We have now wrapped up 2009, having weathered the toughest economic conditions since the Great Depression. In 2009 we saw stock markets crash, housing markets collapse, and historical unemployment statistics. As a result, many people have now counted their losses and are gritting their teeth looking into an uncertain 2010, hoping for a quick and substantial recovery. However, before allowing the pessimism of countless market studies and media coverage to take over, it is essential to take a more comprehensive look at the concept of wealth and the ways in which we measure it. By taking a step back and analyzing the various factors that determine wealth, we can see a far more optimistic view of the past, present, and, most importantly, the future.
So what is wealth and how do we measure it?

Simplified, wealth is the accumulation of valuable assets, real estate and investment portfolios being the most prominent. We can break this down further by categorizing wealth into two main areas: income and net worth. Income is the cash flow that an individual earns (i.e. employment income), or the cash flow that an individual receives from other sources (i.e. rental income, dividend payments from stock holdings). Net worth is simply the current value of any assets minus the total of any liabilities. When assessing an individual’s wealth, the common tendency is to focus strictly on an individual’s net worth, not the cash flow generated by the assets being accounted for. The question here, of course, is what should you, the investor, focus on most?
The simple answer, especially in a down market environment, is cash flow.

Let’s use a rental property as an example. An individual bought a home in 2003 for $750,000 that they, in turn, decided to rent out for $2,500 per month to produce income to help fund personal expenses. They have no intention of selling the home to generate a profit anytime in the near future. Annually, they have been able to raise the rent on the property by $100 a month, meaning they now rent out the house for $3,100 per month. In this same time period, the value of the home reached a high of $1.1 Million in 2007. The value in 2009 fell to $600,000. On this individual’s net worth statement, it appears as if they have lost $150,000 (or 20%) on the purchase, much like most investors feel as if they “lost” a great deal of assets in the stock market last year. The question here is, if the client does not need to sell the home, does the value of the home really matter?  The simple answer is no. Until the asset is sold you have not gained or lost anything. What the net worth statement does not reflect is the increase in cash flow the house has produced. If the rental income the home produced fell by 20% to $2000 per month it would have a far greater impact on this individual.

So, why do investors look at the stock market any differently?

The stock market, as reported by the media, tends to be the general public’s barometer concerning economic conditions. Each day the value of the stock market is relayed to the public based strictly on the value of the underlying shares. The problem with this is how those shares are priced, determined generally by perceived value rather than fundamental value. This places assets at the mercy of irrational investors who have the ability to inflate or devalue assets based solely on perception. As a result, the inherent value of an asset is muted by the compulsions of investors who buy and sell based purely on speculation and emotion. The market’s daily gains and losses are based on the capital value of outstanding shares, but rarely is the cash flow these stocks produce ever reported.

Cash flow continues to be more consistent than the capital values of stocks. In 2008 S&P stocks fell 45%, however, dividends of these same stocks fell less than 7%. When evaluating your losses for the year, it is important to determine the cash flow your portfolio produced. Unlike price, which is subject to the emotions of the market, income generated from assets is largely dependent on the true value any given asset has in the marketplace.

The key in any economic downturn is to own stock in companies that have a solid track record of cash flow and dividend payments. This way, even if the capital value sinks, you will still get paid in the form of dividends while patiently waiting for the stocks to rebound.

Before you let frustration set in the next time you receive a quarterly statement that shows a capital loss, go one step further and determine how much cash flow was generated during that time period to give you new perspective. 

Glenn Ayrton is registered as an Investment Advisor through Sora Group Wealth Advisors Inc., a Member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund (CIPF). This information is general in nature, and is intended for educational purposes only. For specific situations you should consult the appropriate legal, accounting, or tax expert. This update is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell any securities. The views expressed are those of the author and not necessarily those of Sora Group Wealth Advisors Inc.