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Both might decline, but income usually not as much, can recover. Wealth and value follow
Published on Monday, Dec 22, 2008
One of the best lessons I've learned was not in a classroom. It was from a crusty machinist in Rochester, N.Y. I haven't seen him in 25 years, but the lesson has stayed with me. It seems particularly important now.
His name was Jerry Pfrengle, so I call it the Pfrengle Principle. It's all about the income. To have value, you need income. Never forget that income precedes value.
Here's the story. In the early 1980s, I was on the board of directors of a small, multidivisional manufacturing company with about $50 million in annual revenue. I was also chairman of the audit committee. The company manufactured and supplied rubber, plastic and metal parts to companies like Xerox, Kodak, IBM and Ford. One division made spark plug boots for Ford. Another made major castings for Xerox copiers and IBM keyboards. Jerry's division made machined parts for everything from cameras to snow blowers.
Pfrengle was a machinist who started with a handful of machines. He grew it into a much larger shop. He could do just about anything with metal. Jerry wore a long shop coat, but even when he took it off, the deep scent of machine oil preceded him like a strong aftershave lotion.
Jerry was also a collector. Only he did not collect old cars, vintage watches, revered wines or ancient lithographs. He collected automatic screw machines and other metal-working equipment. Behind his shop, a large Quonset hut was stuffed with his machinery, all bought at scrap metal prices.
When he got a piece of equipment — often at a going-out-of-business sale or auction — he took it to his Quonset hut and refurbished it at his leisure, the way other men restore old boats and antique cars. Then it just sat there.
Jerry would wait for a turn in the market. When it came, he either put the machine to work in his own shop, or sold it at a large profit.
''The big companies give them away when the economy is off,'' he told me. ''And small companies pay a premium for them when they have orders in hand.''
Value was all about the income you can produce with an added machine, he explained. Without orders, the machines were only worth their scrap value — and even that would be low when everyone else was scrapping, too. But with orders, a single busy machine could provide a living for a machinist, pay the rent, and put money in Jerry's pocket. Or it could be sold at a fat premium.
''The swings in value are always extreme,'' Jerry told me. ''They're much more dramatic than the swings in income.''
As consumers, we seldom see this reality so clearly. Whatever the market value of our home, it still provides shelter. The same applies to our cars, appliances and other goodies — if they are being used, they have a value. We just don't know what it is in dollars and cents. Similarly, we're inclined to believe the old Mustang convertible or the aging Persian rug has value because someone, somewhere, will want to add it to his collection.
Call it the Greater Collector Theory. Basically, it's difficult to get a visceral understanding of modest changes in income and extreme changes in value.
Trust me, this does not apply to automatic screw machine equipment.
If it can't be put to use producing income, you might have to pay someone to haul it away. You could learn that by spending only five minutes in Jerry's Quonset hut.
So what does the Pfrengle Principle have to do with you and me today?
Lots.
Right now we're all transfixed by the disappearance of wealth, vast quantities of it. Much of it is due to empty houses in Florida, Nevada and California. That is producing a second wave, a major ''wealth effect,'' as we attempt to save real money now that home appreciation isn't doing all our saving for us.
So I have a suggestion. Next time you are impressed by a decline in value, check income. Note that it hasn't changed nearly as much as value. Note also that income may dip, but it also recovers.
It's scary out there when you view the world by wealth. So just remember — it all starts with income. Wealth and value are artifacts created by income.
Questions about personal finance and investments may be sent by e-mail to scott@scottburns.com. The Web site http://www.scottburns.com has articles, offers referenced Web links or a discussion of personal finance topics. Questions of general interest will be answered in future columns and on the Web site.
One of the best lessons I've learned was not in a classroom. It was from a crusty machinist in Rochester, N.Y. I haven't seen him in 25 years, but the lesson has stayed with me. It seems particularly important now.
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