Friday, February 28, 2014

Just A Litte Interest

Prudential recently announced that with profit payments, its policyholders in the United Kingdom who had contributed £50 per month for 25 years would receive £31,438. A quick calculation shows that the annual return on this investment was an APR of 5.36 percent. By now, you should know a small difference in interest rates can result in a large difference in future values because of the effect of compounding. For example, a similar policy with Aviva had an ending balance of £28,869, an APR of 4.79 percent. So, over  this period, a difference of .57 percent per year resulted in a difference in the future value of £2,569. Policies by Standard Life, with an ending balance of £27,304 returned 4.41 percent, and Scottish Widows policies returned £25,842, or 4.04 percent.

Monday, February 17, 2014

February Dividends

Investors are watching dividend announcements closely during February. Although a company can increase or decrease a dividend at any time, February is a popular month for dividend announcements since it is often when the previous year's final earnings are announced. Last year, February saw 78 dividend increases by S&P 500 companies. So far this February, there have been 28 dividend increases announced. Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, expects that dividends paid by S&P 500 companies will reach $319 billion in 2014, topping the $312 billion in dividends paid during 2013.

Is The IPO Market Booming?

Our guest blogger today is Dr. Jay Ritter, renowned IPO researcher. Professor Ritter is the Cordell Professor of Finance at the University of Florida and has published more than 30 papers regarding equity issuance. Below, Dr. Ritter updates his previous post on the current IPO market.  

2013 saw more initial public offerings (IPOs) in the U.S. than in any year since 2007, and the financial press has been full of stories about the booming IPO market.

IPO volume tends to fall in bear markets and rise in bull markets. In the United States in 1980-2000, an average of 302 operating companies went public each year. Since then, volume has been much lower. Indeed, even with the S&P 500 increasing by 30% in 2013, only 156 operating companies went public last year. The low level of IPO activity compared with the 1980s and 1990s has frequently been attributed to a changed regulatory environment, with the Sarbanes-Oxley Act of 2002 being singled out for increasing the costs of being publicly traded. The Jumpstart Our Business Startups (JOBS) Act of 2012 reduces some of these burdens, especially for Emerging Growth Companies, defined as companies with less than $1 billion in annual revenue that have recently gone public.

In “Where Have All the IPOs Gone?”, which will be published in the Journal of Financial and Quantitative Analysis, Xiaohui Gao, Zhongyan Zhu, and I present an alternative explanation for the prolonged low level of small company IPO activity that has existed since 2000. We posit that there has been a structural change whereby getting big fast is more important than it used to be, especially for technology firms. We argue that organic growth (that is, internal growth) takes too long for a company with a hot new technology. Rather than going public and remaining as an independent firm, the company finds that its value-maximizing strategy is to sell out in a trade sale. The acquiring firm is willing to pay top dollar because it can create more value by rapidly integrating the new technology into its existing products, generating greater sales because it can certify the product with its brand name and use an extant marketing organization, rather than needing to hire new employees to expand. 

People frequently think of an IPO as part of the life-cycle of a successful firm founded by an entrepreneur, with the IPO being both a capital-raising event and a “liquidity event” that occurs once a firm has achieved a critical level of scale. In the 1980s and 1990s in the U.S., this framework was very descriptive of actual practice for many entrepreneurial firms. Since the tech-stock bubble burst in 2000, however, this framework is increasingly at odds with practice. Instead, venture capitalists have been operating with a “build to sell” model in which they exit from an investment in a successful portfolio firm via a trade sale, in which the entrepreneurial firm sells out to a larger firm in the same or a related industry, rather than remaining independent. In other words, the traditional life-cycle for a successful technology change has permanently changed.

Wednesday, February 5, 2014

Ethics And Stock Prices

CVS Caremark, operator of CVS stores, announced that it would no longer sell cigarettes in its stores. The company estimates that it will lose $2 billion in annual revenue and six to nine cents per share in EPS. In addition to the lost sales from cigarettes, CVS will lose sales of other items that cigarette purchasers would buy at the store. The decision by CVS is likely part of a larger move as pharmacies are trying to become health care providers. The company's stock dropped about 1.8 percent, although it did recover some. As one analyst put it "Good for them that they're taking a stand, and I'm selling my CVS stock." 

The statement made by CVS indicates the company made the decision for ethical and health reasons. That raises the question of how far CVS will go. While we are not stating that cigarettes are good for you, one article discusses five other items that CVS sells that are unhealthy. For example, CVS still sells soda (or pop as it is more accurately known by Northerners.) Recent studies have found that soda increases the risk of diabetes by 22 percent and the risk of cardiovascular disease by a third. So, should investors be concerned that CVS will state that the ethical standards of the company are such that it will stop selling these other items as well? 

Monday, February 3, 2014

Seahawks Win Good For The Market?

The Super Bowl indicator is a stock market indicator which holds that if an NFC team wins the Super Bowl, the market will be up for the year and if an AFC teams wins, the market will fall. However, some argue that an original NFL team must win for the indicator to indicate an up year. This year, if the Denver Broncos had won, it might have been a good sign since the previous two times they won the Super Bowl the market was up 28 and 15 percent. In any case, the Seattle Seahawks won in a rout, so we will have to wait until the end of the year to see if the indicator is based on an NFC team winning or an original NFL team winning. Of course, if this really is your investment strategy, we would suggest rereading Chapter 14.

Sunday, February 2, 2014

Bankruptcy Priority In Detroit

A common question we get is how the market determines the YTM on a bond. One thing that investors do is look at history to see how the corporation or municipality has treated its investors. A recent bankruptcy proposal in the Detroit bankruptcy may increase the future YTM for Michigan municipalities and possibly all U.S. municipalities. Investors have generally believed that a municipality would increase the tax rate in order to repay outstanding bonds. The proposal made by Detroit's emergency manager calls for:
  - Paying pension funds at a rate of 45 to 50 cents on the dollar.
  - Paying retiree healthcare liabilities at 13 cents on the dollar.
  - Paying $1.4 billion of loans made to fund the pension fund at 20 cents on the dollar.
  - Unlimited-tax general obligation bondholders would receive 45 cents on the dollar
  - Limited-tax bondholders would receive 28 cents on the dollar.
If the plan is permitted by the bankruptcy judge, future municipal bondholders will likely demand a higher interest rate since they would effectively be classified as subordinated creditors.

Securitizing Rent

Mortgage-backed securities were given much of the blame for the recent financial crisis. As a result of the financial crisis, home prices dropped dramatically in many areas of the country and homeowners who had their homes foreclosed were forced to rent. Because of these conditions, some investors have found an opportunity by buying houses at reduced prices and renting those houses. For example, Blackstone Group LP has spent more than $7.8 billion on 41,000 homes. To fund the house buying, bonds backed by the rental income from the houses are now being sold and could reach $30 billion per year. Because of the rapid growth in the market and fears of a repeat of mortgage-backed bond problems, at least one California Congressman has requested that the Financial Services Committee hold hearings on these bonds. 

Dead Peasant Insurance Ethics

A recent article in the Los Angeles Times has brought company owned life insurance (COLI) back into the limelight. COLI, or dead peasant insurance, occurs when a company buys life insurance on an employee, typically a rank-and-file employee. When the employee dies, the company receives the death benefit from the insurance. In this case, the LA Times took exception when its competitor, the Orange County Register, asked its employees to agree to these life insurance policies, with the death benefit being used to partially fund the company's pension fund. Ethical questions may arise when these policies are issued. For example, if a company has a COLI policy on an employee, perhaps the company will be more willing to scrimp on safety protocols. While some argue that COLI policies are unethical, very few argue that key person life insurance is unethical. A key person policy is a company owned policy on a key employee such as a CEO, whose death would impact the company in a negative manner.