Thursday, December 10, 2015

Buybacks And Bonuses

A recent article discusses how buybacks at Humana earned CEO Bruce Broussard a $1.68 million bonus in 2014. Humana was on target to miss its target EPS of $7.50. However, the company announced a stock buyback of $500 million, which increased EPS to $7.51, triggering the bonus. In all, 255 of the S&P 500 companies have executive performance tied in part to EPS. As we have discussed, in our opinion, EPS is not an appropriate measure of performance as it is easily manipulated. Executive bonuses should be tied to measures that better align with increases in shareholder value. As an example of EPS manipulation, the article reports that, in 2012, then-CEO of Humana Michael McCallister received a $1.63 million bonus because the Board of Directors removed litigation expenses from the EPS calculation.

Tuesday, December 8, 2015

Evaulating Corporate Management

One of the most difficult task for an investor is how to evaluate company management. The CFA Institute recently published an article describing one method to analyze company management. First, concentrate on the numbers on the balance sheet and income statement. Of particular interest are gross margins, operating margins, income tax rates, foreign sales and earnings translations, and balance sheet concerns. Second, the company should have well understood and written processes for its critical functions. Finally, you should look at management. In this area, you should look for unquestioned integrity, innovation of products and processes, how well employees are treated, and good control of people and processes. If a company meets these screens, it indicates a strong management team.

Monday, December 7, 2015

2016 CFO Goals

A recent survey by Proviti asked CFOs about top priorities for 2016. At the top of the list was margin and earnings performance. Next on the list was cybersecurity risks, strategic planning, periodic forecasting, and budgeting. Executives are also seeking more precision in cash forecasting, an often overlooked area. From a student's point of view, the list of priorities can indicate areas in which they could hopefully make an immediate contribution to their employer.

IPOs Exhibit Material Weakness

From 2011 to 2014, the number of IPOs on the NYSE has more than doubled, from 128 to 293. However, from a financial reporting view, the IPOs have grown weaker. The percentage of IPOs that reported material weaknesses, or deficiencies, in financial reporting grew from 23 percent in 2011 to 31 percent for 2015 IPOs through September. One reason may be the JOBS Act, which allows smaller companies to raise external capital. Staggering 88 percent of IPOs with less than $500 million in revenue reported material weaknesses.

Monday, November 23, 2015

Retirement And Time Value Of Money

A recent article at discusses how saving earlier in your IRA can mean big money at retirement, which we hope you already know this. As the article discusses, many people make their IRA deposit right before April 15th each year when taxes are due. However, if the deposit were made a year earlier, the difference under Bankrate's assumptions would be $113,985 at retirement. The assumptions used in the article are a $5,500 annual deposit at 8 percent for 40 years. Check for yourself that if the deposits are at the end of the period, the future value is $1,242,810.85 and if the deposits are an annuity due, the future value is $1,538,795.72. So, Bankrate's article presents a set of calculations that we hope you are already familiar with. Of course, the future value will increase another $30,000 or so if you make your deposits on January 1st of each year, 15 months before the last date April 15th of the following year.  

Pfizer-Allergan Acquisition

Pfizer announced that it would buy rival pharmaceutical company Allergan for about $160 billion. The new company will be based in Ireland, a tax inversion deal that will lower Pfizer's tax rate from 25 percent to 15 percent. The deal makes 2015 a record breaking year for mergers and acquisitions. For example, healthcare M&A deals have topped $600 billion, shattering the previous high of $362 billion in 2014. Energy and power M&A currently stands at $572 billion, while high technology M&A has reached $514 billion. And, worldwide, total M&A activity has reached $4.2 trillion, topping the previous high of $4.1 trillion set in 2007.

Wednesday, November 11, 2015

Clawbacks And Restatements

A major provision of the Dodd-Frank Act requires corporate executives to certify the accuracy of financial statements, in part to help reduce restatements. Another provision of the Act requires that all public companies have a "clawback" provision that permits the recovery of any incentive compensation paid to executives if the restated financial statements show that the incentive compensation should not have been paid. In 2012, 87 percent of publicly traded companies had a clawback provision. Previous research has found that companies with a clawback provision are less likely to have restatements. This was attributed to executives doing a more diligent job when certifying the original financial statements. However, new research indicates that the drop in restatements may also be due to executives fighting restatements. Often, restatements are the result of auditors disagreeing with the original financial statements because of the accounting choices made. Since a restatement that reduces the company's reported performance can cause the initiation of the clawback, corporate executives appear more likely to fight restatements.

Tuesday, November 10, 2015

Corporate Leverage Increases

According to Goldman Sachs, the level of debt on corporate balance sheets has risen to a level not seen since before 2008. With record low interest rates, companies have increasingly borrowed to fund buybacks and acquisitions. During 2014, about 10 percent of debt issues were used to fund buybacks. And, so far during 2015, about 8 percent of debt issues have been used for buybacks. Meanwhile, goodwill, which is created from mergers and acquisitions, has risen 32 percent since 2010 and more than $1 trillion in goodwill has been added to corporate balance sheets since 2008. While goodwill can represent real value, such as a brand name, it could also indicate that companies have made negative NPV acquisitions.

Thursday, November 5, 2015

WACC And Acquisitions

An article on CFO discusses the WACC for S&P 500 companies and the use of the WACC in mergers and acquisition. An interesting number in the article is that, according to research by Bain & Company, the average WACC for a company in the S&P 500 has dropped from 10 percent in 2010 to 8 percent in 2014. Much of this is likely due to lower interest rates. The article also discusses how companies add a risk premium of 200 to 300 basis points to the WACC (the subjective approach) when analyzing a potential acquisition, plus another 50 to 100 basis points due to conservatism about the WACC calculation. Although the article is not specific, we should reiterate the correct WACC to use when analyzing a potential acquisition is the WACC of the target company, not the WACC of the acquiring company. To clarify terminology, the hurdle rate used in the article is the required return, or cost of capital.  

The Market Return For The Next Decade

So what will the stock market return be going forward? John Bogle, founder of Vanguard Mutual Funds and proponent of index investing, recently stated that investors should only expect about a 4 percent annual return from the S&P 500 for the next decade. According to Bogle, he expects a 2 percent dividend yield and earnings growth of 5 percent, for a 7 percent return. However, he also expects the PE ratio on the S&P 500 to fall from its current level of 20 times earnings to 15 times earnings. This decrease in the PE ratio will cause a 3 percent decrease in stock prices, resulting in his estimate of a 4 percent annual return. So is Bogle right? Check back with us in 2025 and we will let you know.

Tuesday, November 3, 2015

Democratization Of IPOs

So you have read about IPO "pops" in this chapter and want to buy IPOs. A major problem is that the majority of IPO allocations are sold to institutional investors like banks, mutual funds, and high-net worth investors who have an established relationship with the underwriter. JP Morgan has decided to change the IPO investing landscape. The company has teamed with online brokerage Motif Investing to allow small investors to participate in IPOs. Motif will allow investors to submit commission-free orders in IPOs underwritten by JP Morgan with a minimum order of $250. One risk of the new process is that while IPOs typically have very heavy trading on the first day, institutional investors tend to hold the securities for a relatively long time. Small investors may be hoping for the IPO pop and sell the stock quickly, which could lead to even larger trading volume early in the life of the IPO, with more price instability.   

Monday, November 2, 2015

Bond LIquidity And Yields

Many observers believe that the Federal Reserve may increase interest rates in December. According to a recent article, that could be the worst time for the bond market. During December, bond trading slows dramatically as banks clean up balance sheets in preparation for year-end stress tests. As a result, banks are less likely to enter into large trades. Strategists at RBC Capital Markets argue that the large jump in yields on bonds in late September was due to the lack of liquidity in the bond market because of banks preparing for quarterly reporting. If this is true, an increase in interest rates by the Federal may result in larger increases in bond yields than might be expected due to lack of liquidity, at least temporarily.     

Saturday, October 31, 2015

Startup Investing Expanded

Yesterday, the Securities and Exchange Commission approved Title III of the 2012 Jumpstart Our Business Startups Act (JOBS Act). Title II of the JOBS Act, which was approved in in 2013, allowed accredited investors to in startups. The approval of Title III allows anyone to invest in startups, small businesses, and real estate through crowdfunding. The total amount of investment in such ventures is limited to 5 or 10 percent of the investors annual income, which provides protection to small investors from themselves. But, it does allow small investors into startups, which can provide very high returns. However, before you make these investments, remember the lessons from Chapters 10 and 11: The only way to increase your return is to increase the level of risk you take. 

Robert Schiller Examines Your Weaknesses

In a recent interview, Nobel Laureate Robert Schiller discusses how companies can mislead consumers and how the media latches on to smalls stories. His comments are based on human behavior, which is the basis for behavioral finance. His last comments are a very interesting take on investing: "We don't know the probabilities of future events. Still, you have to take action and so you do it on gut feeling. That's the world we live in. There's so much disagreement about investing, and it's because nobody really knows." Interestingly, although we greatly respect Dr. Schiller, he is still guilty of making his own market predictions.

Thursday, October 22, 2015

Cat's Good Bad News

Caterpillar Inc., announced lower quarterly profits and that it expected sales in 2016 to decrease 5 percent, the company's 4th consecutive yearly sales decline. On this announcement of seemingly bad news, the stock was up as much as 5.7 percent on the day. So why was the stock price up today? The news in the announcement today was consistent with the company's warning last month.

Wednesday, October 21, 2015

Negative U.S. Interest Rates?

Back in March, we posted about negative interest rates in Europe. And while recent speculation has centered on the Federal Reserve increasing interest rates, at least one member of the Fed has pushed for negative interest rates. Narayana Kocherlakota, president of the Minneapolis Fed, has advocated for the Federal Reserve implementing negative interest rates in the U.S. Although Kocherlakota is a non-voting member of the Fed, he has been joined by other Fed officials arguing for negative interest rates. An extra mattress for your savings account is looking more appealing.

Ferrari Strong Off The Line

Ferrari stock was strong off the line on its IPO. The company's stock, which was priced at $52 in the IPO opened at $60, a 15.4 percent price jump, before closing at $55, a 9.5 percent price increase. The company raised $893 million in its IPO, which could increase to $982 million if the Green Shoe option is exercised. 

Friday, October 16, 2015

Buybacks Hit $600 Billion

S&P companies have announced about $600 billion in stock buybacks this year. A major reason for the high level of buybacks is the low interest rate. The dividend payout ratio for blue chip companies is about 3 percent, but the same company can borrow at about 2.2 percent. This means that it is actually cheaper to buy back stock with borrowed money as this will save the company .8 percent per year. Of course, there is a widespread belief that the Federal Reserve will raise interest rates soon, which will lessen the appeal of buybacks funded with new borrowing.

Tuesday, October 13, 2015

An Unsystematic Risk

Often, we get asked by students for examples of unsystematic, or firm specific, risks. We are sure that you have heard about Dieselgate, or Volkswagen's deliberate programming of emissions devices in its diesel vehicles to fool emissions tests. Dieselgate is a perfect example of unsystematic risk as it affects only Volkswagen, although it appears that other auto makers may face unsystematic risks as well as several other manufacturers may have similarly created programming to cheat emissions tests. If you think about Volkswagen's actions and the risk, the news will likely greatly affect VW's sales as some consumers will avoid the company's vehicles. And while these consumers will be forced to look elsewhere, the sheer number of alternative manufacturers means that it is unlikely any particular manufacturer will receive a huge spike in new customers.

Control Of GE

Activist investor Nelson Peltz, who has a one percent stake in General Electric through Trian Fund Management has outlined plans that he feels GE should follow to behave like a cash cow, not a growth company. For example, Peltz wants GE to get rid of its finance division, add debt to buy back stock, and cut costs. What is interesting is that GE has recently sold its appliance division for $3.3 billion, sold its vehicle-fleets assets business for $6.9 billion, sold its health finance unit for $9 billion, and today sold GE Capital, with $32 billion in assets, to Wells Fargo. In fact, since April 2015, GE has sold $126 billion of the $200 billion it plans to divest. It sounds like Peltz is suggesting GE do what it said it was going to do.

Wednesday, September 16, 2015

Bond Prices Relatively Unchanged

Bond prices were in both positive and negative territory today, with the yield of two-year Treasuries settling up 8 basis points, the highest level in four and a half years. Bond traders are uncertain of the direction of interest rates leading into the Federal Reserve meetings this week. So will the Fed raise interest rates this week? Yes, No, No, Yes.  

Wednesday, September 9, 2015

Correlation With Apple

A recent article discusses the correlation that various stocks have with Apple and some of the stocks are surprising. For example, industrial products manufacturer Illinois Tool Works (ITW) has the highest correlation at .61. Payment technology firm Fiserv and Honeywell have the next highest correlations with Apple. Facebook and Texas Instruments also have high correlations with Apple, which is expected since Facebook is a tech stock and Texas Instruments is a major supplier to Apple. By now, we hope you understand how important correlation is to diversification, but, as with most numbers, we need to apply economic rationale to the numbers. There is no reason that ITW and Fiserv should have such high correlations with Apple, and in the future, these correlations will likely fall. Remember, what we really want is the correlations going forward, not correlations in the past. As Eric Chemi, the author of the article, states in the accompanying video: "That's where the data can get you and I think people need to be careful to not get trapped in these types of numbers."

Macy's Options

When a company makes an announcement, most people do not consider that many of these announcements are in fact real options. For example, yesterday Macy's made two separate announcements that are both real options. First, the company announced that it would close 35-40 underperforming stores, the option to abandon. Next, the company announced that it would open Best Buy outlets in 10 of its stores. While this is a small capital budgeting decision, it is an option to expand as Macy's and Best Buy both hope the combination is successful, in which case more Macy's will feature a Best Buy outlet.

Tuesday, September 1, 2015

VIX Volatility

The VIX, which measures the volatility of the S&P 500, has recently had an increased volatility, reaching levels not seen since the financial crisis of 2008. The level of the VIX is still in the area that generally occurs when the economy is in a recession. A JPMorgan analyst argued that the increased volatility was the result of price-insensitive traders who had "trend following strategies (CTAs), risk parity portfolios, and volatility managed strategies", all of which served to increase market volatility.

Wednesday, August 26, 2015

Market Efficiency Wins Again

Skeptics of stock market efficiency are always ready to argue "evidence" that the stock market is grossly inefficient. One piece of evidence that has been used in recent years is the performance of hedge funds. An oft reported statistic is that the average hedge fund return since 1996 was 12.6 percent per year. A recent article highlights research that indicates this claim is incorrect. Overstated hedge funds returns are due to the fact that hedge funds self-report returns. So, if a fund has poor returns, it stops reporting returns. Additionally, when a hedge fund is started, it will often not report returns until it has "something to brag about."  After removing these biases, the researchers found that the average annual hedge fund return since 1996 was only 6.3 percent, half of the reported average!

Annuity Sales

The stock market crash in 2008 made many investors nervous. As a result, many of these investors have searched for more certain investments, including annuities. We describe annuities as an equal payment at some specified interval for a fixed period. In an investing prospective, annuities are an investment vehicle that can have a fixed rate. Although there is more involved in an annuity, the basics of an annuity are that an investor deposits money into the account and either immediately or at some point in the future receives payments. The payments are calculated like the annuity payments in the textbook. So, the payments are based off the amount deposited, the interest rate, and the number of payments. Since annuities are currently paying below 3 percent, it is surprising that sales of annuities have increased because this lower interest rate results in lower payments than when the interest rate is higher.

Stock And Gold Correlation

Historically, the correlation between the stock market and gold prices is low, or even negative during some periods. Because of this, gold is often seen as a good asset for a diversified portfolio since a low or negative correlation can increase diversification. However, just because it happened in the past does not mean that it will happen in the future. For example, while the market dropped on Monday, gold prices also took a hit. While one day does not a trend make, both the stock market as a whole and gold are down year-to-date. All of this should be taken as a warning. Just because two assets have had a low or negative correlation in the past does not mean that the correlation will hold going forward. In other words, when using correlation, we want the correlation going forward but are often forced to use historical correlation. 

CEO Pay Ratio

One of the most controversial provisions of the Dodd-Frank Act is the CEO pay ratio rule. This rule requires that public companies report CEO pay as a ratio of the median employee pay. And while this seems like a relatively easy computation, many large multinationals are arguing that it is a difficult and expensive proposition. Compensation around the world is measured in different ways, depending on government regulations about social benefits, healthcare, and taxes. Additionally, whether part-time employees should be included in the calculation has become a contentious issue. Since wages overseas are often lower than in the U.S., companies are eager to exclude foreign workers. Either way, the rule will be expensive: The SEC has estimated the cost to all companies in the first year will be $1.2 billion.

Monday, August 3, 2015

Greek Stocks Tank

Even though Greece reached an accord on the repayment of its sovereign debt, there are still those who believe the reprieve will be short-lived. Given this fear, coupled with the weak Greek economy, it is little surprise that the Athens stock market nose dived when it opened for the first time in five weeks. Overall, the Athens market fell 16.2 percent today, with several bank stocks dropping 30 percent, the maximum allowed according to Greek stock market regulations.

Wednesday, July 29, 2015

Losing Money At Zero Percent

One thing that can drive students crazy when first learning Finance is that sometimes things seem counterintuitive. For example, a recent article highlights that while a zero percent interest rate on car loans seems like a good deal, it can actually cost the uninformed buyer money. One specific example is the 2015 Jeep Cherokee SUV.  The vehicle lists for $27,153, but the buyer can take a $2,000 rebate or zero percent financing for 60 months. While many people would jump at the zero percent financing, the monthly payment under this option would be $452.55. If the buyer takes the rebate instead and finances the vehicle at 2 percent, the monthly payments would only be $440.88 per month. Although the article does not discuss a breakeven interest rate, we hope your time value of money skills allow you to calculate that the breakeven rate is 3.10 percent. So, if you can borrow at any rate below 3.10 percent for 60 months, the $2,000 rebate is preferable to zero percent financing!

Tuesday, July 28, 2015

The Chinese Stock Market Rout

Any market can experience a bear market and the Shanghai Composite, the 144 China-based companies that have a primary listing on major U.S. stock markets, is no exception. The Shanghai Composite lost about 8.5 percent on Monday and is down about 27 percent since its June 12 peak. The result is a loss of about $40 billion in stock value! Another measure of Chinese stock performance, the CSI300, which comprises the largest listed companies in Shanghai and Shenzhen, fell 8.8 percent Monday. As a result, the Chines government has said that it was ready to buy shares of stock to stabilize the market and stop the "systematic risk." Regulators also said that they would harshly punish anyone who was malicously shorting stocks.

Saturday, July 25, 2015

Really Bad Financial Analysis

There are times when we get a headache from slapping our foreheads after reading really bad financial analysis, especially when done by a well-respected S&P 500 company like Boeing. But, after reading this recent article, it may be a headache that lasts for a while. As you can read, the article states that Boeing loses $23 million on each 787 it sells. And while we Microsoft loses money on every XBox One, it makes up for those losses on the sale of each video game. So, we were wondering how Boeing was making up the losses on the sale of each 787 until we read this:

"Commercial jetliner programs typically lose money in the early years of production until the heavy upfront investments in engineering and production are repaid. Boeing's accounting spreads those costs over a large block of planes the company expects to deliver."

In other words, Boeing is losing money only because they are spreading the initial cost of the project over the life of the project! Accounting for the initial cost of a project in this manner not only violates a basic tenet of capital budgeting, but gives a misleading profitability number to investors.

If You Don't Like It, Create Your Own

Russian authorities are upset that Standard & Poor's and Moody's, who cited falling oil prices, a recession, and international sanctions due to the conflict in the Ukraine, rated the country's debt as junk. With the mindset "We can do it ourselves and everyone will believe", Russia announced that is starting its own credit rating agency. We are sure that Russian sovereign debt will be AAA rated. 

Wednesday, July 22, 2015

Apple's Cash Hoard Grows

Apple's cash balance, which has been enormous by any measure, topped $200 billion for the first time. Cash held internationally has reached 89 percent, or about $180 billion, of Apple's cash. Apple has been reluctant to repatriate the money back to the U.S. as it would be forced to pay the full 35 percent corporate tax rate on the repatriated money. In an effort to pay investors, Apple has issued $50 billion in debt in various currencies around the world.

Tuesday, July 21, 2015

A $120 Million Bogey?

So what affects stock prices? In reality, pretty much everything, possibly even a bogey at the famed Road Hole at St. Andrews in Scotland. For the non-golfers, phenom Jordan Spieth made a bogey (one over par) on the 17th hole in the final round of The Open Championship on Monday, which virtually eliminated him from contention. Shortly after he made the bogey, stock in Under Armour, the company Spieth has a marketing deal with, fell from $89.47 to $88.79. While this is a relatively small dip, it reduced the market value of the company by $120 million. All in all, a pretty expensive round of golf.

Monday, July 20, 2015

An Overconfident Donald

One of the biases often discussed in behavioral finance is overconfidence, that is the belief your abilities are better than they are. Further, many people actually have overconfidence in individuals who tell everyone how good they are. Take Donald Trump. Although his wealth is estimated by Forbes at $4.1 billion, he recently stated that he was worth $10 billion as a self-made man (who started with his father’s millions.) And while his companies have filed bankruptcy four times, The Donald will tell you how good of an investor he is. Unfortunately, a recent article disputes this statement. If The Donald had taken his stated wealth of $500 million in 1982 and invested in the S&P 500, he would now have $20 billion, twice his stated worth. We hope you note a couple of important points. First, as we discuss in the textbook, the power of compounding greatly increases the value of a portfolio over time. Second, don’t always believe the hype of self-styled investment gurus.