Value Investing – Concepts of Economics and Business Models (Lesson 19)
There is no single statement or overriding concept that equates to defining economics. There are about a half dozen or so concepts that the average person would state as a definition of economics. The most commonly accepted definition of economics is the balance of supply and demand. In effect, it refers to determining the relationship between needs/wants against limited resources. With value investing, understanding the concepts of economics allows for a more comprehensive elevation of thought related to financial analysis. There are literally hundreds if not thousands of forces at work at any given moment impacting the market price and of course a value investor’s intrinsic, buy and sell value points.
The study of economics is done at two levels. The macro level refers to the study of economics as a whole. It focuses on how different characteristics impact the overall ability to efficiently produce and delivery goods to consumers. Think of the impact the federal government has related to laws that in turn affect production and consumption of goods and services. For value investors, there are many different macro level decisions that affect financial analysis. These include decisions made by the Federal Reserve, specifically related to interest rates. Others include unemployment, tax rates, and governmental expenditures especially for capital improvements.
The second level is called micro economics. This brings in all those macro level changes and their respective impact on individual businesses and industries. As an example, a simple increase in the interest rate by the Federal Reserve affects the interest rate related to long-term leases. In the immediate short time period, there is very little change as leases have cycle time frames before they the lease’s interest rate changes. But, in due time, it will affect the interest rate which in turn impacts certain industries. A single railway leases thousands if not tens of thousands of railcars. An interest rate increase will in turn up how much cash outflows for leasing purposes. Ultimately, the railroad will raise their revenue per mile of tonnage which increases sales to offset the outlay of money for a lease.