we don’t add a tip of 20% or anything. And we do certain transactions which are tax-advantaged, and we do certain deals that are tax-driven. Wind energy deals and solar energy deals don’t make economic sense without tax benefits.

    We follow the rules. We don’t begrudge the taxes we pay.
    ———
    I’m a big fan of [Benjamin] Graham and [Philip] Fisher. What differences do you have for calculating intrinsic value than described in Security Analysis? For instance, how do you factor in management? Second, what company do you fear the the most? Why has no one done what you have done?

    Warren: Graham didn’t get too specific about intrinsic value in terms of precise calculations, but intrinsic value has become the same as private business value. Now, I’m not sure who first came up with it — well, actually, it was Aesop. The intrinsic value of any business is the present value of all cash distributed between now and judgment day. We’re not perfect in judging that, by the way. Aesop said a bird in the hand is better than two in the bush, in 600 B.C., and that hasn’t been improved much by business professors since then. The question is: How sure are you that there are two in the bush, how far away is the bush, what are interest rates? Aesop wanted to leave us something to work on, but that’s intrinsic value.

    Fisher would say he’d want to look at the qualitative factors in calculating the value of the birds in the bush. Graham would say he wants to see the $2 in the bush, one looking at qualitative factors and the other in quantitative factors. I started out influenced by Graham, so I emphasized quantitative factors, and Charlie came along and said I should value qualitative factors. And he was right. It’s really cash in, cash out.

    If I had a silver bullet, what company would I shoot? I see no competitor to Berkshire. I see private equity buying lousy businesses and leveraging up while debt is cheap. Which is the main occupation for Charlie and me. But I don’t see anyone with a model or trying to build one to go after what we are trying to achieve, which is buying a business from people that care about who they sell to.

    Charlie: The Berkshire model as now constructed has legs and will go on for a long time. It has enough advantage that it will just keep going a long time and most businesses don’t. Of all the great businesses of yesterday, few have gotten big and stayed big. We’re getting to a territory where very few other people have done very well. But I think we’ll just keep going. We will keep doing what we’re already doing. We’ll keep learning from our mistakes. The momentum’s in place, the ethos is in place. It’s going to keep going. For the young people in the audience, don’t be too quick to sell the stock.

    Warren: Why don’t we get more copycats? [to Charlie]

    Charlie: It reminds me of Ed Davis, he took on an operation and he made this operation his own and all the other surgeons came and wanted to copy him. and they watched him do this operation and they said, well this is really hard and so maybe we won’t copy him.

    Warren: Ed Davis is the guy who introduced the two of us, a famous urologist in Omaha. I think slowness turns off more people than anything else.

    Charlie: It doesn’t look all that easy. It’s slow. The difficulty of being slow is that you’re dead before it’s finished.

    Warren: Well, that’s kind of cheerful.
    ———
    On a more cheerful subject: inflation. In your 1981 shareholder letter, you discussed ROE, inflation, and that Berkshire was not immune. Today, it seems like every central banker is desperate to create inflation. Should investors and business owners be thinking about inflation? How would it affect Berkshire?

    Warren: Only compared to Charlie could inflation be cheerful. Inflation would hurt us, but would hurt most businesses. Certain assets that are highly leveraged would benefit from inflation.

    Let’s assume that all over the U.S., $1 million was given to every household. Would the U.S. be better off? One thing I can guarantee, Berkshire would be worse off. What I describe would be wildly inflationary. The trick is realizing you’ve got a million dollars before everybody else.

    You don’t create wealth by inflation. You can move it around, but you don’t create it. Berkshire’s earnings per share would go up, our intrinsic value in dollars would go up, but the value of the business in real terms would go down.

    But, if you own a home and inflation wipes out the mortgage, you’d be better off.

    Charlie: We had a test of hyperinflation in Weimar Germany. The people that owned stocks like companies like Berkshire, they got through. And everyone else got wiped out. Of course, if you create so much misery that you get hit by war and Holocaust and so forth, it’s not a good idea to let it go that far. I don’t like this huge confidence of people creating a whole lot of money and spending it. I don’t forget Weimar Germany, and I don’t think the U.S. should, either. I don’t think we should risk blowing up the whole thing because of some crazy politicians. And in Weimar Germany they gave you back the mortgage at the end.

    Warren: Well that’s very interesting. He’s way ahead of me folks!
    ———-
    What are your thoughts on the education in U.S. and China in the future?

    Charlie: We certainly are getting the easy questions right now…

    Warren: Whatever he [Charlie] says, I agree with him (laughs).

    Charlie: I think America made a huge mistake by letting the public school systems go to hell, and I think the Asian countries are much less likely to do that. And I think that we should be more like them.
    ——
    To Your Wealth!
    Garrett

  • Garrett

    Rulers,

    “Stocks plunge as oil prices drop below $50 per barrel”

    Only in a messed up world would reduced energy prices cause everyone to panic!

    For those countries that rely on oil as their main export – sure – there is good reason to panic. But for the average US Citizen, it’s quite nice. As even my daughter has appreciated her “pay raise” at the pump when filling up the car.

    It appears, at least on a technical level, we’re going to see oil prices continue to drop. I’m mostly out of the oil business (sold out of BP at $45 per share last year) and waiting to see where/when oil finds a bottom. There isn’t any indication that we have yet – so we wait.

    There’s a psychological floor for oil at the $40.00 price range. That’s the number I’m waiting to see before I buy any tranches of any oil companies. And before we buy an oil companies, we have to be able to figure out what per share price we’re willing to pay for them. This is challenging in a commodity biz if we can’t nail down the price of our commodity – which is oil in this case.

    But eventually, the big guys will price the big oil companies at a price that is consistent with the volatility in oil prices.

    Remember, long-term Mr. Market is mostly rational – and gets it right. As Rulers, we’re looking for an EVENT that causes short-term panic and allows us take opportunities when others are fearful. We are in one of those events now. Actually, we’ve been watching the EVENT unfold since summer of 2014.

    Be patient – wait and read. Get BP and XOM seeking alpha articles forwarded to your inbox so you can keep yourself in the game and know what’s going on. That’s what I’m doing. And if I can get a great dividend paying company like XOM and BP at a discount, then I’ll buy a bunch and just sit on it for 20 – 30 years.

    If you’re a 401K investor with your money following the S&P 500 then you’re doing great – The S&P 500 set up with a big picture Monthly View using “The Tools” shows that we’re still “all in” as of about Feb 2012 when it was trading around $1350ish. Had I done that last year, I’d have done better than trying to buy big oil – And wouldn’t have had anything to think about!

    To Your Wealth!
    Garrett

  • Garrett

    Rulers,

    It’s time to get back to work. My 401K portfolio was doing great in June of 2015 – ahead of the S&P 500 and then tanked with the drop in oil prices. Now I’m still mostly cash and waiting to buy at deep discounts. All the value investors say not to mind the yearly gains/losses – just make sure you’re buying great companies at great prices. So I’ll just wait and let the dividends and covered calls reduce basis – which reduces my market risk.

    I thought I’d share some of my personal thoughts, concerns and goals for 2015. Perhaps some of you may find comfort that I too believe we’re all messed up one way or another, all confused, all have that person in our family that has gone astray and all share a common concern for the future.

    We spent some time up in Montana for Christmas and watched the snowfall accumulate on the deck and in the trees. Absolutely gorgeous.

    Some of us on the blog have read Guy Spier’s book,”The Education of a Value Investor” and may remember one of his lessons was to “get away” from WallStreet and find a place far away from the noise. He went to Europe, Buffett went to Omaha, Pabrai went to the opposite coast in Irvine, California…me…I’m content someday to check-out in the backcountry of Montana.

    That’s where time slows down for me. My mind clears, I’m less concerned about the future and can just rest in the beauty of the mountains. I spent each morning just looking out the window – not really too concerned what my investments will be worth in 20 years.

    While the family was out and about, I sat down for awhile and just brainstormed a list of short-term one year goals. At least I have a plan – an idea where and what we want to do. A few things I’ve learned about life is that it generally changes in an instant – with a choice, and opportunity, a phone call. -Sometimes good, sometimes bad.

    My golden retriever is getting weak. She’s having a difficult time walking – stumbling over herself as her arthritis is getting the best of her – yet she’s still always at my feet. Over the last two months, it’s been a significant decline – like the price of oil I guess. $420.00 later on a Vet bill, her vitals are all good – she’s just very arthritic. We’re giving her some meds for the pain and inflammation. I wonder if 2015 will be the year we put her down.

    One of our goals this year is to sell our home here in Maryland and significantly downsize to a small two-bedroom house in Florida to be next to my mom and dad. Florida is not really my thing, but in March dad turns 75 and I know like our golden retriever, dad is going to slow down a lot over the next 5 years. We want to get down there so we can have good memories while everyone is still healthy.

    Other goals – I’m on Day 3 of my Insanity 60 Day program – which I’ll follow up with more of the same after day 60 so that by the time summer comes around I can check out for two months in the mountains. We stay fit all year ’round – but I definitely eat more ice cream starting in November and now it’s time to work that layer of fat off.

    Our daughter starts college in the fall at the University of Tampa – so I suppose no matter how much money you’ve saved it’s just never enough for college. If you’re 18 years behind us in your college savings plan, might as well just cave in to the fact that it’s going to cost twice as much as you think – Downsizing to Florida may make it more affordable!

    Today I’d like to share an article I read on Gurufocus. Rather than reading the WSJ headlines, sometimes it’s better to just read a few graphs on Oil Supply/Demand.

    http://www.gurufocus.com/news/303570/the-truth-about-oil-is-not-what-you-think-it-is

    To Your Wealth!
    Garrett

    • Garrett

      typo in that first sentence- I meant “My portfolio was doing great in JUNE 2014 – ahead of the S&P 500 and then tanked with the drop in oil prices.”

      Garrett

    • noel

      Of all the comments you have posted on the blog, sharing your insights with us, I think this one speaks volumes on your character as person. Kudos to you on those goals and setting them in action. Noel

  • david wang

    Hi Phil, My son is going to medical school next year. The decision was not made by debts accumulated, but by his passion to be a doctor.

    On today’s seminar, you mentioned that to check 13f, can you give us the link? http://www.sec.gov/13f, I cannot find it.

    Thanks.

    David Wang

    • Mike Mac

      http://www.sec.gov/answers/form13f.htm

      You can search for and retrieve Form 13F filings using the SEC’s EDGAR database. To find the filings of a particular money manager, use the “Companies & Other Filers” search under “General Purpose Searches” and enter the money manager’s name. To see all recently filed 13Fs, use the “Latest Filings” search function and enter “13F” in the “Form Type” box.

  • Rob Steele

    That is a very interesting way of determining the value of a medical degree. The one thing that would be of interest would be the additional value of actually being able to be a doctor. The satisfaction of a successful surgery, or as a family practitioner the admiration from a desperate family that you were able to correctly diagnose a fatal but curable disease, in their only child. The pure joy of helping people. How could this be calculated compared to a career in finance?

    • beau

      Rob, I don’t think it can calculated. You would also have to factor in the hardship of losing an incurable patient. This blog might not be the place for that argument, but I think the calculation we can make for ourselves is the ability to provide for our families as if we were doctors. That aside, the ability to work finance hours is another calculation we could put on the finance side of the equation.

  • Garrett

    Rulers,

    Here’s an example of a sweet Rule #1 Trade:

    On Dec 16th, you could have bought BP at $35.05 at the open and simultaneously Sold to Open the Jan $35 BP PUT for $4.35. Right there, that’s a pretty sexy basis for a first of four possible tranches.

    Four trading days later you could have sold the shares for a nice profit making $4.05 / $35.05 =’s 11.5% and closed the Jan 2016 $35 PUT for $1.65 profit.

    If you don’t know what that means or how to do that, then I’d encourage you to get into Jeff Town’s class like some of the fellow blog contributors (such as Moncho) have done. Contact Michelle at support@ruleoneinvesting.com.

    To Your Wealth!
    Garrett

  • Garrett

    Rulers,

    Today I read an interesting article as I continue to try to understand the fact, fiction, truth and lies about why oil is $55.67 today. And it reminded me that sometimes we’re not asking the right question.

    For example, I just googled “10 Year Price of Oil” and looked at some charts.

    Here’s the question that investors and drillers should be asking – “Why did the price of oil rocket from $20 a barrel in 2001 to more than $150 a barrel in 2007, before stabilizing around $100 for the last 5 years.”

    Did demand suddenly surge to such unprecedented levels? Did demand today suddenly drop to such unprecedented levels?

    I suppose there is probably some truth to every pundit and talking head on CNBC that is parroting the same media driven explanations for the lower price of oil. But I think the bigger reason might just be our friends at The Fed and the herd mentality of the institutional investors.

    The Fed has pushed up oil prices over the last 10 years the same way they pushed up other commodities like the gold run, real estate, stocks, bonds etc.

    I think oil went higher because the herd at Wall Street believed that the Fed would keep printing money. And a weaker dollar causes oil prices to rise.

    What does the Wall Street herd believe today? Today they believe that the Fed is going to tighten and raise interest rates.

    If they believe that, then the oil bubble gets popped.

    But I think the Wall Street herd is wrong. I don’t believe the Fed can EVER raise interest rates – at least not in any meaningful way. The US Gov’t debt can’t handle it. So the party continues – to the tune of the S&P 500 PE Ratio at 20.16 and the Shiller PE Ratio at a bubbly ratios of 27.29

    In a normal, un-manipulated market, people would rejoice at the cost of energy going down. That’s logical. But in our messed up and manipulated markets, suddenly lower energy costs are scary. That’s because lower oil prices could mean global recession and deflation – The Fed’s worst nightmare – yes, cheaper prices scare them – their logic is if prices are cheap, people are getting laid off. And if prices are raising, people are getting hired. Don’t try to understand them or it – they’re Keynesian Economic Distortions of Reality.

    It’s all so insane, sometimes I just want to go backpacking and never come back – maybe my wife and I should go hike the Pacific Crest Trail next year and just “check out” for a few six months!

    In fact, if the Fall of 2015 begins another round of our 7 year cycle of huge market corrections, then what will the Fed Do? The only thing they can do is print. Here then comes QE 4. And when the economy goes into recession (if it does next year) and the Fed prints, wouldn’t that be a huge catalyst for the price of oil to go back up as it did in 2001?

    And how does the Fed unwind their 4 Trillion dollar balance sheet? I don’t have a clue. All I know is that none of it ends well. I just don’t know when it ends or bad it gets when it finally gets bad.

    So what do we do? The same thing we always do as Rulers. We buy great companies that are on sale that meet our 4M requirements. However, I have to be mindful of something – Be careful what shares you load up on! What looks cheap today may be expensive in 9 months!

    To Your Wealth!
    Garrett

  • Garrett

    Rulers,

    I like how Phil demonstrated the above in his headline. I’ve had similar thoughts though not as detailed. I’ve often wondered what our daughter for a career if we paid $50,000, $100,00 $150,000 or $200,000 for a college education? Many times college seems like a scam to me.

    I’m of the opinion that the US Government has totally screwed most Americans with exorbitant college loans. Rather than Universities lowering their costs and reigning in spending, they’ve raised them to ridiculous levels and the US Gov’t made it worse by giving out low interest rate loans to pay for them. There was/is zero incentive for colleges to lower tuition if parents and kids can defer it with a “low monthly payment.” What a scam.

    Had the Gov’t just stayed away, colleges wouldn’t have been able to keep raising their tuition rates. Now, kids graduate with no job, $50K or more of debt and little to no chance of every providing for their own financial security.

    The need for a car, home and children suddenly divert any money that could be going towards a retirement. The college loans take priority over their financial future. It’s a horrible situation as a young adult.

    Personally, when I look around me I truly don’t know how 80% or more of Americans my age (soon to be 45) are ever going to have any kind of financial security when they can no longer work.

    My wife and I are in the minority for W-2 Wage earners – we’ve both succeeded at making a descent living and have the ability to sock away a pretty good amount of money each year towards our retirement accounts. But I have plenty of friends that simply won’t have anything. They’ll probably have a house paid off – nothing else.

    The only people I know that appear to believe they have any financial security are the Federal and State employees – they have pensions. Now, if I were in their shoes, my fear would be that such a pension won’t be worth much in 20 years due to inflation.

    To Your Wealth!
    Garrett

    • John Kerr

      Unfortunately the time has come to drop Medical School and becoming a Doctor the same way the rich dropped the boating industry. Wait till theres a shortage and government gets out of our way.