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What You Should Know About Public Markets – Episode 24


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Unless you happened to live in 18th century Western Europe, you might not understand how the modern economy was born – or even who the father was. It’s a fascinating tale of deception, greed, pirates, and a Scottish visionary who borrowed French vocabulary. Plus it provides a great foundation for understanding financial markets. In this episode of Dentist Money™, Reese & Ryan discuss the evolution of public markets and how they can work in your favor.

Podcast Transcript:

Speaker: Consult an advisor or conduct your own due diligence when making financial decisions. General principles discussed during this program do not constitute personal advice. This program is furnished by Dentist Advisors, a registered investment advisor. This is Dentist Money. Now here’s your host, Reese Harper.

Reese Harper: Welcome to the Dentist Money Show, where we help dentists make smart financial decisions. I’m your host Reese Harper, here with my cohost, Sir Ryan Issac.

Ryan Isaac: Hello, Reese.

Reese Harper: It is another great day to talk about money.

Ryan Isaac: Sure is.

Reese Harper: We’re going to take you back a few centuries this time to the 1500s. We’re going to talk about, mercantilism.

Ryan Isaac: Don’t tune out, it’s an amazing subject, people.

Reese Harper: Don’t stop there. Mercantilism, what is that? That was the main operating economic theory for about three centuries.

Ryan Isaac: It’s the way people thought about money for 300 years.

Reese Harper: A long time.

Ryan Isaac: All the way up to the American Revolution, which is a war, for those of you who don’t know.

Reese Harper: War.

Ryan Isaac: The American revolution was really a byproduct of mercantilism. The idea was that countries would get rich by accumulating gold and silver. If you just had more gold than the next country, then you would be able to have more armies and buildings and power, because gold was the form of currency that functioned, right? That created any sort of wealth.

Reese Harper: Yes. Is this another gold podcast?

Ryan Isaac: No. But I kind of want it to be, but they wouldn’t let me.

Reese Harper: By they, I mean the proverbial, they. The other two guys in the room.

Ryan Isaac: I just need to talk about it for a minute. Just so everybody knows. We’re setting the stage for a good conversation about stock markets.
All right? But you need to know what mercantilism was, in order to understand the stock market theory. You have all these countries in western Europe who are really trying to gain wealth through precious metals. And they would do it by regulating imports and exports.
The idea was that the more stuff you sold, the more stuff you exported, the more gold you get in your country. There’s a ton of trade regulations to make it harder to bring products into the country. It made it easier for countries to export. A lot of countries didn’t like that. That created a lot of problems. Right?

Reese Harper: Well, we found a statement from an English discourse published in 1549 that addresses-

Ryan Isaac: Yes, please read it with an English accent that you’ve been working. Cue, English accent.

Reese Harper: Downtown Abbey.

Ryan Isaac: Which character?

Reese Harper: Bates.

Ryan Isaac: Bites.

Reese Harper: Can’t do bites.

Ryan Isaac: That was Australian accent.

Reese Harper: Bites? Heights.

Ryan Isaac: We must always take heed that we buy no more from strangers then we sell them. For, so should we impoverish ourselves and enrich them.

Reese Harper: Yes. Is that going to do that work?

Ryan Isaac: Yes. For those of you who didn’t understand what he just said, it meant that they were really stoked about impoverishing other people and enriching themselves.

Reese Harper: Yes, exactly. We don’t want to buy more from them.

Ryan Isaac: You sound a lot smarter when you talk like that.

Reese Harper: Thank you.

Ryan Isaac: And you just kind of permanently do that…

Reese Harper: That’s right.

Ryan Isaac: Well, fundamentally there’s two major problems with mercantilism. And the first problem was that it brought on a lot of different regulations because countries wanted to limit imports. They would charge a lot of taxes, they call it tariffs. For good-

Reese Harper: Tariff?

Ryan Isaac: That would come into their ports. They’d put a bunch of other policies in place to make sure that the trade balance stayed in their favor, so that they would end up with more gold. They would do things like ban the export of gold or silver.
They would prohibit the use of foreign ships for trade. They wouldn’t allow subsidies on any exports. Then they would monopolize markets with the use of what they called, staple ports.

Reese Harper: I thought that was actually interesting. Staple ports basically gave local buyers the first right of refusal before goods could be sold to out the country. What would happen is the ships would, they’d pull up to a port and they display all their goods for a few days and they’d let all the local people buy as much as they wanted to, before they could pack up and move on to the next port with whatever they had left in their ships.

Ryan Isaac: As you can imagine, it was a time of a lot of war and conflict between countries who are fighting each other over this trade manipulation concept.

Reese Harper: And you mentioned an earlier, this was sort of the root cause behind the American Revolution.

Ryan Isaac: Yes. The British put all sorts of legal and economic restrictions on the colonists who eventually got fed up and retaliated. Now, I want to get to the second problem with mercantilism. Which is that it’s based on the idea that resources are limited.
There’s a limited amount of stuff. It’s about scarce resources. We talked a little bit about that.

Reese Harper: Yes, we talked about that in our last podcast about gold. There’s only so much gold in the world.

Ryan Isaac: Yes. That’s why it’s so valuable, because it’s a finite quantity, but if you’re defining a country’s wealth by how much gold it has, then the entire economy is limited by how much gold exists, and so you just can’t continue to grow.

Reese Harper: This is a good time then to transition the conversation to modern economic theory, and how it begin taking shape in the 1700s. You have the father of modern economics, Scottish economists. I’m not going to do this in a Scottish accent.

Ryan Isaac: It’s the same for those of us who don’t know the difference.

Reese Harper: Named a Adam Smith, a very Scottish name. He was anti-mercantile-

Ryan Isaac: I bet most people don’t know the Adam Smith was Scottish, but that’s just…

Reese Harper: Can we be candid here?

Ryan Isaac: Yes.

Reese Harper: I’m not sure I did. Till I read this.

Ryan Isaac: That’s good. I mean, let’s own up to that. We don’t always know everything about every podcast we’re putting out.

Reese Harper: That was new. It was new.

Ryan Isaac: He talked about this free market, right here.

Reese Harper: Yes this free market, and you have a French word that you’d like to use.

Ryan Isaac: I do speak French?

Reese Harper: Yes.

Ryan Isaac: No, I do not.

Reese Harper: But it’s called, [French 00:05:42]. It’s a French word that means let go or let do. It’s a concept of free market economics. This theory that Adam Smith started talking about really turned mercantilism on its head.
The basic premise was that, wealth isn’t limited to the amount of gold available in the world. That’s not how we can define wealth. That wealth can be created when people specialize in certain trades, and invent better ways of doing things.
Modern economics also says that, both parties can benefit from a transaction, but under the mercantilist approach like you had with all of these monarchies. You always had a winner and a loser. And you could tell who was winning by how much gold they had and how big of a population that they had in the country and how strong their military was.
But Adam Smith was saying that everyone could benefit by doing what they’re good at and exchanging things, exchanging products and services. When you take away that regulation, smaller populations… people in smaller countries, they can do just as well as the bigger ones can. Where does the beginning-

Ryan Isaac: Eventually.

Reese Harper: Eventually. They can get there. There’s at least a fair playing field in some regards. Where does the beginning of the stock market fit into all this?

Ryan Isaac: Well, the first company to issue stock was called, The Dutch East India Company. They started selling spices back in the early 1600s, and that’s when mercantilism was still in full swing. They actually had a pretty heavy monopoly on the spice trade. They definitely had some advantages that aren’t normal. Those were the first stock shares that were ever issued.
In some ways that was one of the reasons why they’re able to take over all of the spice industry for almost around 200 years.

Reese Harper: Until, what was it like, late ’90s when the Spice Girls came around?

Ryan Isaac: Exactly. Now, that’d be 400 years. Not quite that long.

Reese Harper: A 21 year monopoly, that’s probably not the best example of how a free stock market approach is supposed to work.

Ryan Isaac: No, but there were a lot of things-

Reese Harper: That was the start of it.

Ryan Isaac: There were a lot of things about it that really started the foundation of how stocks would be traded. But, it probably makes more sense to fast forward to 1776, when the US issued war bonds. That was the first time when you know that, that the United States issued bonds to finance anything that they were doing. That was the War of Independence.

Reese Harper: They were trying to raise money to fight.

Ryan Isaac: Mm-hmm (affirmative). And 16 years later, a number of really large businesses and individuals got together to create what is now the US Stock Exchange. They met every day to trade stocks and bonds on Wall Street.
By the mid 18 hundreds the US was growing really rapidly and companies were selling stock to finally raise money for their first time, instead of just using their existing resources like gold that they had-

Reese Harper: They had stored popcorn.

Ryan Isaac: That was interesting, when we were getting ready for this podcast, the stock market didn’t even move indoors until 1921. Used to just hang out outside.
That caught me off guard too. I didn’t actually know the timing of that. I would have thought we were hanging out outside over a butcher block…

Reese Harper: Why not?

Ryan Isaac: Exchanging shares of our company.

Reese Harper: That’s how it would happen.

Ryan Isaac: Until early 1920. You just touched on something that I want to underscore really quick though. Because the science of the stock market can get people confused. At a fundamental level, it’s just helpful to remember that the stock market exists so that companies can raise money for growth. That’s the whole point of it.
It gives us the ability to invest in those companies in small quantities without any barriers to entry.

Reese Harper: Yes, and it’s really important. It’s a good point. And it’s much different than a market that excludes the public from putting their own money to work. A lot of countries have followed the success of the US market, and opened stock exchanges. They’ve transitioned from state controlled exchanges to free market economies. There’s a foundation called the Heritage Foundation. It ranks countries on their level of economic freedom.
I don’t know if you’ve ever seen this website, but it’s a pretty interesting one to check out. But they have an economic freedom index that they track. They assign certain variables to each country and then rank each country based on how free it is. Some of it is like rule of law, and property rights and functioning markets, open markets, that kind of stuff.
They go into a lot of details, and the US is actually not as high as you’d think on that list of free market economics.

Ryan Isaac: America?

Reese Harper: Yes. America.

Ryan Isaac: Oh, man.

Reese Harper: It’s not as high as you think. Who’s at the top of the list? This surprising thing for most people is probably that number one most free autonomous, we call it a country, is a Hong Kong. Which is really a sharp contrast to mainland China, because most people assume when they think Hong Kong, they think China, but it’s really not.
It’s an autonomous state. A lot of people don’t realize that Hong Kong probably has one of the best open markets. They have some of the best property rights. It’s a really free society. Singapore, New Zealand, Switzerland, Australia, those are all the top five. You probably thought-

Ryan Isaac: Where are we at? Where are we at?

Reese Harper: The US comes in at number 11, and we’ve been going down every year for the last while in their little index. I just think that part of it isn’t that we’re all screwed up. It’s that the larger you get, the more population you have, the more diverse your population is. And different people are going to have a lot of different preferences about how to run an economy.
For having 300 plus million, 350 million people in our country, we’re probably not doing too bad to come in at number 11 in terms of a free market.

Ryan Isaac: Just wish there with someone that could help make America great again.

Reese Harper: Classy guy.

Ryan Isaac: Anyway, slight detour. Let’s talk about markets, please. Why don’t tell the listeners why a stock market works, and how all this fancy free market stuff can help them out in the end?

Reese Harper: Yes. Well, It’s probably important to say that first off, the stock market isn’t really quite as simple as it used to be.

Ryan Isaac: Yes. In the early 1900s, like we were saying the market… the New York Stock Exchange was really small, and it was only in the US and now markets have grown to include thousands and thousands of companies all over the globe trading on different exchanges in different countries. You have to be really careful when you start talking about the market, as if it’s just the New York Stock Exchange, or the United States because it’s not that simple.

Reese Harper: Important to note though. Maybe stocks headquartered in the United States still make up half of the world’s available stock. It’s not small potatoes.

Ryan Isaac: Did you really cite potatoes, right?

Reese Harper: Yes. Potatoes was the first stock market of all time.

Ryan Isaac: It was the first one?

Reese Harper: It was the first commodity market of all time for those who love the.

Ryan Isaac: Irish potatoes cost a lot.

Reese Harper: We won’t go there. I don’t even know if that’s true. I did not look that up. Don’t quote me on it.

Ryan Isaac: We should talk about that sometimes.

Reese Harper: Jeff? Jeff can put it on the list of podcast topics.

Ryan Isaac: Yes. Jeff put that in the podcast and next time.

Reese Harper: Well, for now we’ll put potatoes aside.

Ryan Isaac: Yes, sweet potatoes.

Reese Harper: Let’s talk about the process of, actually… I want people to understand how a company actually gets-

Ryan Isaac: How they raise money?

Reese Harper: Yes. We’ll do that in terms of defining, what is a stock, what is a bond, and how they work in real life. When companies start out like we did in our business, you have a few different options for how you’re going to grow. You can run out of money and crash and burn. That’s an option. Statistically happens quite a bit.

Ryan Isaac: Yes. A lot.

Reese Harper: That’s the majority. And that you could use your savings. You could borrow against your house, you can get debt from a friend or a bank, or you can sell off a part of your idea or your company to a partner. When you borrow money from banks or from other people, that’s like a bond. When someone lends, it’s like lending some someone money and they’re going to pay you interest and you’re going to get the money back at some point in the future, that’s a bond.
The opposite of that is a stock. When instead of lending money or borrowing money, you can choose to sell ownership in your company to someone else. That’s a stock. Those are the opposites.

Ryan Isaac: Let’s talk then about how a company goes from being really small. Kind of like how anyone really starts to being a really large company, that gets on a stock exchange eventually.

Reese Harper: Well, even private companies still have stocks and bonds. They’re not publicly available for bartering.

Ryan Isaac: I was wondering why they didn’t talk about Dentist Advisers on CNBC very often.

Reese Harper: The stocks and bonds are sold to different investors along the way as companies get bigger and bigger. Those are things you’ve probably heard of before, like a seed fund. Or your buddies probably got a…

Ryan Isaac: Yes, my buddy.

Reese Harper: Connection with private equity, venture capital, angel investors. There’s things called institutional investors that are larger than normal people. Then you have individual people-

Ryan Isaac: Like Mottola?

Reese Harper: In size wise, like money. Wait. Individuals can buy stocks and bonds in small companies. They’re just not traded publicly yet, but there’s some exceptions. Most people, you have to attract that first investor who takes the most risk right up front. That’s your seed investor.
That guy doesn’t really usually know what’s going to happen. They just have a good idea that they like you and your team, they like your PowerPoint presentation. They know the financials that you just showed them or just all a bunch of BS because you can’t possibly know what’s going to happen.

Speaker 4: You take him golfing.

Reese Harper: Yes. Your first capital deposit from an investor is usually very speculative, because you just don’t know what you’re doing yet. I mean, you don’t have any proof that it’s working.
As the business progresses and your systems get in place, the new investors, they’re going to have to pay more. Right? Because it’s easier to see how they’re going to get their money back, right? The company’s got systems in place and it’s more stable and it’s been around for a while. It’s selling a product and there’s a market for it-

Ryan Isaac: It’s proving moving?

Reese Harper: Yes. And this happens clear up to the point when the company and the investors that have invested in it up to that point feel so good about the business, that they’re willing to release all their financial information to the public and let millions of people start looking at everything about the company. That’s what’s called an IPO. When you go public.
Because people are willing to do this, or businesses are willing to do this, investors actually are willing to pay them a much higher value for their investment.
The willingness that businesses have to go public creates a huge possible benefit. They can also go bankrupt, but the possibilities for growth are much higher, as long as the company is really worth what it thinks it’s worth.
You don’t really know as as a business, when you’re about to go public, you want, you hope that the public sees the company at the value that your other [crosstalk 00:16:39] investors did, and everyone else has paid for it and that they’re willing to pay for it that price as well.

Ryan Isaac: Which should be a topic for another time. That’s why IPOs can be so unpredictable.

Reese Harper: Yes. You saw it happen with Facebook when it IPO ed and significant decline in value. You’ve seen it with a lot of other companies in the last year or two. Some IPOs hold their value and grow in some decline sharply. At six months after an IPO hits the markets when the founders can finally sell their stock in the open public. Like if you’re a founder of a company and you go public, you can’t just unload your stock data. You have to wait for six months. And if you-

Ryan Isaac: Show some confidence, man.

Reese Harper: Legally you’re required to do that for 180 days. If you look at charts at about the 180 day mark for most IPOs, the values of those IPOs just get tanked. Because all of this early cheap stock just gets unloaded, and the company doesn’t really have a way to repatriate that money in a way that’s productive.

Ryan Isaac: Spot on, and it’s aged 25 years?

Reese Harper: He’s like, “I’m ready to sell.”

Ryan Isaac: He just wants a few bucks for his…

Reese Harper: We’re talking about how investors are willing to pay a better value for their investment when it gets to that size. If you’re in a private company, your valuation isn’t quite as good as it would be in the public market. Right? For example, a dental practice might be worth, I don’t know, 60 to 90% of annual collections.
But if lots and lots of dental practice is banded together, like we’re kind of seeing in the market now, that they would fetch a higher multiple value, like two or three times or even more times their annual collection.

Ryan Isaac: Yes. The further you get up to that cap, they call it a capital stack. From the time you’re a startup to the time you go public, different investors are willing to pay you better multiples for your earnings or your collections, we’ll call it. It’s actually even a lot better than two or three times annual collections.
Which is kind of crazy to think about because the dental practice would never fetch. A solo dental practice is not going to fetch two or three times-

Reese Harper: And five times, or something.

Ryan Isaac: Investors are willing to pay a lot higher multiple of sales or collections or income because it can do something that no other business can do. And a public company can provide what we call, liquidity. That’s the main reason why it’s worth a lot more. It can provide liquidity to individuals and institutions the minute they need it.
Right now the entire stock market today is trading at like 23 and a half times what they call earnings. Earnings for dentists to be able to relate to this thing, is like your salary and your net income.
Whatever your P and L says your profit is, it’s kind of like your earnings. Profits and earnings, kind of the same speak in in finance lingo. The whole stock market right now trades it 23 times. You take all the companies combined in the US, at least this is the S&P 500. 500 largest ones trading at 23 and a half times what they earn in a year.
That’s like the equivalent of a dental practice trading. Imagine what you make plus your net income traded at 23 and a half times, you could sell your dental practice for 23 and a half times what you make in a year, then you should quit tomorrow.

Reese Harper: It’s like done.

Ryan Isaac: It’s not just your salary. Salary plus net income times by 23. You’re done son. You quit the day you started it. That would be the equivalent to seven or eight times collections. Wait a minute, it’s a huge value that… And it’s the same business. It’s the same company, it’s just once it’s public and it’s willing to subject itself to all that scrutiny because you have millions of people now who can see everything about you. They’re going to place a fair value on you.

Reese Harper: Every second of every day.

Ryan Isaac: Every day. And the reason they get a higher valuation than they do when they’re private is, because of the liquidity they can provide. If I need five grand out of my investment, I can get it in a second. There’s really no other investment like that in the world.

Reese Harper: Which is fascinating. Why don’t all businesses then just go public?

Ryan Isaac: Oh, my.

Reese Harper: If they make more money? Why doesn’t everyone just get huge? Why does it one dental practice turn into 20 and then sell?

Ryan Isaac: There’s a ton of reasons. But for all your business owners out there it’s a lot easier said than done.

Reese Harper: You know why?

Ryan Isaac: I’ve almost quit running this company probably every week of my life.

Reese Harper: I think you tell me about every week, Ryan, if you had any money I just sell it to you.

Ryan Isaac: I think I’m done. Will you buy it from me?

Reese Harper: Yes. The problem is the longer you go, the more your company does start to take shape. It is worth something and it is starting to be pretty compelling to own it. But getting from like a mid size business. I’d say like a company like ours or a dental practice with a few locations, or even a single dental practice with a few staff. And hygiene departments functioning well, it isn’t easy to get to the point, where you can add a second location, add a third location, add an associate. Find a partner, make that merger work like it.
There’s a lot of reasons why people don’t want to do it. The biggest reason I’d say why companies don’t do it is because as soon as you start raising capital. As soon as you sell stock to someone else, as soon as you get a partner, it changes your life in a really major way.
Now you don’t have allegiance just to what you want to do. You have to answer to everybody else that is a partner. And when you go public, you don’t have really any choice anymore about how you want to run your company. Your primary responsibility is to take care of every other investor.
No more taking that nice a fancy vacation on a credit card. Right?

Ryan Isaac: And often they credit cards. The financial payoff that is there, it’s all about liquidity.

Reese Harper: Mostly. Yes. In the end, these companies, they just have the financial strength to provide other investors with immediate access to cash when they need it. The growth potential that they have combined with that instant liquidity, trumps a higher return that people can get somewhere else, but with less liquidity.
Maybe you can invest somewhere else and get a slightly higher return, but you don’t have the same amount of access to your cash.

Ryan Isaac: That’s the cause. That’s what you’re giving them. I wonder then if Adam Smith ever envisioned how this theory would ultimately result in a global market worth almost $50 trillion. That was a long way from-

Reese Harper: Crazy.

Ryan Isaac: Where he started in Scotland, which we learned.

Reese Harper: Crazy. Long live, the invisible hands is what I always say.

Ryan Isaac: You would do all we say that, and since you always say that, I thought we’d end with… I’m all pretend that I don’t know what that means. And you should explain what the invisible hand means.

Reese Harper: Well-

Ryan Isaac: As you do always say that.

Reese Harper: I tell you that regularly.

Ryan Isaac: Then text it to me, again.

Reese Harper: The invisible hand is a force that is constantly at work in a free market. Now, Adam Smith was the one that kind of coined this phrase. He’s got a book he wrote called Wealth of Nations, where kind of all of this stuff was documented and all of his thoughts.
He said that, “People are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made had the earth been divided into equal portions among all its inhabitants. And thus without intending it, without knowing it, advance the interest society.”
Basically a free market is constantly advancing the interest of society by providing better products and services. These entrepreneurs go through a really tough path to get to the point where companies were able to go public and it can support the public scrutiny.
Investors can capitalize on the power of that invisible hand by keeping a really diversified portfolio. Don’t hedge into one company, don’t time the market, don’t jump in and out of cycles. Then watch how the invisible hand can work throughout your career. By investing across thousands of companies and staying very broadly diversified and just trusting the market to go through its natural cycles.
Well, we’ll end on the irony of watching the Invisible Hand.

Ryan Isaac: Love it.

Reese Harper: Thanks to all our listeners for joining us. Do us a favor. Go to the listen tab at the top of dentistadvisors.com. Says listen right at the top. Give us some feedback on this episode. There’s a place for you to add comments and questions.
We’d love to hear four from you. And while you’re on the website, you can also schedule a free consultation. You can visit our Dentist Advisors Facebook page and you can learn more about us as well. And we’re always here to help. Love to talk. Carry on.

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