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Stock buybacks: what are they good for?

I used to wonder why companies would throw their hard-earned cash into the stock market when it obviously would have been better spent developing new markets, creating jobs, opening new facilities, etc. Then I got an education last year via a part-time gig editing newsletters for Charles Biderman of TrimTabs Investment Research. Biderman has a complex theory built around the supply and demand for stocks that boils down to this: Stock issues like IPOs increase the supply and press down on prices; stock purchases like buybacks and mergers decrease supply and drive prices up. Large shifts in buying are bullish, large shifts in selling are bearish.

Biderman developed a formula for measuring stock supply and demand across the entire U.S. stock market. It’s not perfect, but it’s pretty good at signaling where the market’s going before the retail crowd knows it.

If Biderman’s so clever, why have you never heard of him? Mainly because he sells the results of TrimTabs’ research to hedge funds, institutional investors, pension funds and so forth and isn’t particularly interested in “retail” stock advice. I’m bound by a contract which naturally forbids me from revealing for free what he charges his clients several thousand dollars a year to learn.

I can share a few things I’ve learned about stock buybacks, however:

  • Company insiders have the most intimate knowledge of how their company’s doing: Because stock is as liquid as cash, investing some of their cash in stock is a reasonably safe investment if they know things about sales, earnings and cash flow that will juice their stock price. A buyback can be an announcement of good tidings ahead.
  • Only a small amount of any stock is free to trade: Most sensible investors buy stock and hold it for years; this is especially true of pension funds and mutual funds, which, depending on the stock, can hold a very large percentage of the shares that are not on the market. This means a company can buy back, say, 5 percent of its shares and still affect the prices of the other 95 percent.
  • Stock buybacks usually spike during major market downturns. Corporate financial managers like to buy stuff on sale too, especially when they’re reasonably certain the price will go back up again soon. I’m sure Charles wouldn’t mind me telling you this as a public service: companies have not been buying back their shares in response to September-October selloff. This tells us what we kinda sorta already know: the recession will punish earnings growth, and the markets will punish companies that report earnings reductions. Buybacks are a cinch in a bull market when the trend is your friend, but they are a very risky proposition in a bear market that chews up cash for months on end.
  • Some of Biderman’s research shows up in a regular column at Forbes. From the latest:

    Corporate America is using hardly any of its near-record cash hoard to buy shares. In December, announced corporate buying was only $3.6 billion, the lowest monthly amount in this decade. Particularly worrisome is that new stock buybacks plunged to $15.8 billion in November and December, down 90% from $164.4 billion in November and December 2007.

    Companies have had two full months to digest the autumn collapse in stock prices and they haven’t made their typical decision to throw their cash at their own stock, even when they know doing so will decrease supply and help prices rise. Translation: the bear market seems poised to overwhelm the buybacks’ benefit.

  • Buybacks can happen for the wrong reasons. Flailing companies have been known to use buybacks — rather than building market share, cash flow and profitability — to rescue their stock price. I saw this happen in the newspaper business: Knight Ridder, the now defunct newspaper chain, promised to buy back a bunch of its shares after the markets turned against the industry. People were getting out of the habit of reading newspapers, which was affecting circulation, which was affecting advertising revenue, which was making newspapers less profitable. The market plainly knew this and spanked Knight Ridder’s shares accordingly. A Knight Ridder buyback would have thrown untold millions that might better have been spent on building its business down a stock market rathole. (I’m not certain that KR actually went through with the buyback, but I do remember a buyback announcement).

Bottom line: Buybacks represent a useful data point, but they must be considered in the context of everything else you also know about a company.

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Tom Mangan posted at 8:28 am January 7th, 2009 |

Are 401(k)s doomed?

Last week my employer announced it is suspending 401(k) contributions for 2009. Mind you I work for a debt-burdened company in an industry seemingly on the verge of extinction (seemingly because most individual newspapers still turn a nice profit, but sales, margins and circulations are all shrinking, hence the doom-and-gloom.) One writer worries what happens if this idea catches on, quoting a New York Times story from last month:

Traditional pensions are disappearing, and Washington has yet to ensure that Social Security will remain solvent as baby boomers retire and more workers are needed to support each retiree.

The company cutbacks may mean that some employees put less money into their retirement accounts. Even if they do not, the cuts, while temporary, will have a permanent effect by costing many workers years of future compounding on the missed contributions. No one knows how long credit will remain scarce for companies, or whether companies will start making their matching contributions again when credit loosens and business improves.

401(k) investing was the engine of the 1990s bull market — billions of new money flowed into the market as people began signing up. The logic of a 401(k) seems flawless: If you sock away 6 percent of your income and your company matches half of that, you have a built-in 50 percent profit. I got greedy in 2007 and 2008 last year and took out 9 percent vs. the company’s 3 percent match. Last year’s 45 percent decline cleaned my clock good, but I lost only about a quarter of my own money (Disclosure: I’m all in cash now as a hedge against getting pink-slipped: It could take awhile for this going-on-50 white guy to scare up new revenue sources after two decades in a going-out-of-style industry.)

Take away the guaranteed profit of a 401(k) match and all the sudden you’re up against all the market risk instead of half of it — and you’re limited to the funds your company lets you invest in. Not very sexy from a “where should I stow my life savings?” standpoint.

Also, companies that stop 401(k) contributions may find that all the sudden their employees aren’t so hot for a voluntary pay cut: with no company match I might as well draw my full salary and invest my cash in the best place I can find.

But what about the tax deferral? A co-worker of mine who is very savvy about such things expects taxes to be much higher 20 years from now, when all the baby boomers have retired, so he’s putting as much as he can into a Roth IRA, which allows you to make tax-free withdrawals in retirement because you’ve already paid income tax on the money (you’d still owe taxes on the capital gains, presumably, but with a 401(k), all money you take out is treated as taxable income because you paid no taxes on it when you earned it.) More on Roths at this page.

Hopefully the cut-off of 401(k) funding is temporary.

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Tom Mangan posted at 11:59 am January 2nd, 2009 |

Handy links for dividend hunters

Bloomberg lists the dividends of S&P 500 stocks. Caterpillar’s yield is 3.76, but here’s something that may surprise you: Intel’s dividend (3.82) is even better. Heck, I thought tech stocks didn’t pay dividends.

(Dividends yield basics: yield travels in the opposite direction of price, so stocks with extremely low prices can have extraordinary dividends; the caveat being that extremely low price usually represents the market’s judgment on the company’s overall prospects. Gannett, the newspaper chain, is paying a 20 percent dividend, for instance, but newspaper stocks are off by an average of 83 percent in the last year).

Dividends, incidentally, are essential to the popular Dogs of the Dow strategy.

“Dogs of the Dow” or “High Yield 10”, is a popular investment strategy that defines a portfolio by equal dollar value investments into the 10 highest yielding Dow stocks at the end of a year. The theory behind the strategy is that dividends are more stable than stock prices and therefore, a high dividend yield reflects a stock that is near the bottom of its business cycle and has a beaten down share price that is poised for a rebound.

Good news: Cat is not a Dog.

Lastly: Some folks buy stocks just before their dividends are paid, then cash in shortly afterward. Note this supposedly works best in bull markets.

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Tom Mangan posted at 8:16 am January 2nd, 2009 |

Great stock screener: is a data junkie’s wet dream. It’s all charts, numbers, headlines and other data points, but it also has an excellent stock screening tool with just about every sort-down you could imagine.

it also includes a page of news headlines with a column of blog posts.

And, naturally, you can sort by ticker. Here’s Cat’s page. Note the nice candlestick-pattern charting. Also: Latest SEC filings at the bottom. (Bonus link: CNCB blogger predicting great days ahead for Cat stock.)

Definite add to my bookmarks list. Another for the technically minded:

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Tom Mangan posted at 10:12 am December 30th, 2008 |

Become a millionaire on $20 a day? Please

Nothing to it, Motley Fool says. Just put $20 a day in stocks for the next 25 years and you’re all set. A few quibbles:

  • Twenty dollars a day is Seven Thousand, Three Hundred Dollars a year. If you can spare seven grand after paying for houses, kids, clothing, health care, groceries, cars, college funds, etc., you probably don’t have all that much to worry about, financially.
  • Say you followed Foolish advice and invested wisely in stocks for the past 25 years and had your million in the bank as of this time last year. Today you’d be down Four Hundred Thousand Dollars. Given that most most bubbles overcorrect to the tune of 80 percent, it’s not unreasonable to assume another 40 percent haircut in the next year. OK, so having 200k left over after the worst crash in history wouldn’t be so bad, but it wouldn’t exactly be fulfilling those Foolish promises of becoming a millionaire.

The surest way to pile up money in your investment accounts is to put more in than you take out. Stocks offer the promise of more rewards, but they also carry significantly more risk. Every stock can go to zero and you can lose all your money, just like at the casino.

I met a guy the other day who made an risky bet on building the business of his dreams and it cost him four million dollars. Entrepreneurs and professional traders lose this kind of money all the time; they share a common trait: major appetite for betting large, minor fear of losing large. If you’re one of those people, you ought to be risking it all on building that biz of your dreams rather than chasing paper profits in the stock market. If, like me, you have zero discipline and a tendency to panic, you’re better off in money market funds.

There are lots of ways to become rich; the stock market has disappointed far more than it has pleased, because amateurs buy tops, sell bottoms, get in/out at the worst times and have little/no concept of risk management. Not that the professionals have done that much better: this year they gave us the worst crash in 80 years (it’s probably no coincidence this happened after almost all the survivors of ’29 had died).

I’m all for saving $20 a day — but if you can avoid the temptation to think a penny saved is a penny earned and therefore justifiably spent on, say, a 52-inch plasma TV, you’ve got more self-control than most. Sure, the best things in life are free, but most of the next-best things cost money — it all comes down to how much next-best stuff you want to do without so you can have a few extra bucks in the bank.

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Tom Mangan posted at 12:34 pm December 27th, 2008 |

The *other* infrastructure play

RealMoney contributor Robert Loest says the debt-fueled economic expansion of the U.S. consumer sector has about had it. He contends the developing world will be a major source of growth in coming years and that large multinationals like Caterpillar are best poised to exploit those opportunities because they have such a huge head start at doing things like building factories, developing markets and dealing with political complexity around the globe.

Investors may want to consider replacing many of their iconic consumer companies with global industrials with good, relatively secure dividends such as Caterpillar, Rockwell International , Emerson Electric , ABB Limited and similar companies, unless their consumer stocks are really undervalued and pay a hefty, secure dividend

You’ll have to forgive the author for using buzzwords like “paradigm shift” and “event horizon.” Some can’t help themselves.

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Tom Mangan posted at 1:08 pm December 26th, 2008 |

Lenny Dykstra on finding a stock’s PEG

Lenny Dykstra, the former Major League Baseball star, is a financial wiz these days with a column at and everything. He offers a primer on adding a growth component to a stock’s price/earnings ratio to get a better idea of a stock’s potential momentum.

When you add the growth trajectory to a P/E, what you get is a PEG ratio: a P/E multiple divided by its expected rate of earnings growth. A stock is generally considered to be fairly priced when its P/E ratio equals its growth rate, which works out to a PEG ratio of 1 (for example, a P/E of 10 divided by an EPS growth rate of 10% equals 1). A PEG ratio below 1 is considered undervalued. The lower the PEG the better, as long as it’s not in negative territory.

You have to rely on companies’ and analysts’ estimates of forward earnings to arrive at the PEG, so it’s a bit of a crapshoot (as is every other data point in isolation), and it’s especially rough sledding in times like now, when so many companies are lowering their profit estimates. You can’t calculate Price/Earnings/Growth if there’s no growth. How does Cat fit in?

In this recession, we’re seeing many companies predict lower total sales for 2009. For a company whose earnings will drop, the PEG ratio becomes meaningless. For example, Caterpillar has a forward P/E of 8.9. But its consensus 2009 EPS estimate is about 20% lower than 2008 earnings. Dividing P/E by a negative growth rate gives a negative PEG number that is not useful.

The reality is that Caterpillar’s earnings outlook is unclear, and an expected revenue drop could be offset next year by a big federal infrastructure spending package once President-elect Obama takes office.

Dykstra shows how it works by crunching numbers for a couple tech companies with actual growth estimates for next year.

You don’t have to do the math yourself: Yahoo’s stock screener, for example, includes PEG. Interestingly, very few stocks have a PEG under 1, according to Yahoo’s screener, suggesting either a) the screener is wrong; b) stocks are still overpriced despite the fall crash; or c) everybody’s earnings are falling next year so their PEGs are negative.

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Tom Mangan posted at 11:23 am December 23rd, 2008 |

My accidental lesson on leverage

I learn far more from what I screw up than what I get right. For instance, when I created Cat Stock Blog I started a fantasy portfolio in my Wall Street Journal account. I funded it with $1,000 in fake money, but I mistakenly entered my first transaction for 100 shares of Cat at $42.33, giving myself a balance of minus-$3,233 on the first day. This the equivalent of putting $1,000 in cash down and investing the rest on margin, just like the big boys do (except when they don’t).

Every day I get an e-mail telling me my day’s returns. At first I wondered why my returns were so totally out of whack with the day’s close, the it dawned on me what was happening: The automated portfolio software was accidentally replicating the process of using leverage to juice returns.

Here’s what happened today: On a day when the market fell about 2 percent, my fake portfolio’s net worth plummeted by 13 percent. Three-to-one leverage looks risky as hell in a down market; imagine how careful/crafty/brilliant/lucky you’d have to be if you were floating 30-to-1 leverage like many of the hedge funds and investment banks did until recently.

And people were surprised that there was a crash.

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Tom Mangan posted at 1:49 pm December 22nd, 2008 |

9 things to do with your life other than buy stocks

Scott Adams, creater of Dilbert, passes these along, courtesy of Motley Fool:

  1. Make a will.
  2. Pay off your credit cards.
  3. Get term life insurance if you have a family to support.
  4. Fund your 401(k) to the maximum.
  5. Fund your IRA to the maximum.
  6. Buy a house if you want to live in a house and can afford it.
  7. Put six months’ worth of expenses in a money market account.
  8. Take whatever money is left over and invest 70% in a stock index fund and 30% in a bond fund through any discount broker, and never touch it until retirement.
  9. If any of this confuses you, or if you have something special going on (retirement, college planning, tax issues), hire a fee-based financial planner.

I don’t see any money for beer and rock concerts in there, alas.

Also, any time is a good time to ask yourself how much of your wealth you want tied up in your own company’s stock. Remember Enron.

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Tom Mangan posted at 10:46 pm December 21st, 2008 |

Cat options update

Seeking Alpha posted a summary yesterday of what’s up in the Caterpillar options market:

Caterpillar Inc. (CAT) – Despite a share price decline in today’s session to $43.42 option investors retain a positive bias on Caterpillar’s prospects no doubt with what one might coin as the Obama-put. Media is today banding about news of a proposed $850 billion stimulus package in the works, which is expected to address infrastructure and would be a boon to heavy equipment makers – at least that’s the theory. Investors used the January 45 strike call option to add 11,000 more bullish bets on the company and paid a 2.55 premium, which implies that Caterpillar needs to rally to $47.55 by expiration for investors holding calls to make money. Through Wednesday investors held 16,014 lots of open interest at the strike price.

You got all that? Eleven thousand bets that the stock’ll go over $47.55 by January expiration is not a trivial gamble. But folks play options with money they can afford to lose (or use them to hedge money they want to keep). Yahoo keeps a page of Cat options quotes here. Even if you don’t dabble in options (which requires cojones of iron), you can watch the supply and demand for puts and calls to get an idea of where options traders think the stock is going.

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Tom Mangan posted at 9:24 am December 19th, 2008 |