Why Understanding Financial Accounts Is So Important At School
Updated: Jun 13, 2022
I want to give a few words about some of the work you’ve already covered, and I, as an asset manager, a fund manager, and also somebody who works with businesses with my government hat.
As an author of 18 books on investing published by the Financial Times, I thought it might be helpful to give you a practitioner’s insight into some of the things you’ve already covered in school.
Now, I know you’ve covered sources of finance, why finance is raised, the importance of financial statements, cash flow statements, profit, and loss statements, and the balance sheet. These are my favorite bits in a moment, both as an asset manager, as somebody involved in private equity, involved with FinTech companies, and entrepreneurial companies worldwide. I’m going to tell you why I think those are important.
So whether you want to go into business or want to go into accountancy, or just generally know about investing, because you know it can help your future. I think you’ll find this rather interesting, whichever area you’re looking at.
I’ll also talk to you about not just why those areas you’ve learned are significant to open up your options in life. But also why it’s important for both public companies, which is what I generally invest in.
My asset management company has a hedge fund unit and a private equity one, which invests in private companies, so those accounts you’ve been learning are essential for both those segments.
But it’s also important because in life, especially when you’re at school, you want as many choices and options open to you as possible. After all, you often don’t know what you want to do for the rest of your life.
You don’t know whether you want to be an accountant, a lawyer, private equity fund manager, a government advisor, author, who knows, and the skills you’re learning now will help keep all those options open to you and make you incredibly invaluable to not just an employer, but hopefully to society as a whole.
You can see my life in finance has been good to me, and that’s the great thing about the things that you’re learning; they are skills that can be taken across professions. So I started off originally qualified as a barrister, and then I was asked to present my own finance show on Bloomberg Television and BBC doing the paper review.
Yes, all those things are a lot of fun, and they’ve taken me around the world as well, and that’s why I think the things you’re learning in finance, as I say, are so critically important.
I hope you’ll work incredibly hard in your exams, because it’s worth it, it’s all worth it. The hard work you do now is really worth it for the rest of your life, and I tell you that when I’m sitting on a beach in Bali or the Maldives, all those times in school where I did nothing but lock myself in my room and study and revise and study and revise, they were worth it, okay? And I’m not just saying it; they were worth it to open up those options.
So who am I? Just a bit of background before I deep-dive into everything. Currently, I have two leading roles – I have a role with the U.K. government, where I look for the most outstanding technology companies from around the world with a view of bringing them to the United Kingdom. That sees me traveling the world and meeting some of the people you see there.
Thanks to finance, I’ve been able to explain finance to wide audiences, whether it’s on Newsnight or again for the U.K. government, whether in Singapore, Hong Kong, India, Turkey, Middle East. It’s been a great privilege to be able to do that, and it all started because, well, yeah, it’s going to sound a bit boring and parental; I worked hard at school, but honestly, it is, and because finance opens up probably more doors than any other… Or business studies, more economics, and I have a degree in economics, more doors than any other degree I can think of, or any other piece of education I can think of from my school days.
I’ve also written all these books, published by the F.T., and I want to tell you something related to it. When I was at school, I was told I had a problem with my English, and there I am publishing books.
I want to tell you that whatever hardships you’re facing at school, whatever things seem like, they’re insurmountable; just persevere, okay? Just get through it. You’re young, you’ve got so much advantage and potential on your side, so listen to your schoolteachers and do persevere with it and make your teachers proud, that’s one of the… And make your family proud; that’s one of the greatest things you can do.
This is me in 1999; that’s before you were all born, okay? And it’s my column in the Financial Times about investing, and I’m going to touch upon these investment issues.
So this article is about me, though it might seem like it, it’s just to build up my credentials, so hopefully, you’ll think, “Yeah, maybe we should listen to this guy, he might know a little thing or two that we should listen to.” I know I sound cocky and arrogant; I’m not; Honestly, I promise you.
Do follow me on LinkedIn. You’ll see that that’s a perfect way of learning what people are doing in the workplace, so if you follow people on there, there are people like Bill Gates on there. There are all sorts of business leaders, people from Dragon’s Den on there, and so on; it’ll give you a bit more business insight.
There’s the chairwoman of Pepsi who I follow, and there are other business leaders that I like to follow as well on there. Because you’ll see articles they’ve written, you’ll see what they’re talking about, what’s important in the world to them at the moment. So that’s a top tip when you’re learning about business; that’s a good way of keeping your finger on the pulse, okay?
Now, I’ve been talking about this whole thing for over 20 years now, about business and investing, and part of my job, as I said, is to look at those accounts you guys have been looking at, of companies like this, and come to a decision on what we should invest in. That’s what part of my job is.
Sometimes, like you do your business studies or your economics homework, I feel like banging my head on the desk. So listen, that feeling never goes away, so don’t feel you’re alone. But I have to say, having that knowledge of P&L accounts, balance sheets, cash flow, and how they interrelate, how they work, has sort of been a bit of a secret sauce to all the rewards I wanted in life.
Now, I don’t want to sound selfish. In finance, people often sound really selfish: “Me, me, me, money, money, money.” It’s all meaningless unless you do something with it which is good and useful. I happen to be chairman of the Loomba Trust, which looks after widows and orphans, and I know for people of your generation, the great thing is you want to do more than just make money; you want purpose in your life. I know some of you are going, “No, just the money, please, just give me the money.” Deep down, you all want to do something more purposeful, so I want you to keep that in mind as you go through your school careers.
Now, I can’t analyze these companies unless I know everything about their accounts. We have little spreadsheets like this which we put together, where we will draw upon the various companies, we’ll draw upon their balance sheets, their profit, and lost accounts, and their P&L statements to work out their valuations, the share price P/E ratio, share price to profitability, their revenue growth, their cash flow statements.
I’m going to come to that in a second and a whole host of other things. None of those things could be possible… And that’s with listed companies, with private companies, of course, they don’t have a share price as such. None of those would be possible without some understanding of their accounts, and that’s been critical, okay? So if there’s a secret sauce, you’ve got it. That’s what you’re learning at the moment.
Again, part of my job is to work out, not gamble, not speculate on where the future will be, but to make sure the companies I pick are resilient and have solid balance sheets. So I might look at their price-to-book ratios, that they don’t have too many liabilities, that they can cover those liabilities, that they’ve got strong cash flow. I’ll look at their cash flow statements, that they’ve got good, strong earnings and earnings growth, so I’ll look at their P&L statements because I want resilient companies.
After all, I don’t know what the world will bring. We’re not in the business of gambling and speculating on the next big thing or the next fad; we just want to see that the numbers in their accounts are solid and are likely to remain so. That’s how we look to invest. We don’t trade in and out. We’re certainly not in the business of gambling because our investors in our asset management company are pension funds; they’re people who want safety and security.
One of the other reasons I like to talk to different audiences about investing is that there’s an enormous ignorance about it. You guys are at a considerable advantage in your school, being able to learn these topics, because the vast majority of people don’t know about investing, don’t know about what makes a company good, whether it’s private or public, and if it’s public, guess what? The SIPPs and ISAs in people’s pension funds, things you’ll worry about in the future, they’re all invested in public companies, so you need to know the stuff you’ll already be comfortable with, and I’ll tell you why.
Look at the big gap. In red, you can see the five-year returns of the FTSE 100, the 100 largest U.K. companies, and in the blue, you see the Nasdaq-100. They’re just index trackers; they’re just tracking indices of those companies, but look at the massive gap between somebody who might have, in America, tracking the U.S. markets and somebody over here who might have tracked only the U.K. ones.
That’s not saying the U.K.’s bad or good, or America’s good or bad; what it’s to say is with a bit of knowledge, you would know about investing because you know about accounts and P&Ls and so on. That makes you more confident, more familiar with the tools you’re going to need in life to save for when you grow older, accumulate wealth, and hopefully do good things with that wealth.
So when, as my clients often ask me, “Is this a good fund?” And I point out to them that they’re down 2% when the markets have been rising so much after three years, and this is somebody’s retirement fund. Unfortunately, my clients never had the education you had at school, so they have to come to me a lot later in life, and they don’t have the advantage of knowing what they should be doing. You’ll have those advantages because, as I said, you’ll have financial knowledge and confidence.
Not only that, part of my whole philosophy has always been that you can learn it yourself, even at school. I started investing when I was 12 years old, with £100 borrowed from my aunt. Okay, I’m not suggesting you all go and invest; your parents will kill me if I suggest that.
I’m saying you should at least have the education to know how to do it because somebody like me was entirely self-taught. From my school days onwards, I went on to win competitions on investing and beat fund managers manage billions and billions of pounds.
So what I’m saying is I don’t want you just to look at others in awe and say, “Oh, I’ll just give my money since they know best; they always know best.” You, too, can work it out. As somebody who started off investing as a schoolchild and started learning about it, I didn’t have much money to invest. I wouldn’t really call it investing, but I certainly learned about it when I was at school; that confidence stays with you for the rest of your life and can be life-altering.
This is not what investing is about. It is not meant to be this. It is not the whole day trading, and the “Give me the latest crypto and the latest TikTok news” and so on. It is not meant to be that. I think that’s gambling; I believe that’s speculating; I don’t think you should be looking at that, other than purely for fun, so not with real money, just fun, just to see what’s going on in the world, that’s fine.
What I do think investing is more about and the things. Some of these things that you’ll have come across, and I’ll tell you what, again, my favorite indicators are in a moment, is about valuation. And these are some of the indicators I look at – Discount cash flow, price-to-sales, price-to-book. It’s about has the company got growth, private or public? Sales growth, earnings growth, cash flow growth? What about income? Is it generating dividends, is it generating earnings to pay those dividends?
What about momentum? You probably haven’t come across these things yet, but you can look at them in due course. On the hedge fund side, we very much look at momentum. Are prices in a rising trend? And statistical analysis you probably haven’t come across in terms of share price movements, but we do look at this. How are the companies’ prices and returns distributed? In other words, do they consistently get high returns year-on-year? How do they do over 20 days, six months, a one-year period? Are they always positive, or could there be some large drawdowns? How do they correlate to the broader market? Because we actually want lots of companies which aren’t correlated to each other. Otherwise, we’re just buying one big company. There’s a lot to be learned, and this is just the tip of the iceberg.
I wanted to tell you a bit about my favorite indicator or my favorite ratio because I know there are many ratios. So what does Goldman Sachs tell their wealthiest clients? So as a hedge fund manager, I was invited to a lunch by the chairman of Goldman Sachs Asset Management. I know it sounds like I name-drop a lot, tell you about the time I met John Lennon. I haven’t met John Lennon. And they revealed this ratio that they use to tell their wealthiest clients.
Now, imagine that. They tell their wealthiest clients, so unless you’ve got $50 million to deposit with Goldman Sachs Asset Management, they use this to pick stocks and investments, and this is what I continue using. I’m afraid I copied it, and it’s called cash return on capital invested, or CROCI. It’s a cash flow measure, and they discovered that companies in the top quartile, the top 25% of companies by CROCI, generate 30% per annum returns over the long term. In 2008, nobody got 30%, so it’s not every year, it’s not a bank account, but over an extended period of time, on average, that’s what it works out at.
So that’s my favorite ratio; it’s not probably one you’ve covered; I’d be surprised if you have because very few people know it. Deutsche Bank invented it, Goldman Sachs Asset Management uses it, and there you go, you can see the slide; it’s part of their Quantum database. So shh, don’t tell anyone else. St Bede’s School, Redhill has got a complete advantage on investing, okay?
On a broader note, why might you want to invest? Well, I’m going to give you, and some of you might be thinking already at this stage, “Shut up, Mr. Patel, I’m rich already.” Well, assume you plan to invest over 15 years. Let’s assume you make 20% per annum, which is a lot. Maybe some years you make more, perhaps some years you make less, maybe some years you make a lot less, nothing extravagant, but let’s just take that as an assumption to get you a bit excited. The great advantage you’ve got is your youth.
Let’s say you’ve got £10,000 in a SIPP or ISA. You probably haven’t got a SIPP or an ISA right now. Your parents will know what I’m talking about, look into it. You plan to add £500 each month. There’s no way you got £500 at the moment unless you’re an entrepreneurial genius at school, but these are just numbers for you to play with.
In 15 years, you’ll have 600K, which is nearly a million dollars, in 15 years, by the time you’re touching about your early thirties, which seems really old. Trust me, somebody who’s passed 30 in the rear-view mirror a long time ago, that is not old. And this is what it looks like. In green are your contributions, and in red is the future value.
Now, everybody always talks about compounding, don’t they? Do you know why people don’t do compounding? Because for the first three or four… Well, three, four, five, six years barely makes any difference. No, it makes a difference back then. Delayed gratification is what psychologists call it. People who succeed in life are the ones who can delay their gratification. In other words, they can delay consumption and spending in exchange for saving.
And you might say, “Oh God, how boring, Mr. Patel, how boring, want to live our lives.” Do live your lives, but just keep this in mind, that your life isn’t what’s happening just today; it’s actually what’s going to happen for the next 10, 20, 30 years, and you’ve made the greatest start to it because you’ve already started learning about investing and those things.
Anyway, one thing that I’ve been a part of has been a campaign to teach a million people entirely for free how to be better investors. It’s more geared towards people a little bit later than yourselves, but you’re more than welcome to have a look at it all, and there are virtual internships when you’re at the right age.
They’re virtual; they’re online, lots of free education from my Financial Times books, and you can download free copies of my books. It’s all completely free, and its goal is to make sure people are more financially literate, there’s improved financial education. And I’m proud to say the Financial Times newspaper, who are my publishers for my books and my newspaper columns, is also leading a financial education drive within our schools.
And it’s also been for me, as somebody who grew up in Leeds, no silver spoon in my mouth, it’s been really important for something called social mobility, which I’m sure you’ve heard of. And so there are these more important things that you want more of when you get older; if that doesn’t sound too patronizing, forgive me if it does, I apologize.
Well, congratulations to your parents for picking a good school for you and the excellent education that you’re getting. Keep up with it, revise hard, make your teachers proud, make yourselves proud, make your families proud.
When you’re sitting on that beach in Bali or Maldives, thanks to the results you got in your education today, you’ll be thinking of me for at least half a second and thinking, “God, that old man was right.”
But honestly, those bigger purposes will matter more when you’re older, and it’s better to plan ahead now, and you’re already on the right track for that, so congratulations.
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Alpesh Patel OBE