Need Someone To Explain the Turmoil To You? Don't look at me. It's horribly complex. I have talked to several who claimed to understand it and found out that they really only thought they understood it. One thing I do know is that the problem is a great deal more complex than some bad loans. My strategy is to conservatively manage my assets and do the same with client funds. One thing is apparent to me: Both "good assets" and 'bad assets are under selling pressure. Why the good assets? Because investors are selling things they might not normally sell in order to raise capital to make up for the bad assets. Whatever congress decides to do, there is little prospect for a quick turnaround.
Let's Talk About Something More Simple. Several companies have announced that they intend to repurchase their shares in the open market. Some clients have told me that they don't understand how share buybacks can benefit shareholders. Here is a simple explanation. Suppose you own 1000 shares of XYZ company. Suppose there are 9 other shareholders with 1000 shares each. If the company has a million dollars in assets, half of which is in cash, the asset value of each share is $100. Looking at income produced by the company, let's assume it is $250,000 per year or $25 per share outstanding. That means your 1000 shares earns entitles you to $25,000 of those earnings. If the stock is selling on the open market for 15 times earnings, the market value of each share is $375. Since the company has a half million in cash, it can buy 1000 shares on the market for $375,000 and still have $125,000 left. After the purchase, there will be only 9,000 shares outstanding and each share is entitled to $27.78 of earnings per year. At 15 times earnings, your stock would now be worth $416 per share. Hopefully, this tells you why a company might embark on a share repurchase program.
The Real Question Is The Best Use of The Excess Cash. Share buybacks are but one use of the excess cash a company has beyond that needed for reserves. In the previous example, the company could have distributed the $375,000 in excess cash to shareholders with each share receiving a $37.5 dividend. Your 1000 shares would entitle you to a dividend of $37,500, a 10% yield on your investment. The share repurchase increased the value of your stock by $41,600, only slightly more but you also have to consider the tax implications. There is no current tax on the increase in value but the dividend would leave you with a tax bill of $5625 at 15%. One of the main benefits of both dividends and share buybacks is that it keeps the cash from burning a hole in management's pocket. It seems that the better company executives are at managing the business, the worse they are at managing cash. Years ago Mobil bought, now bankrupt, Montgomery Ward. Arco bought Anaconda Copper just before metal prices crashed. Paying out dividends or buying back shares keeps management from doing something stupid with the money. (Part of the Data for this paragraph came from an article in the Wall Street Journal by Jason Zweig)
The Downside To Buying Back Shares. While it would seem that putting capital into the hands of shareholders is a good thing, we can't overlook the fact that companies often buy back shares when the company is producing cash and prices are high, only to need the money later when the business is weak and share prices are down. In 2006 and 2007, Washington Mutual bought back 6.5 billion worth of stock at $43+ per share. This spring, they had to issue new stock at a price of $8.75. Citicorp and Wachovia made similar moves. That will dispel the rumor that these executives are smarter than the rest of us.
Who's Buying Back Shares Now? Microsoft just announced that it is going to buy back $40 billion worth of stock. While they are only sitting on $21 billion in cash now, they have good cash flow and borrowing power for the rest. Hewlett Packard is going to buy back $8 billion with part of the 14 billion in cash they now have. The biggest share buybacks came from Exxon-Mobil with a total of $102 billion worth of shares bought back.
Denver Real Estate Market Better than Most. A leading indicator in the Denver real estate market is the number of homes for sale. In this regard, things have improved immensely. Last August, a buyer had 30,800 homes to choose from. This August, there were only 24,648 homes, a drop of 20%. This is highly significant. Part of the reduction is due to major decreases in the number of new homes being produced. My belief is that inventories will continue to shrink until demand catches up with supply. Buying a residential rental unit right now may not produce a quick increase in price but it appears highly probable that prices will begin to increase in the near future.
Trying To Finish Up In Colorado. It has been a busy couple of months here in Colorado. I still have some real estate business to clear up and I have been making considerable effort to understand this crazy market. I am anxious to see what unfolds in the energy business as we argue over how to break free of foreign oil. Hopefully, we can make some of the right moves in stabilizing our economy.
Wednesday, September 24, 2008
Wednesday, September 17, 2008
BULLETS FLYING EVERYWHERE
Looking For A Place To Hide? If you find one, call me. I have long warned my readers that it is impossible to correctly predict market directions with a high degree of accuracy. I also warned that, if you can't anticipate the future, the next best thing was to be resilient and ready to persevere when negative events happen. In my thirty years as an entrepreneur, I went through a number of negative events and watched clients and colleagues do the same. Those that fell by the wayside were the ones who blamed others for their misfortune and expected someone else to bail them out. Successful people realized that they created their own existence and were responsible for correcting the situation. By resiliency, I don't mean that you should sit where you are and do nothing. That also is a recipe for disaster. What you have to do is assess the situation and develop a coping strategy. Of course you could be like Bill O'Reilly and blame everyone from the oil companies to the "speculators" to the government. His most stupid comment was that the President had the responsibility to monitor the financial markets and warn "the folks" when a disaster like the present one was coming. Can you imagine what would happen if the President called a news conference and warned that certain companies were doing things that put the system at risk. If there wasn't a panic before, that would certainly start one.
The Two Best Things You Can Do. One of my clients suggested that he might purchase a mountain condo which he could use for business purposes. He has $70,000 in cash for a down payment. My advice is one that I would give most everyone: Keep a Cash Reserve and Guard it With Your life. Now is not the time to speculate on anything, much less a mountain condo. I don't mean that you should have all your money in cash, only that you should have enough to see you through a crisis or take advantage of opportunities that may arise. The next point is Take A look At your spending habits and eliminate expenditures for which you don't receive adequate value. I am a good example of someone who needs to do that. I bet I could cut $500 a month from my expenditures and barely notice it. While that doesn't sound like much, in this market it would take $100,000 in capital to produce that kind of income at a reasonably safe rate. I am going to work on that while I am in Denver.
Hospices, Hurricanes, and Other Unfortunate Events. It's been a difficult summer. I just spent two weeks taking shifts in a hospice watching Betty's brother go through the trauma of dying. He was only a year or so older than me. It was hard on everyone. My son-in-law lost his mother to pancreatic cancer. She was a beautiful person who will be strongly missed by all of us. A hurricane blew into the Southeast Texas area and left a lot of my family members without power. My brother-in-law's barn was virtually ruined in the wind and one of my neighbors on the lake lost virtually his whole house when the roof blew off and the inside soaked with 12 inches of rain. I lost a few trees, none of which hit the house, gazebo, or boat house. I am lucky but I guess I hurt for all these people. The trauma of the current financial markets is certainly secondary to what happened to lots of other folks. I can little afford to quit fighting at this point. It's what I've done for most of my life. I am reminded of a joke one of my buddies used to tell because it reminded him of me. It is about a man who fell from the top of a 60-story building. When he passed the 30th floor he looked at the people watching and said, "So far, so good." I guess my friend, who died 12 years ago, was right about me. Next week, I'll have some comments about the markets with an emphasis on energy.
The Two Best Things You Can Do. One of my clients suggested that he might purchase a mountain condo which he could use for business purposes. He has $70,000 in cash for a down payment. My advice is one that I would give most everyone: Keep a Cash Reserve and Guard it With Your life. Now is not the time to speculate on anything, much less a mountain condo. I don't mean that you should have all your money in cash, only that you should have enough to see you through a crisis or take advantage of opportunities that may arise. The next point is Take A look At your spending habits and eliminate expenditures for which you don't receive adequate value. I am a good example of someone who needs to do that. I bet I could cut $500 a month from my expenditures and barely notice it. While that doesn't sound like much, in this market it would take $100,000 in capital to produce that kind of income at a reasonably safe rate. I am going to work on that while I am in Denver.
Hospices, Hurricanes, and Other Unfortunate Events. It's been a difficult summer. I just spent two weeks taking shifts in a hospice watching Betty's brother go through the trauma of dying. He was only a year or so older than me. It was hard on everyone. My son-in-law lost his mother to pancreatic cancer. She was a beautiful person who will be strongly missed by all of us. A hurricane blew into the Southeast Texas area and left a lot of my family members without power. My brother-in-law's barn was virtually ruined in the wind and one of my neighbors on the lake lost virtually his whole house when the roof blew off and the inside soaked with 12 inches of rain. I lost a few trees, none of which hit the house, gazebo, or boat house. I am lucky but I guess I hurt for all these people. The trauma of the current financial markets is certainly secondary to what happened to lots of other folks. I can little afford to quit fighting at this point. It's what I've done for most of my life. I am reminded of a joke one of my buddies used to tell because it reminded him of me. It is about a man who fell from the top of a 60-story building. When he passed the 30th floor he looked at the people watching and said, "So far, so good." I guess my friend, who died 12 years ago, was right about me. Next week, I'll have some comments about the markets with an emphasis on energy.
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