Friday, August 1, 2014

Diversification And Rebalancing

By now you are aware of the benefits of diversification. As this article states "you don’t diversify to gain the highest returns. You do so to ensure you don’t get the lowest." An important part of diversification that you should be aware is rebalancing. Suppose that you decide you want a portfolio that has 70 percent stocks and 30 percent bonds. Since stocks generally have a higher return than bonds, over time, your portfolio weights will gradually shift more heavily toward stocks. Because of this, you should rebalance your portfolio periodically. In other words, you should sell some of the better performing asset and buy the other asset in order to return the portfolio weights to 70/30, your original allocation.

Thursday, July 31, 2014

Share Buybacks

In the first quarter of 2014, S&P 500 companies repurchased about $160 billion of their own shares. Companies may be motivated to repurchase shares because of slow domestic growth, which can make share repurchases an attractive alternative for corporations. Another motivation mentioned in the article  is that share repurchases may be used to readjust a company's capital structure. In the past several years, the stock market has increased in value, which has likely increased the equity weight of a company's capital structure. As a result, a company's capital structure may be too heavily tilted toward equity. A share repurchase can reduce the equity, thus restoring the capital structure to the optimal level.

A point about share repurchases addressed in the article that is particularly near and dear to us is research that finds companies are not particularly good investors. In fact, companies tend to undertake repurchases when company stock valuation is at a peak instead of when company stock is undervalued. One reason for this contradiction may be that as company performance increases, cash held by the company increases, as well as the stock price. As a result, companies have cash available when its stock price is high, which is the worst time to buy stock. 

The Value Of Stock Splits

In the textbook, we argued that stock splits appear to have no value to either shareholders or corporations. However, it appears that our analysis may be incorrect and there could well be an important advantage from stock splits that accrues to management.

Monday, July 28, 2014

Ratio Valuation Of The Clippers

Steve Ballmer's $2 billion bid for the Los Angeles Clippers shocked many people. Leaked court documents show why. Ballmer's bid was 12.1 times revenues (Price/sales ratio). For the last 25 NBA teams that were sold, only four have sold at a ratio above 4.0, and none had a ratio above 5.0. Similarly, the $2 billion bid price implies an EBITDA multiple of 12.1 times, while the league average has been 6.0 to 6.4 times EBITDA. All in all, it appears that Ballmer is willing to pay a high price for the Clippers, at least relative to revenue and EBITDA. 

Another Big Mac

Even though we discussed the most recent Big Mac Index yesterday, this article caught our eye. As you will see, the article discusses how the valuation of the dollar has changed over the past several years based on the price of Big Macs. For example, the average value of a basket of foreign currencies against the U.S dollar was about neutral in 2009. Based on the recent Big Mac Index, foreign currencies are about 15 percent undervalued against the dollar now. Several currencies have had wild fluctuations, including the euro, which was as much as 50 percent overvalued in 2008 and is now about fair value, and the yen, which has gone from fair value to 24 percent undervalued.

Saturday, July 26, 2014

The Big Mac Index

The 2014 Big Mac Index at The Economist is out and the average price of a Big Mac in the U.S. is $4.80. Norway has the most expensive Big Mac at $7.76 and the Ukraine has the cheapest Big Mac at $1.63. According to the Big Mac Index, five currencies are overvalued relative to the U.S. dollar by ay least 10 percent and 29 currencies are undervalued by at least 10 percent. Remember, the Big Mac Index is based off absolute purchasing power, which may not hold. For a video explanation of purchasing power parity, check out this video at Yahoo! Finance.

Friday, July 25, 2014

2014 Working Capital Survey

CFO just published the 2014 working capital survey by REL Consulting. The report indicates that the average days working capital decreased only .2 days over the past year. REL's analysis indicates that the 1,000 large U.S. companies included in the survey could reduce payables and receivables by $266 billion and $331 billion, respectively. While efficiency in short-term financial operations will help profitability, the lack of improvement in working capital management in recent years is likely due to the low interest rate environment. Some of the better performers in day's working capital outstanding include Murphy Oil (negative 60 days), Linn Energy (negative 50 days), Anadarko Petroleum (negative 45 days), and Dell (negative 23 days).