Motley Fool Money - A "Shock and Awe" Acquisition

Episode Date: November 1, 2022

A 50% premium is a buyout price most investors would love to see. To acquire Abiomed, Johnson & Johnson was happy to pay it. (0:17) Bill Mann discusses: - Why he believes a "shock and awe" price was worth paying for J&J - How Abiomed strengthens the company's medical device portfolio - Amazon expanding its ad-free music library for Prime members - Signs that the retail giant is gunning for Spotify, Disney, and other entertainment companies (10:33)  Alison Southwick and Robert Brokamp discuss how shortcuts can make you a smarter saver. Companies discussed: JNJ, ABMD, AMZN, SPOT, DIS, PARA Host: Chris Hill Guest: Bill Mann, Alison Southwick, Robert Brokamp Producer: Ricky Mulvey Engineers: Tim Sparks, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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If you're 45 or older and at average risk, ask your health care provider about the Coligard test. Colagard is available by prescription only. Learn more or request a prescription today at colagard.com slash screen. We've got a big deal in healthcare and some budget shortcuts that anyone can take. Motley Fool money starts now. I'm Chris Hill, joining me today, Motley Fool's senior analyst, Bill Mann. Happy November.

Sure, if you say so, how you doing? If November goes as well for the market as October did, I think I'm doing pretty well. I ended up having to buy a surprise new water heater yesterday. I do love surprises in general, but a surprise new water heater that you have to pay for is pretty low on the list. Yeah, it was a good October. The markets were happy. I guess I would have been less happy about my surprise new water heater at the beginning of October than at the end of October. So, good news. Let's keep a good thought. We're going to start with the deal of the day and possibly end up being the deal of the week. Johnson and Johnson is buying Abiyamed, a medical

device company that makes heart pumps. This is a $16.6 billion deal. And Johnson and Johnson must have really wanted this company because they are paying a 50 percent premium on where the stock was previously. And based on the fact that shares of Johnson and Johnson are down only about a half percent or so makes me think that the market in general does not believe J&J is overpaying. What do you think? It was a shock and all purchase price for sure. I mean, there are a couple things here. For one, Johnson and Johnson is paying less than Abia Med's all-time high share price, which

was in 2018. So not that there's anything magical about an all-time high, but you have a company that's been growing really, really quickly. They make primarily, I think, the thing that Johnson and Johnson wanted more than anything else was their Impella heart pump, which is billed as the world's smallest heart pump. The other thing, Chris, is that some of the performance for Abbey Ahmed has been backloaded. If you notice all of the statements about this purchase were $16.6 billion up front. There are additional payments that they could receive should certain milestones be met moving forward. So, yeah, I think it's a pretty good deal for Johnson and Johnson, even though it is

absolutely a big premium over last Friday's clothes. Are you surprised at all that they have made a purchase of this size? This is the biggest deal J&J has made in nearly six years. And this comes at a time when they're They are preparing. They're in the process of getting ready to split the company. It's expected to happen in late 2023, but I'm wondering if on any level you're surprised that they took on this. Look, this is a big, important company with a lot of moving parts. So it's no surprise that separating the company is going to take a long time. They're being very diligent and careful with that process. Adding a business like Abiy Ahmed has to be a very

has to complicate that, if only slightly, right? I mean, I think it probably complicates it a little bit, but the CEO of the combined Johnson and Johnson is Joaquin Duotto, and he's been very clear about the fact that as part of the separation between their consumer drug division and their medical device division, that they want to beef up the medical device division. It's been an area that has not had a whole lot of growth, both. And part of the process of doing this has been to make this a much stronger division.

So they were pretty clear about the fact that they would not, you know, that they would be looking for bolt on acquisitions. And we need to be clear, $16.6 billion is a lot of money. It's a lot of cash. But it is still a pretty small fraction of the size of Johnson and Johnson now and Johnson and Johnson Medical Device Division, I guess we can call that Johnson and Johnson and Johnson moving forward. It is not a huge acquisition for them relative to the size of the overall business. Let's move on to Amazon then, because Amazon has increased the price of a subscription to Prime from $119 a year to $139 a year. And this morning, Amazon made a couple of announcements aimed at signaling to people, hey, if you're a prime member, we're going to

try and give you more than we have been giving you. Amazon is expanding its library of ad-free music. And as a prime member who uses that library, I appreciate that. I'm looking forward to searching up songs and albums and being able to access them rather than being told, Oh, this is only available for Amazon Unlimited members, and you have to pay a subscription for that. So, I appreciate that. I think it's a good move. I'm a little confused by the other announcement, which is that Amazon, which has systematically moved into live sports programming to the point where it is now the sole place to find Thursday night football, Amazon is launching

12 hours of sports talk programming on Amazon Prime. TV. I'm confused. What is your reaction to this? Because if you had told me that they were testing daily sports programming, I would say that makes sense. The fact that they're jumping in with 12 hours a day, that's the surprising part to me. It's amazing to me just thinking about this. and we talked about that a little bit beforehand, how many different companies Amazon is going after with this one announcement? They're going after Spotify, for real. They're going after ESPN, part of Disney, for real.

They're going after Paramount and CBS for real with this announcement. And I think the ESPN model is probably most illustrative for where they're going. They've decided to get into this business. And if they are going to be broadcasting live sports events, they may want to be looking for ways to broadcast live and taped commentary about it as well to keep people on the platform for as much as possible. So, yeah, I'm with you. Twelve hours of sports commentary for me is about 11 hours and 30 minutes to much.

Maybe, but, you know, I think that there's something there. And they're already doing this with the Premier League, for example. They've had absolutely fantastic, not just coverage of the sporting event itself. I'm always a little bit torn as to whether I should call it soccer or football. But let's go with soccer. We're in the United States. They've done a delightful job in adding additional. commentary and additional features to their coverage of the Premier League.

So to me, it's not a surprising step. I'm not necessarily the audience, but I'm not necessarily not the audience either, though, Chris. Well, and you know, you talk about the Premier League. Again, if they had, if they had made it more targeted and built specifically around the programming that they had, you know, that would make more sense to me, rather than, as you said, this is kind of aimed squarely at ESPN. Yeah. I mean, I think if you think about it, which is easier and which is cheaper to launch?

Is it easier and cheaper to launch sports commentary? Or is it easier and cheaper to go out and buy the rights to broadcast games? I think probably they are attempting to get to the latter by doing the former. It's just not as expensive. And it's not as much. of a of a, not even for Amazon, I mean, they've got billions of dollars in cash, but buying rights to sporting events is a really, really big business and it's really expensive. So for this to be built in to prime, you know what, Chris, as we're talking, I'm talking myself into how smart of a deal this is. This is brilliant. I don't know what your problem is. It makes sense to me from that standpoint. Well, it makes sense to you from an economic standpoint.

Maybe not a programming statement. And I hear the point you're making. Yes, it's absolutely much more expensive for them to go to the NFL and say, here are truckloads of money and we would like exclusive rights to Thursday Night Football, as opposed to going to, you know, presumably a showrunner. I'm assuming there is, whoever is the Jimmy Pitaro of Amazon Prime, I'm assuming they've got that person to oversee all of this programming. you know, I'm assuming whoever these people are hosting these shows, they're not making

the kinds of, you know, dollars that Al Michaels is. No, I'm just, at this point, I'm just questioning why you hate Amazon so much. It's fair. That's fair. I've been bearish about Amazon since the day I started. So, you know, it's a fair criticism. Bill Mann, great talking to you. Thanks for being here. Thanks, Chris. Do you really need a detailed budget or? Can you take a shortcut? Alison Southwick and Robert Brokamp look at some common and lesser known rules of thumb that can make you a smarter saver and spender. Financial planning can be complicated.

You have to figure out what to do about your budget, housing expenses, retirement savings, life insurance, college savings, and asset allocation, all while trying to manage a career and perhaps raise a family. Fortunately, the world of personal finance offers many rules of thumb that can at least get you started down the right path. And so today, we're going to talk about some of the most well-known and some not-so-well-known. Indeed, we are, Allison. And I should point out that many experts really aren't big fans of these financial shortcuts. And I definitely agree that doing some sort of full-fledged, personalized analysis of all your

money-related decisions is ideal. But, you know, that takes time and maybe money, especially if you're getting help from a professional. So with a handy-dandy standard guideline, you can at least get started. As Lucia Fernand of Morningstar wrote, these rules of thumb, quote, lessen the psychological pressure in the decision-making processes while they are easy to follow and reduce choice complexity. And that's just a fancy way of saying that a rule of thumb is more likely to result in someone actually doing something rather than getting stuck in analysis paralysis. So as we go through these very general guidelines, you've got to use your foolish wisdom in determining whether they are good enough for your situation. And I also want to add that however you make your decisions, it's still probably a good idea to change.

check in with a fee-only financial planner every few years and right before major financial decisions just to make sure you're on the right track. All right. For our first rule of thumb, let's start with a conundrum faced by every household. How to divvy up each paycheck between wants, needs, and savings. Yeah, the most popular budgeting guideline these days has come to be known as the 50, 30, 20 rule. And it goes like this. 50% of your after-tax income should go to necessities like mortgage, health care, groceries, 30% to discretionary purchases, things like entertainment and vacations, and then 20% to saving for financial goals. And I think it's a fine guideline, though, I personally

would like to rearrange it to the 2050-30 rule because it emphasizes that you should prioritize your savings first. And if you're saving enough, then how you divvy up the rest of your budget really may not matter as much. Though if you're spending more than half of your budget on essentials, it doesn't leave much left over for fun. But I know that's the situation for many middle income, families, especially in high-cost areas. Since we're on the topic of budgeting, I'll throw out another guideline. And the fact is, most people actually don't budget because it could be tedious and time-consuming. And it certainly makes sense to sit down and look at your expenses like once or twice a year or so. But what you'll find is, frankly, that a lot of them

are relatively fixed. So besides that annual check-in, a more productive use of your time might be to just focus on the spending that tends to get away from you. So it'll be different for you. It'll be different for each person, but it tends to be things like going out to eat, shopping, clothes, tech gadgets, stuff like that. So figure out how much is reasonable to spend each month on a few discretionary categories and just track those. I think that's a lot more manageable. Okay. So you have a plan for where your money should go, but that can be tough to stick to when, you know, maybe you're scrolling through Instagram and something pops up and you want to buy it and why not? Just do it. You're bored. So what are some ways to think about spending that might

help resist those sort of urges to spend stuff that you don't need. Yeah, this is tricky, especially with the holidays coming up. But here are a couple suggestions. So first, before you buy something, think about how long you had to work to earn that money. And if you're paid by the hour, that's easy to do. For salaried folks, here's the rule of thumb. Divide your salary by 2,000. So if your pay is $100,000 a year, that works out to be about $50 an hour.

But that's before taxes. You have to lob off a third to get to the amount you can actually spend. So, again, if your salary is $100,000 a year, you make $50 an hour pre-tax, but around $33 post-tax. Therefore, if you're in the store or you know, on Instagram or whatever, and you see something that costs $100 that caught your eye, it took you three hours of work to earn that money. And is the purchase worth three hours of your labor? So that's one guideline. And another is to consider the opportunity cost. The more you spend, the less you have to invest for the future. Here are some numbers to keep in mind. Each dollar you spend represents about $2 of future value in 10 years, $5 in 20 years, and $10

in 30 years. You could spend $100 a day or have $200 in 10 years, $520 years, 1,030 years. And that may not sound life-changing. You may think, like, is it a big deal if my portfolio is smaller by a few hundred dollars way into the future. But if you ask this question every time you spend money for the next month, I bet you'll get an appreciation for how these purchases shortchange your future net worth by thousands and thousands of dollars. Now, one expense that we can't talk ourselves out of is housing, because we all have to live somewhere. What's the rule of thumb on how much someone should spend

on rent or a mortgage? I would say the upper limit that anyone should spend on housing is 30% of their budget. In fact, according to guidelines from the Department of Housing and Urban Development, a family that spends more than 30 percent of its gross income on rent is considered, quote, cost burdened. And according to the Census Bureau, around 50 percent of renters fall into this category. Now, when it comes to buying a house, there are two classic guidelines. The first is known as the front end ratio. And it says that your monthly housing expenses, including mortgage, taxes, insurance, shouldn't be more than 28 percent of your monthly income. And then the other is the Backend ratio, which adds other debt that you may have, like school loans or credit cards

or auto loans to your housing expenses. That shouldn't be more than 36% of your income. That's the most you should spend. If you can get below that, it's even better, though that's pretty difficult in today's housing market, given high mortgage rates and high prices. Fortunately for potential buyers, prices have begun to come down a bit. I'll throw in one other guideline, and this comes from David Bach and his book, The Automatic Billionaire Homeowner.

quote, you should generally assume that the amount the bank or mortgage company is willing to loan you is more than you should borrow. And I think that's actually a pretty good advice. But one of the biggest expenses a family might make in their life is a college education. According to the college board, it costs more than $23,000 a year to attend an in-state public college and more than $53,000 a year to attend a private school. So multiply that by four, sprinkle in some inflation. And you're looking at a pretty big outlay of cash by the time the it has earned a degree. So, bro, what are the rules of thumb for covering the cost of college? The most common is the rule of thirds. And it goes like this, save a third, pay for a third out of

cash flow, and then borrow a third. So let's break those down. For saving, you first have to figure out how much college is going to cost. And there are plenty of college savings calculators available on the internet. But as a family, you have to decide whether you're shooting for an in-state school or you want to save for a private education. Either way, I do agree with this guideline in that you don't have to have every penny saved by the time the kid is 18, which brings us to the third that will come from cash flow. And this can work because the average American reaches their peak earning years in their late 40s or early 50s, which is around the time the kid goes to college. Plus, frankly, and I know this from personal experience, some of your household

expenses will drop when the kid goes to school, right? You won't spend as much on food, utilities, sports, high school activities. So some of that money can be directed toward paying the college bill. Now, this brings us to borrowing the remaining third. This one's much more debatable. Some families don't want to burden themselves or their kids with debt, while others think it's actually a good idea for the kid to have some skin in the game, so to speak. So you're going to have to make the decision that's right for you and your family.

But if the student is going to borrow money, here's another rule of thumb. Limit the debt to roughly amount that the student expects to earn, in her or his first year after graduating. Now, that's going to be difficult for many kids who enter college, not knowing what they want to do after they graduate, which, you know, frankly, is most of them. Nowadays, the average college grad earns $55,000 in the first year out of school. So if the student doesn't have a clear career choice,

I'd actually aim to borrow much less than that only if necessary. And finally, on this topic, I'm just going to point out that in July, we interviewed former FDIC chair, Sheila Baer, about a new tool she helped develop that helps kids determine an appropriate amount to borrow for school, and you can find that tool at student debt smarter.org. All right. Let's move on to another aspect of personal finance that is important when you have a family, and that's life insurance. According to Limra, 50% of Americans have life insurance,

which is down from 60% in 2016. And according to the American Council of Life Insurers, the average policy is worth a bit under $200,000. So, bro, is that enough? Well, I'm going to say probably not. And the rule of thumb here is to get a term policy, not permanent, term policy worth 10 times your salary, perhaps plus another 100,000 to 200,000 per kid to pay for college. Now, I will say there are plenty of online calculators that can help you determine a more customized figure, and I've used many. But I actually think this guideline does a pretty good job. You might get some coverage through your employer, and that's often like one to two times your salary. So you might think, well, yeah, I may not need to buy as much on my own.

However, given the fact that people often change jobs, I think it's best to just go with a 10 times rule and that you buy it for yourself. Now, I'm a cheap skate, but here's a place where I think you really shouldn't skimp. Getting another $100,000 to $200,000 or more of extra coverage of term insurance really doesn't cost that much, but it could be a huge help to your family if they end up needing it. I also want to point out that non-working spouses should also be covered, especially if their main job is take care of the kids at home. So for this, you calculate the cost of hiring help to provide the services that the spouse is providing,

and you multiply that number by the number of years needed. All that said, you only need life insurance if other people rely on your income or your services. So if everyone would be fine financially if you passed away, you probably don't need life insurance. Okay, so you may not need life insurance, but everyone should be saving for retirement. All right, bro, how much should people be saving? So, the rule of thumb here used to be 10%. But nowadays, most studies indicate that 15% of the household income is better. And that is to account for, I think, most experts expect returns from most portfolios to be lower than they have been in the past.

Plus, we're all living longer. So 15% of household income. But that does include the employer match if you get one. So these days, the average match is between 3% and 5%. So let's say it's 4% where you work, then you need to contribute just 11% to hit that 15% target. However, this 15% guideline is for people who start saving in their 20s, maybe early 30s and work until age 65 or 67. If you're getting a late start or you want to retire earlier, then you likely need to save more. Okay, so workers are going along in their careers, growing their 401ks and IRAs.

How much should someone have to feel reasonably sure that their retirement? plan is on track? Well, fortunately, nowadays, many financial services firms provide savings benchmarks based on age, and they're expressed as a multiple of household income. So what I've done here is taking the general average of benchmarks provided by Ally Bank, Bank of America, Fidelity, J.P. Morgan, and T.R.R. Price. So according to the average of what these folks say, someone who's 30 should have 0.8 times their household income saved for retirement. So if your household income is $100,000, you should

have 80,000 saved already. That factor moves up to 2.5 income by age 40, five times income by age 50, eight times income by age 60, and by the time you retire, you should have 11 to 12 times your income saved up. Now, these are super general guidelines, and there are many, many factors that will determine the correct savings benchmark for your situation. One is your income, and that is because Social Security is designed to replace more income for lower income workers. So, for someone who earned, let's say, on average, $50,000 a year over their career, Social Security is going to replace around 45% of that. But for someone who averaged $150,000 a year over their career, Social Security is only going to replace around 25% of that. So the more you earn, the more

you have to save because Social Security replace less of your pre-retirement income. And this is reflected in the guidelines provided some of the firms I mentioned. For example, according to Jayfew, P Morgan, someone with a lifetime earnings of $70,000 a year, they're only going to need six and a half times that at retirement because they're going to get a good dealer replacement from Social Security. But if your household income on average was $200,000 over the course of your career, then you need 12.3 times that before you can retire. All right. Now you have all this money saved for retirement, but how should you invest it? And this is going to be our final rule of thumb today. And it's one that you actually think is

kind of outdated. Yeah. So it's a rule that's been around for a long time, and it's basically this. You subtract your age from 100, and that's the amount you should have in stocks. And this is also known as the own your age in bonds. So if you're 30, 30 percent of your portfolio should be in bonds, and if you're 60, it should be 60 percent in bonds and so on. And this is likely way too conservative.

We have a full have a general guideline that you just have about 10 percent of your portfolio in cash just to take advantage of opportunities. But it could be argued that investors would be able to be. with a high risk tolerance could keep 90% of or more of their money in stocks well into their 40s, if not later, especially in light of the fact that people are retiring later and living longer. I should say that to compensate for these rising longevity, this rule has been updated. It first moved up to 110 minus your age to arrive at your stock allocation, and more recently it subtract your age from 120 or 125.

And I could be much more on board with those latter two, again, if you have the risk tolerance to handle the ups and downs of the stock market. However, even that guideline is imperfect because it presumes that as you age in retirement, you should lower your allocation to stocks. But research shows that it's actually better to maintain a static allocation to stocks in retirement, maybe 50 to 65 percent with regular rebalancing. You're going to need a sizable allocation to stocks in order for your portfolio to last as long as you do. Well, that's it for our financial shortcuts. Do you have a question about them or about personal finances in general? If so, you know, you?

You're in luck. On November 15, we're going to do a mailbag episode. So send your questions to podcasts, plural, at fool.com. And we may answer it on the show. As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against. So don't buy ourselves stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.