RIGHT NOW: 12 INVESTING MISTAKES of Physicians to Avoid in Late 2022!

A MEDICAL “TREATMENT PLAN” APPROACH

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By David Edward Marcinko, MBA, CMP®

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MEDICAL TREATMENT PLAN: A detailed plan with information about a patient’s disease, the goal of treatment, the treatment options for the disease and possible side effects, and the expected length of treatment.

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COMMON INVESTING MISTAKES

Fees are down, expenses are up and the days of fat profit margins for physicians are over. Managed care in some form is here to stay. The tidal wave of baby boomers approaching retirement suggests the pendulum will not swing back to the “good old days” of fee-for-service medicine. Even the venture capitalists are laying off doctors because of the corona virus pandemic. And, the ACA and U.S. government, the payer for more than 50 percent of the covered population, continues to ratchet down reimbursement. Accordingly, many doctors are now working harder than ever. Unfortunately, they are also prone to irrational investing behavior and making more investment mistakes than ever before.

Here are the Institute of Medical Business Advisors’ “dirty dozen” investing blunders of physicians. Indeed, we see these common miscues among a variety of medical professionals.

Mistake 1: Having No Investment Policy Statement
Just as one would not think of treating a patient without a careful history and physical examination, you should not embark on investing your hard earned capital without an investment policy statement (IPS). This important document separates do-it-yourself investors, financial salesmen, stockbrokers and amateurs from true financial professionals.

An IPS is a document specifically detailing what you want your money to do for you with an understanding of who is to do what and how they are supposed to do it. It may be three to five pages long for an individual physician, 10 to 15 pages for a small medical group retirement plan or dozens of pages for a clinic or hospital endowment fund.

Treatment plan: A properly written IPS should contain the following:
• Statement of purpose
• Statement of responsibilities
• Investment goals and objectives
• Proxy voting policy
• Trading and execution guidelines
• Asset mix guidelines
• Social policies or other restrictions
• Portfolio limitations
• Performance review benchmarks
• Administration and fee policy
• Communication policy
• Reporting policy

Mistake 2: Not Diversifying Portfolio Objectives
Although the media frenzy of a few years ago has subsided, anecdotes of easy money still abound and doctors may forget that investment portfolios serve a specific purpose (e.g., retirement, college funding, etc.) within the content of a broader financial plan. Moreover, a single investment may become too large or too small a portion of the portfolio. This may be due to market growth in one component or slack in another.

Treatment plan: Diversify, monitor your holdings and select components with your risks and goals in mind. Time horizon and risk tolerance are likely to change as will the investment environment. One key contribution of modern portfolio theory (MPT), according to the 1990 Nobel Prize winner Professor Harry Markowitz, PhD, is the understanding that diversification can reduce portfolio risk. Indeed, the specific risk of a single stock may overwhelm any justification for failing to diversify.

Consider investing in sectors like basic materials, capital goods, communications and services, technology, consumer cyclicals and non-cyclicals, healthcare, energy, financial services and utilities. Investors can purchase most as individual securities, in mutual funds or as exchange traded funds (ETFs) or worldwide equity benchmark shares. Do not forget about cash equivalents, treasuries, zero coupon and municipal bonds and international securities.

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Mistake 3: Forgetting The Investing Risk/Return Tradeoff
Some physicians fall into the trap of chasing “hot” securities like hedge funds, limited partnerships, non-registered securities or alternate investments promising high returns. High returns are associated with increased investment risk. Accordingly, it is important to understand the risks embedded in an investment before it becomes an exposed reality.

Treatment plan: Beware of projecting historic averages going forward. The stock market is inherently volatile. While it is easy to rely on past historic averages, there are long periods of time where returns regress from their long-term historic mean. On the other hand, slumps eventually correct themselves so you should continue a prudent investing plan.

Do not confuse investing with trading or speculation. According to Gene Schmuckler, PhD, the Director of Behavioral Finance for the Institute of Medical Business Advisors, Inc., there are momentum-driven market periods when investors start to believe profits are easy and there is always a “greater fool” to buy at a higher price. Such trading has more in common with gambling than investing. Avoid market timing and the urge to jump in or out at every economic hiccup.

Mistake 4: Not Factoring In The Impact Of Taxes
The desire to avoid capital gains and other taxes as a result of solid investment returns may lull some doctors into a false sense of security. An attractive investment and a slick sales pitch sometimes hide the underlying tax costs of the investment, especially when the investment is questionable. This leads doctors to give up a significant portion of the long-term growth of their assets.

Treatment plan: Income tax brackets, rates and estate taxes are almost at an all-time low in the U.S. This good fortune is due in part to the Taxpayer Relief Act of 1997, the Economic Growth and Tax Relief Reconciliation Act of 2001, and the Job and Growth Tax Relief Reconciliation Act of 2003, among other tax credits and deductions. Some mutual funds, for example, are not tax efficient while some ETFs may be tax efficient. Strive for legitimate tax reductions and avoidance but remember that tax evasion is illegal.

Mistake 5: Not Factoring In Fees And Expenses
Front-end loads, back-end loads, disappearing and hidden loads, 12-b1 fees and commissions, and advertising and sales expenses can all have a significant impact on a particular investment program.

Treatment plan: Monitor the costs of your investment program to ensure that total costs are known, reasonable for the services provided and are not consuming a disproportionate amount of the investment returns. Carefully consider full-service versus discount brokerages.

Take care using discretionary assets under management (AUM) accounts where you pay a percentage for personalized money management. More often than not, these one-size-fits-all accounts are aggregated under a larger automated umbrella to harvest economies-of-scale automatically. Indeed, the mistaken notion that the advisor “is sitting on the same side of the investment table as you” starts deteriorating on critical reflection. Do not fall for the siren sales pitch (“If I make money, you make money”). Excessive risk taking, purchases and sales activity may be at your expense.

Carefully consider whether golf balls, seminars, football game tickets, pens or quarterly meetings with your “advisor” are worth the price you may ultimately pay for these minor trinkets and services.
For example, in a 2 percent AUM program of $1 million, you may pay $20,000 annually, which is automatically deducted from the account. Are these “perks” worth $200,000 over the course of a decade? During the “golden age of medicine” in the ‘80s or the ranging bull market of the ‘90s, some doctors may have thought it was worth it. What about during a bear market or the projected market of lower than average returns that may be upon us?

Other problems with AUMs include: a higher fee to managed stocks than bonds, creating an equity bias; bias against paying of the mortgage, practice or acquiring real estate; bias against gifting initiatives or charitable intent. These are all problematic for the same reason that over-weighted equity classes increase advisor compensation while these other equally important considerations do not.

Mistake 6: Inappropriate Risk-Management Techniques
Traditionally, physicians protected their families with life, disability, malpractice and business interruption insurance yet insurance products are not investment vehicles. They merely indemnify against catastrophic economic losses that are typically extinguished over time. Behavioral economists like Daniel Kahneman, PhD, of Princeton University, and Vernon L. Smith, PhD, of George Mason University, warn us to use these insurance products carefully since we tend to experience financial losses more intensely than gains and evaluate risks in isolation.

Additionally, a comprehensive risk management plan for doctors must acknowledge risks such as sexual harassment risks; workplace violence risks; Medicare documentation, recoupment and compliance risks; and the economic risks of divorce. There is also a plethora of acronymic risks such as the Health Insurance Portability and Accountability Act (HIPAA), the Occupational Safety and Health Administration (OSHA) Act, and many others.

Treatment plan: Be willing to abandon ancient thoughts and remain open to new ideas that identify and provide solutions to the contemporaneous insurance problems of physicians. As an example, in 2001, economist Christian Gollier, PhD, of the University of Geneva, asked, “Should one even buy personal insurance since the industry itself is so skilled at exploiting human foibles?”

Mistake 7: Inappropriate Insurance Agent
It is no surprise that goaded physicians might prefer insurance vehicles like the guaranteed minimum death benefit of variable annuities or traditional cash value life insurance policies despite their high costs, huge commissions and lower returns. Agents sell these products and they work for the insurance company, not for you. Basic insurance agent credentials include the chartered financial consultant and chartered life underwriter designations, but they may remain product salesmen.

Treatment plan: Always beware the fear-mongering insurance agent salesman as the flowing coverages may be unnecessary, too expensive, provide only minimal benefits or be duplicated in other insurance policies. These include credit life or home mortgage insurance (decreasing term), life insurance for children or the elderly, accident policies for students, hospital indemnity policies, dread disease insurance, credit card insurance, pet, flight or funeral insurance, prepaid legal insurance, trip cancellation, flood, earthquake and termite insurance, and most appliance extended warranties.

Instead, consider a licensed insurance advisor or insurance counselor who sells no products, accepts no commissions and charges by the hour, all while shopping for the best companies and rates for the risk being researched. A fiduciary focused Certified Medical Planner® may be even better.

Mistake 8: Selecting The Wrong Accountant
When asking for the value of a practice, ask specifically for the fair market value (FMV). One podiatrist who consulted us asked her accountant for the “value” of her practice and received its lower “book value” rather than the higher fair market value as a profitable ongoing concern. The MD lost tens of thousands of dollars in a subsequent sales transaction. Unfortunately, although the CPA produced correct figures for exactly what she requested, the doctor did not differentiate between the two terms. Later legal mediation determined that neither was responsible for the linguistic error as both parties acted in good faith. Of course, the doctor paid dearly for her mistake.

Treatment plan: Dr. Gary L. Bode, CPA, MSA, a former medical practitioner and CFO for iMBA, Inc., suggests that you take the time to discuss wants and needs with your accountant. Those from the National CPA Healthcare Advisors Association (www.hcaa.org) or the Healthcare Financial Management Association (www.hfma.org) may also increase your comfort level through additional medical expertise. Better yet, contact an experienced medical practice valuation expert or healthcare economist.

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Mistake 9: Not Having Your Practice Professionally Valuated [not appraised]
The sale or purchase of a medical practice may be the most important investment decision of your life. We have observed neurotic purchasers who spend far too much time, money and energy researching a fairly priced and modest practice to no avail (paralysis of analysis). Others have purchased exorbitantly priced practices for over $1 to $2 million on a handshake and promise. Accordingly, give this complex task the gravitas due, and run from those who would broker your sale with a “free” or “Internet-based valuation,” or provide “finance participation” schemes for purchase as a young practitioner.

According to IRS Revenue Ruling 59-60, the value of any medical practice is generally based upon the following:
• level of expected distribution and future cash flows;
• time of expected distributions and cash flows; and
• uncertainty of the expected cash flows and distributions.

Moreover, one should recall that a valuation is not a source document audit. Know specialty and industry economic conditions, trends, operating history, physician bonuses, dividends, distributions and comparable practice sales. A commission or percentage-based fee is considered unethical and may be illegal.

Accounting book value is not the same as a fair market valuation. Do not use back-of-the envelope trade magazine “multiplier methods” and obtain only Uniform Standards of Professional Appraisal Practice (USPAP)-styled valuations, which were first issued by the IRS in 1994-1995.

Combine the recognized USPAP-IRS valuation methods: income method with discounted cash flow analysis, market method and cost approach. Be sure to adjust financial statements in order to normalize each line entry. You must do the discounted cash flow analysis (DCFA) on an after-tax basis and base proper assumptions on physician compensation market rates.

Understand the intangible difference between personal and business goodwill, major premiums and minority control discounts.

Doing a walk through of the practice is mandatory for your protection. Trust but verify tangible assets and liabilities, estimates of practice risks, economic assumptions and future earning capacity.
Obtain a separate and independent real estate appraisal if necessary.

Make sure the valuation is written, substantiates value, supports conclusions and is signed by an appraiser who will defend the valuation in court as a qualified expert witness if necessary. This certification is formally known as an “opinion of value” and the only type we perform.

Remember to obtain two independent valuations, one for the buyer and one for the seller, and pay for each separately.

Treatment plan: Have the financing lined up before you buy a practice. The three major impediments to loan acquisition are school loan debt, a home mortgage and an automobile note in that order So, strive to reduce or eliminate them before applying for a loan. Hire licensed appraisal professionals with publishing, teaching and/or academic experience. Do not hire brokers or commissioned agents.
Organizations that accredit businesses but not necessarily medical practice appraisers include:

• The Institute of Business Appraisers (www.go-iba.org) awards the certifications of certified business appraiser and business valuators accredited in valuation.
• The National Association of Certified Valuation Analysts (www.nacva.com) awards the designations of certified valuation analysts and accredited valuation analysts.

Well-known medical practice and healthcare system appraisers include the big 10 consulting firms for hospitals and national healthcare systems. However, the Arthur Andersen debacle confirms that “bigger is not always better.” Medical practice niche players include Health Capital Consultants, LLC, (www.healthcapital. com), which provides large- and medium-sized practice valuations.

The Institute of Medial Business Advisors Inc, (www.MedicalBusinessAdvisors.com) specializes in small to medium practices, emerging healthcare organizations, clinics and ambulatory surgery center valuations and confers the designation Certified Medical Planner® on its independent consultants, appraisers and advisors.

Mistake 10: Selecting The Wrong Attorney
Consider the bizarre tale of the two fledgling internist partner/classmates who signed an attorney-prepared, buy-sell agreement upon creation of their nascent practice 30 years beforehand. The agreement stipulated that upon departure or dissolution, the remaining partner’s ownership would be determined not by some periodically updated valuation formula or appraisal process, Instead, it would be determined by a “matched and lost” process, also known as the “flip of a coin” for a medical conglomerate now worth over $1 million.

Treatment plan: Select a health law attorney and not your brother-in-law. More importantly, experience in the medical arena counts. Consult iMBA, Inc. or the American Health Lawyers Association (www.healthlawyers.org) as a referral resource.

Mistake 11: Blind Trust Of Wall Street And Financial Advisors
Stockbroker salesmen and the big brokerage houses that underwrite and recommend stocks may have credibility problems and some physicians get burned with the adrenaline rush of “self-directed” portfolios. Presently, both the Security Exchange Commission (SEC) and National Association of Securities Dealers are investigating far too many insurance companies and major wire houses for reverse churning (charging a fee on assets for which the stockbroker is providing virtually no services) and/or double dipping (charging an ongoing fee on mutual funds on which the client already paid a substantial commission).

No one knows for sure how to mitigate such shenanigans since human nature and self-interest are involved. Rest assured that the economic cycle will never be repealed and you must beware the four most dangerous words on Wall Street: “This time, it’s different.” Yet some believe the answer may lay with the independent fee-only advisor who charges by the hour, by the engagement, or pro re nata for advice.
Beware of taking the advice of a financial advisor carte blanche. The prime duty of a financial advisor should be to clients. Yet the very term “financial advisor” has no real academic or consistent meaning in the industry. The only hurdle to becoming one is passing a simple securities industry or state insurance sales licensing examination. Most are brokerage and agency employees with a duty to their respective firms, not you.

Treatment plan: Commissioned stockbrokers are fine to use if their fees are transparent and they offer value to you. However, be aware that Wall Street sales mavens and large broker-dealers (wire-houses) recently lobbied Congress not to be responsible to you after the sale. The Financial Planning Association is suing the SEC over this proposal to exempt the nation’s largest wire-house brokerages from certain fiduciary responsibilities associated with investment advisory regulations.

To avoid selecting the wrong financial advisor, choose an independent advisor who takes pride in fiduciary responsibility, knows the medical profession and eschews product sales commissions whenever possible. Such a professional is more than deserving of a fee. Do not hesitate to pay it.

To determine if your current advisor is the right choice, just ask to see the documents below:
• form ADV parts I and II;
• sample investment policy statement;
• registered investment advisor or series #65 investment advisory license
• CMP® license number;
• ethics requirement or attestation statements; and
• advanced degrees and designations, etc.

Some CMPs® and fee-only financial advisors possess these professional certifications as required. Stockbrokers, salesmen, intermediaries and insurance agents may not. All monikers suggest but do not guarantee impartiality and a lack of bias. Also make sure your financial advisor is experienced in the rapidly changing healthcare industrial complex.

Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

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Mistake 12: Lack Of A Complete Financial Plan
While many doctors have an investment portfolio, few have a comprehensive personal financial plan, especially one designed for medical professionals.

Treatment plan: Typically such plans consider the risk tolerance and time frame of several standard components such as insurance, taxation, investing, retirement and estate planning. Today’s practicing physicians should direct attention toward practice enhancement, economic risk management, valuations, charitable giving and succession planning. All should be interrelated in an economically sound manner and not be counterproductive to individual components of the plan.

In Conclusion
Often, successful investing and avoiding a life of economic servitude is simply a matter of delayed gratification and mistake avoidance rather than investing acumen. A good rule of thumb is to pursue fundamentals over fads and seek wise counsel when required.

About the Author

Dr. Marcinko is a Certified Financial Planner and Certified Medical Planner® and CEO for www.MedicalBusinessAdvisors.com, sponsor of the Certified Medical Planner charter designation program. He can be reached by phone at (770) 448-0769 or by e-mail at MarcinkoAdvisors@msn.com.

References:

References
1. Marcinko DE. Financial planning for Physicians and Advisors. Jones and Bartlett Publishers, Sudbury, Mass., 2005.
2. Marcinko DE. Insurance and Risk Management Strategies for Physicians and Advisors. Jones and Bartlett Publishers, Sudbury, Mass., 2005.

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STOCKS FALL HARD, THEN SOAR: SS COLA = 8.7 Percent

By Staff Reporters

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Social Security just announced an 8.7 percent cost of living adjustment, the largest inflation adjustment to benefits in four decades — a welcome development for millions of older Americans struggling to keep up with fast-rising living costs.

The Dow Jones Industrial Average dropped 500 points at the starting bell, down 1.7% and undercutting its Sept. 30th low. The S&P 500 index sank 2.3% and the NASDAQ composite swooned 3%.

Then Stocks Soared Despite the Hotter-Than-Expected Inflation Report

U.S. equities closed out the day noticeably higher, ending six-straight days of declines, despite the release of today’s key inflation data. The markets seemed to shrug off another hotter-than-expected consumer price inflation (CPI) report, which boosted expectations that the Fed will have to remain aggressive with its monetary policy tightening plans.

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PREDICTIONS: Core Inflation

By Staff Reporters

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Economy: Yesterday brought more sinister inflation news when the September producer price index, which measures wholesale prices, came in higher than expected.

But the headliner is today when the consumer price index appears. Economists predict core inflation will hit a 40-year high, according to Bloomberg, so none of this is likely to get the Fed to chill on rate hikes.

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Hospital Capital Structure

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Understanding the Cost of Capital

[By Calvin W. Wiese; MBA, CPA]

[Staff Writers]

It is critical to understand and to measure the total cost of capital. Lack of understanding and appreciation of the total cost of capital is widespread, particularly among not-for-profit hospital executives.

Capital Structure Defined

The capital structure includes long-term debt and equity; total capital is the sum of these two. Each of these components has cost associated with it. For the long-term debt portion, this cost is explicit: it is the interest rate plus associated costs of placement and servicing. For the equity portion, the cost is not explicit and is widely misunderstood.

Capital Structure of Hospitals

In many cases, hospital capital structures include significant amounts of equity that has accumulated over many years of favorable operations. Too many physician and healthcare executives wrongly attribute zero cost to the equity portion of their capital structure. Although it is correct that generally accepted accounting principles continue to assign a zero cost to equity, there is opportunity cost associated with equity that needs to be considered. This cost is the opportunity available to utilize that capital in alternative ways.

Cost of Capital

In general, the cost attributed to equity is the return expected by the equity markets on hospital equity. This can be observed by evaluating the equity prices of hospital companies whose equity is traded on public stock exchanges. Usually the equity prices will imply cost of equity in the range of 10% to 14%; at least prior to the recent Wall Street meltdown.

Cost of Equity Exceeds Long-Term Debt

Almost always, the cost of equity implied by hospital equity prices traded on public stock exchanges will substantially exceed the cost of long-term debt. Thus, while many hospital executives will view the cost of equity to be substantially less than the cost of debt (i.e., to be zero), in nearly all cases, the appropriate cost of equity will be substantially greater than the cost of debt.

Weighted Average Cost of Capital

Hospitals need to measure their weighted average cost of capital. WACC is the cost of long-term debt multiplied by the ratio of long-term debt to total capital plus the cost of equity multiplied by the ratio of equity to total capital (where total capital is the sum of long-term debt and equity).

Hospital

Assessment

WACC is then used as the basis for capital charges associated with all capital investments. Capital investments should be expected to generate positive returns after applying this capital charge based on the WACC.

Conclusion

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Understanding the Cost of Not-for-Profit Hospital Capital

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A “Must-Know” Economic Concept for Not-for-Profit Hospital Executives

Hospital[By Calvin W. Wiese; MBA, CPA]

It is critical to understand and to measure the total cost of capital for any hospital or healthcare organization. Lack of understanding and appreciation of the total cost of capital is widespread, particularly among not-for-profit hospital executives.

The capital structure includes long-term debt and equity; total capital is the sum of these two. Each of these components has cost associated with it. For the long-term debt portion, this cost is explicit: it is the interest rate plus associated costs of placement and servicing.

Equity Cost

For the equity portion, the cost is not explicit and is widely misunderstood. In many cases, hospital capital structures include significant amounts of equity that has accumulated over many years of favorable operations. Too many physician executives wrongly attribute zero cost to the equity portion of their capital structure. Although it is correct that generally accepted accounting principles continue to assign a zero cost to equity, there is opportunity cost associated with equity that needs to be considered. This cost is the opportunity available to utilize that capital in alternative ways.

Equity Greater than Cost of Debt

In general, the cost attributed to equity is the return expected by the equity markets on hospital equity. This can be observed by evaluating the equity prices of hospital companies whose equity is traded on public stock exchanges. Usually the equity prices will imply cost of equity in the range of 10% to 14%; or lower recently. Almost always, the cost of equity implied by hospital equity prices traded on public stock exchanges will substantially exceed the cost of long-term debt.

Thus, while many hospital executives will view the cost of equity to be substantially less than the cost of debt (i.e., to be zero), in nearly all cases, the appropriate cost of equity will be substantially greater than the cost of debt.

The Weighted Average Cost of Capital

Hospitals need to measure their weighted average cost of capital (WACC). WACC is the cost of long-term debt multiplied by the ratio of long-term debt to total capital plus the cost of equity multiplied by the ratio of equity to total capital (where total capital is the sum of long-term debt and equity).

Assessment

WACC is then used as the basis for capital charges associated with all capital investments. Capital investments should be expected to generate positive returns after applying this capital charge based on the WACC. Capital investments that don’t generate returns exceeding the WACC consume enterprise value; those that generate returns exceeding WACC increase enterprise value. Hospital executives need to be rewarded for increasing enterprise value.

Conclusion

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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WHY: We Bought UBER as the Stock Fell?

By Vitaliy N. Katsenelson CFA

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Uber is the second most controversial stock we’ve ever owned (first place goes to Softbank). Most people have used Uber’s service, and thus everyone has an opinion and the media loves writing articles about Uber. The company has a history of not making any money. I’ve written a long research piece on why Uber, despite (or maybe because of) being a controversial company, has the makings of being a terrific long-term investment.
 
The pandemic had a mixed impact on Uber. Its core ride sharing business, which was supposed to turn profitable right before the pandemic, was significantly affected by the virus. The impact was immediate – people stopped traveling and started socially distancing.
 
But even after the economy reopened and people were willing to take Ubers again, the company did not just snap to profitability; it had to rebuild its driver network. Uber had to pay extra bonuses to drivers, whose pockets had just been stuffed with government stimulus checks, to get them to put their Netflix remote controls down, get off the couch, and start driving again. This was very expensive but necessary – one of Uber’s competitive advantages lies in the depth of its driver network. Without drivers, Uber ride share has no product. Consumers expect to push the button on their Uber app and get a car in 15 minutes or less. I remember worrying in spring 2021 that Uber would take a conservative stance in bringing their drivers back, in order to preserve cash. Uber did anything but – it showered its drivers with cash, burning billions of dollars in the process. It was the right thing to do. Lyft has been slower to respond and today is still struggling with a driver shortage, where Uber doesn’t have this problem. We are glad that we bet on the right company and the right management.
 
At this point in time, Uber’s international ride share business has recovered to the pre-pandemic level, but the US business is lagging behind at 70% of its pre-pandemic highs.
 
The pandemic was a tremendous help to Uber Eats, which at the time was still a nascent food delivery business. Today Eats generates similar revenues to the rideshare business. During the pandemic Uber Eats was fighting with US competitor Doordash for market share and losing a lot of money in the process, but its profitability turned positive in the latest quarter.
 
Today, Uber Eats is barely profitable, but management believes this business has the potential to be very profitable, and it is profitable outside of the US. We’ll believe it when we see it. But we think Uber can build a very profitable advertising business on top of this. The Uber Eats app is a giant marketplace for restaurants, where they are competing for consumers’ dollars throughout the day. Just as Amazon is making billions on advertising on its platform, so can Uber. These advertising dollars come with an 80-90% margin, and it takes little effort (cost) to generate them. The bulk of these revenues will fall straight to Uber’s bottom line.
 
Recent Progress
 
Uber reported a terrific quarter in May. Its revenues and bookings were up 39%. It was the third positive EBITDA quarter in a row. The market yawned at these results and sent the stock down with the rest of the NASDAQ.
 
A week later, in a memo to Uber employees, CEO Dara Khosrowshahi admitted that the environment has changed – the market doesn’t want EBITDA profitability, it wants cash flows. EBITDA is an acronym; it stands for “earnings before a lot of important stuff,” like interest expense, taxes, depreciation, and amortization.
 
Dara pointed out in his memo that the company needs to pay attention to costs, to slow down driver incentives, to be more cautious in hiring (he wrote, “working at Uber is a privilege”); and the company needs to learn how to do more with less. In other words, EBITDA and the unlimited funding party are over; investors want the company to show them the money – free cash flows.
 
(Uber’s EBITDA is about $1 billion greater than the company’s free cash flows. Uber is guiding to be free cash flow positive by the end of 2022. It looks like an achievable goal.)
 
I feel somewhat conflicted about this memo. I really don’t like it when a company takes cues from the market on what to do. On one side, the company is owned by shareholders, so the management is hired by shareholders, so it should listen to them.
 
But!

Uber has roughly 2 billion shares outstanding. 35 million Uber shares change hands daily. A simple calculation would show that the Uber shareholder base turns over every 57 trading days. The reality is that maybe 20-40% of shares are owned by long-term shareholders (like us) and the rest of the volume comes from short-term renters who have never opened the company’s annual report and treat the stock as a four-letter trading vehicle.
 
Uber’s management works for this silent minority that does not vote every day on the stock market with their buys and sells. Those who trade Uber’s shares three times a day, the ones who sent Uber’s stock down, don’t know how to spell EBITDA or care about Uber’s free cash flows.
 
In Dara’s defense, I think he was reacting not just to the lower stock price but also to the meeting with shareholders he’d had the previous week (with the silent minority). Also, he was right with his message, which applies not only to Uber but to a lot of tech companies. The environment has changed.
 
Companies are complex organizations that are run not by computer-like superhumans but by regular people who are given as many hours in the day as everyone else. People who, in addition to managing thousands of employees, have families, drive kids to school, fight with their spouses, worry about their careers and retirement, etc. Yes, they may project the confidence of Greek gods; they may be more eloquent speakers, live in bigger houses, drive more luxurious cars than you and I and their poodles may get fancier haircuts; but their world is actually not all that different from ours. They are humans.
 
These people can only focus on so many things at a time. In a high-growth phase, when capital is abundant for everyone, their focus shifts to growth at any cost. There is a lot of competition for limited talent, and their hiring practices get loose. A lot of exciting ideas land on their desks, which results in too many balls in the air, too many projects with questionable profitability being funded. But more revenue rolls in every day. Capital markets are throwing money at you and everyone is fighting for market share, ignoring the cost.
 
I run a much smaller company, but I observed this in my own behavior a few years ago. As our growth accelerated, I found that I started paying less attention to our cost structure; I started working ungodly hours; I made questionable hiring decisions (which I have since resolved). I can only do so many things well. I have learned since to put many projects in the future pile, realizing that my team and I can only have so many balls in the air before we start dropping them.
 
Similar dynamics happen to executives of larger companies, just on a grander scale with more external pressure and more constituents to deal with.
 
Low interest rates are very stimulative to investors’ imagination. Low interest rates love the promised land, far far away. Nothing brings this imagination back to mother earth like rising interest rates. Uber and the rest of Silicon Valley have entered into “show me the (free cash flow) money” land. I would not be surprised if we started seeing minor layoffs coming from Uber as it rationalizes some of its pie in the sky projects and focuses on doing more with less.
 
This is great news for shareholders, not so good news for tech workers who got used to the idea of making three hundred thousand dollars a few years after college, and not so good for the Silicon Valley housing market.
 
Let me explain why we are not swayed by the recent decline in Uber’s stock price but actually welcomed it and bought more shares.
 
Uber is a dominant global business with a significant growth runway and an insurmountable competitive advantage. The rideshare and eats businesses still have a tiny share of the potential market and will be growing at a high rate for a long, long time (especially the rideshare business).
 
Uber’s competitive advantage comes from several sources:
 
Network Effect
 
Today a consumer pulls up an Uber app, taps a button, and a car shows up in 15 minutes or less. This two-sided network of consumers and drivers is incredibly difficult to build and disrupt.
 
Scale
 
Uber has the largest global platform. It is in 10,000 cities in 71 countries; thus it can spread its R&D across a large revenue base. Being in different markets allows the company to tinker with different business models and adapt what it learns in one market to others. For instance, in Japan Uber doesn’t have its own drivers but the service is used to hail taxis. In 2022 Uber announced that by 2025 it will do the unthinkable; it will bring taxis onto its app in all of its markets. Taxi drivers love this, because how much they make per ride will not change, but they’ll spend a lot less time driving without passengers. The user experience will not change, except that when you order a car, instead of a Toyota Corolla you’ll get picked by a taxi. Uber’s profit per ride will remain the same, but it will double the supply side of drivers in its network in 3 years.
 
On the last earnings call, Uber also announced that it will start pricing rides based not on miles traveled but on the attractiveness of the trip for the driver. For instance, when a driver drops off passenger at the airport, he can get pick up another passenger in a matter of minutes. Thus, he won’t be driving back empty. This ride is more attractive and will be priced on a lower per-mile basis. However, if the passenger is going to the outskirts of a city, where the driver would have to drive back for half an hour without a passenger, this ride will be more expensive on a per-mile basis, compensating the driver for lower utilization. This is a very difficult math and data problem that requires a tremendous amount of R&D effort. Uber can solve it for the US market and apply the algorithm to the rest of the world. Its competitors may not have the ability to do this.
 
Being in different markets also diversifies Uber’s regulatory and competitive risks. If a competitor in one market starts a price war, Uber can successfully wage this fight with other markets subsidizing the at-war market.
 
Name Recognition
 
Uber is synonymous with rides hare. Uber is not the company that invented the ride share business model – that was created by a company called Sidecar, which borrowed the concept from a nonprofit company called Homobile, which provided ride share services for that LGBTQ community in San Francisco. Both Homobile and Sidecar are lost as footnotes in the history books. Uber is the app most people think of when they… actually, Uber is trying to expand what people think about when they think of Uber. Today in some markets you can order a ride, food, alcohol, and groceries; send a package across town; rent a car from other private owners and rent-a-car companies; and even buy bus tickets.
 
Providing all these services helps to increase drivers’ earnings, as they drive people in the morning and evening and deliver food, packages, and groceries in between. Uber is achieving this by developing a super app – one app for everything. Super apps are very popular in China.
 
This brings us to another important advantage: UberOne, Uber’s version of Amazon Prime – you pay $9.99 a month or $99 a year and you get discounts across all of Uber’s offerings. Per Uber management, UberOne’s users spend 2.7 times more than an average user of Uber. Amazon trained us to default to its website when we need to buy something. We stopped comparison shopping (especially for low-ticket items) and now we just hop on Amazon and buy. Uber’s goal is to create a similar muscle memory with Uber customers, and UberOne may lead us there.
 
Uber competitors are coming out with their versions of loyalty products. This is good for the industry overall, as it will cement market shares and stop price wars.
 
Uber’s Valuation
 
To value a company, it needs to have earnings (free cash flow). This means that the company will stop relying on the kindness of strangers – capital markets. Very good news. But this doesn’t mean that the company is worth much above zero. Uber will be free cash flow breakeven by the end of 2022. Uber’s significant earnings (free cash flow) power doesn’t lie that far in the future.
 
Unlike a traditional digital business, Uber lives in both the analog (real) world and the digital one. The analog business (recruiting and supporting drivers) brings a higher fixed-cost structure, and this is why, till this day, Uber has been losing money.
 
Our analytical model is very simple: Today Uber is at scale, and so 40-60 cents of every incremental revenue dollar fall directly to Uber’s bottom line. Thus, Uber’s profitability will grow not at a linear but at an exponential rate. Wall Street estimates that Uber will generate $7 billion of free cash flows in 2026 (or about $3.50 per share). Our own estimates are not much different, though Dara’s focus on “showing the money” may lead to achieving this number sooner.
 
Uber owns a chunk of China’s Didi and other rideshare businesses, which a few months were worth as much as $7 per share.
 
We find ourselves in the somewhat uncomfortable place of not knowing how much Uber stock is worth. But, we know it is worth a lot more than the current price. Uber has a lot of optionality that lies in the future. For instance, grocery and alcohol delivery are in a nascent state which may turn into real businesses. Uber Freight has the potential to become a larger business than rideshare and food delivery combined. Freight shipping (think of all those semi-trucks you see out on the interstate) is a very fragmented market that is mostly operated with technological efficiencies from the 1970s. Uber has a good shot at transforming and dominating this market. This business broke even last quarter and has about $600 million of revenues.
 
A client asked about the risk of investing in autonomous driving. I spent a lot of time thinking about autonomous when I researched Tesla (we’d be delighted to mail you my Tesla book). It will be a long time before it becomes ubiquitous. The technology is not ready for prime time unless the weather is perfect (God forbid it rains or snows) and the car operates in a very discrete environment (within a few city blocks).
 
We still need to develop a legal framework to answer a simple question: Who is responsible for an accident caused by an autonomous vehicle? But let’s say autonomous cars hit the market tomorrow. There are 150 million cars on the road in the US today. You’ll need to have millions of auto-cars on the road to be a threat to Uber. Remember, the key to a successful rideshare business is the car showing up in less than 15 minutes after you request it. It would take a long time to build an autonomous fleet. The most likely scenario is that autonomous cars will join Uber’s platform as another, likely cheaper, service for brave souls.
 
We look at a portfolio as a portfolio. I know, this is the tritest sentence ever written. But it is important to remember that value comes in different shapes and sizes. Our goal is to build a diversified portfolio of high-quality, undervalued businesses. For a lot of stocks we own, value stares you in the face in the form of the earnings that are right in front of you. In fact, that is the case with almost all the stocks we own. Uber requires us to look a bit further, as its earnings power will be unveiled by revenue growth and time. In the context of the portfolio, Uber makes a lot of sense; and over the years, as the company shows us the money, it will look like a perfect fit in our portfolio; but at that point the stock price will, hopefully, be a lot higher.

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What is Hospital WACC?

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By Calvin Weise CPA and Dr. David E. Marcinko MBA

http://www.CertifiedMedicalPlanner.org

The Weighted Average Cost of Capital 

It is critical to understand and to measure the total cost of capital. Lack of understanding and appreciation of the total cost of capital is widespread, particularly among not-for-profit hospital executives. The capital structure includes long-term debt and equity; total capital is the sum of these two. Each of these components has cost associated with it. For the long-term debt portion, this cost is explicit: it is the interest rate plus associated costs of placement and servicing.

Equity portion

For the equity portion, the cost is not explicit and is widely misunderstood. In many cases, hospital capital structures include significant amounts of equity that has accumulated over many years of favorable operations. Too many executives wrongly attribute zero cost to the equity portion of their capital structure. Although it is correct that generally accepted accounting principles continue to assign a zero cost to equity, there is opportunity cost associated with equity that needs to be considered. This cost is the opportunity available to utilize that capital in alternative ways.

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In general, the cost attributed to equity is the return expected by the equity markets on hospital equity. This can be observed by evaluating the equity prices of hospital companies whose equity is traded on public stock exchanges. Usually the equity prices will imply cost of equity in the range of 10% to 14%.

Almost always, the cost of equity implied by hospital equity prices traded on public stock exchanges will substantially exceed the cost of long-term debt. Thus, while many hospital executives will view the cost of equity to be substantially less than the cost of debt (i.e., to be zero), in nearly all cases, the appropriate cost of equity will be substantially greater than the cost of debt.

http://www.HealthDictionarySeries.org

Hospitals need to measure their weighted average cost of capital (WACC).

WACC is the cost of long-term debt multiplied by the ratio of long-term debt to total capital plus the cost of equity multiplied by the ratio of equity to total capital (where total capital is the sum of long-term debt and equity).

WACC is then used as the basis for capital charges associated with all capital investments. Capital investments should be expected to generate positive returns after applying this capital charge based on the WACC. Capital investments that don’t generate returns exceeding the WACC consume enterprise value; those that generate returns exceeding WACC increase enterprise value.

Assessment

Hospital executives need to be rewarded for increasing enterprise value. 

Conclusion

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