Buybacks hit new record: Should you care?

Let’s listen to the latest board meeting of Twango, the highly profitable and entirely fictitious company that makes banjos for Latin dance bands. Thanks to an inexplicable surge in banjo-fueled Tango raves – and a major tax cut – Twango is showing record profits this year.

“What are we going to do with all this money?”, asks the CEO. “Should we give the workers a raise?”

“Heck, they got 1% last year,” the treasurer says. “That’s 1% more than everyone else in the country got.” (No, really.)

“Why not raise the dividend?”

“If we do that, we’ll have to pay the increase for eternity,” the treasurer says. “Don’t know if we want to risk that.”

“How about expanding the factory? Increase advertising? Expand to Europe?”

“Whoa, whoa, whoa,” says the Treasurer. “Someone needs to switch to decaf.”

“Ok, then, let’s buy back some stock.”

“Great idea!” says the board.

While this is entirely fiction, it’s not implausible. Companies spent a record high $189.1 billion in stock buybacks in the first quarter, according to Standard & Poor’s. All other things being equal, buybacks should shrink the number of shares outstanding, thereby making remaining shares more valuable. And you can stop a buyback program with a phone call, and no one on Wall Street will say boo. Aside from showing a lack of imagination, what’s wrong with buybacks?

Ever tried to find a picture of a stock buyback? Here’s a nice giraffe photo.

For one thing, an announced buyback program doesn’t really mean anything if the company doesn’t actually buy back stock, and this is an annoyingly common practice. For another thing, many buyback programs are simply a way to pay off executive options. If our Twango CEO exercises his options for 10,000 shares, the company has to get that stock from somewhere, and it’s usually via a buyback program.

Finally, many companies, like many individuals, aren’t particularly good at buying back their own shares. In 2008 and 2009, buyback programs died like a lawn in the middle of a heat wave. Even now, the excellent insiderscore.com has a long list of companies that are buying back shares at high prices.

At least at the moment, buyback strategies haven’t been producing dividends. Invesco BuyBack Achievers ETF  (PKW), the largest and oldest buyback ETF is down 3.31% this year, while the Standard & Poor’s 500 stock index is up 2.46%. The ETF buys shares of companies that have reduced their share count by 5% or more in the past 12 months. Top three holdings: Walt Disney, American Express, and Procter & Gamble.

SPDR® S&P 500 Buyback ETF  (SPYB) is a newer, smaller entrant into the buyback field. It screens stocks based on the cash value of the actual (not announced) buyback, rather than on the reduction of shares outstanding. The ETF is up 1.58% this year – not better than the S&P 500, but better than the Invesco ETF.

Those looking for companies that seem willing to invest money in the business might check out the Nasdaq US CapEx Achievers Index (CAPEXA). The stocks in the index have increased their capital expenditures for at least three consecutive years. At the moment, there doesn’t seem to be an ETF modeled on the index. Top three holdings: Procter & Gamble, Chevron and Oracle.

Buyback strategies, like most strategies, work best when Wall Street thinks they will. And from 2009 through 2013, buyback strategies worked very well indeed. Lately? Not so much. At least at this point in the economy, it might be best to buy stocks of companies that know how to use their money to grow their business – instead of ones that can’t think of anything better to do with it.

 

 

 

A blue chip by any other name

When it comes to mutual fund marketing, the glass is never half empty: It’s always full. This is why we don’t see funds with names like “The Occasional Outperformance Growth Fund” or “The Somewhat Erratic Income Fund.”

We do, however, have several funds with the words “blue chip” in them. Unfortunately, they may not have the blue-chip attributes you’re looking for.

First of all: What’s a blue-chip stock? The term “blue chip” comes from poker, where blue chips are traditionally the most valuable. “I think of it as a large-cap company that has been around for decades, pays an attractive yield and has an above-average record of raising earnings and dividends for an extended period of time,” said Sam Stovall, chief investment strategist of U.S. Equity Strategy at CFRA. It’s a fairly exalted status that few stocks earn, and fewer keep.  They’re the kind of stocks you’d imagine Uncle Pennybags from Monopoly would buy.

The term “blue chip” has become so popular that there are 15 stock funds with “blue chip” in the Morningstar database. Elizabeth Laprade, research analyst at  Adviser Investments, notes that three of the largest blue-chip funds – T. Rowe Price Blue Chip Growth ($54 billion), Fidelity Blue Chip Growth ($25 billion) and John Hancock Blue Chip Growth ($3 billion) – have between 122 and 429 stocks.

Whether there are 429 or even 122 blue-chip stocks is debatable, at best, and all three funds seem to stretch the definition. T. Rowe Price Blue Chip Growth, for example, has stakes in true blue-chip companies like Boeing and JPMorgan Chase. But its third-largest holding is Tencent Holdings, the Chinese internet advertising company. It also had stakes in Tesla, Monster Beverage and Norwegian Cruise Lines, which are probably not blue-chip companies, at least by Mr. Stovall’s definition.  All three funds own Alibaba.

Distressingly, all three funds have more volatility than the Standard & Poor’s 500 and lower dividend yields, too. This may be because all three are growth funds, and growth stocks often sneer at the notion of dividends. It may also be because of the funds’ expense ratios, which range from -0.78% for the John Hancock fund and O.69% for the Fidelity offering. Those aren’t excessive by large-company growth fund standards, but they do take a bite out of the funds’ dividend payouts.

Even worse is the funds’ maximum drawdown – the most the funds lost from peak to trough during downturns in the past five years. Here again, they didn’t beat the S&P 500, Ms. Laprade notes. “People need to be careful,” she said. “If they’re looking for blue-chip stocks, that may not be the case.”

 

Taking the stock market’s temperature

It’s a balmy 53 degrees here, which isn’t bad for January, but the Standard & Poor’s 500 is hotter than a fire ant’s furnace. As of Jan. 25, the blue-chip index has gained 6.16%, including dividends. How do you know when hot is too hot? You can get one hint from the aptly named Thermostat fund.

A rising stock market, in and of itself, is no reason to panic. Typically, a really good year is followed by at least an OK year. When the S&P 500 gained 26% in 2009, it followed up with a 15% gain in 2010. Similarly, the index gained 13.46% in 2014 after a 32.31% advance in 2013.

What matters is how stock prices measure up against corporate earnings. The basic measure is the price-to-earnings ratio, which simply divides a stock’s price by its previous 12 months’ earnings.

The lower the PE, the cheaper the stock is, relative to earnings. A $50 stock that earned $3 last year has a PE of 16.7. Changes in either price or earnings affects the PE ratio. If the stock’s price drops to $35, its PE is 11.7. If its earnings fall to $2 a share, its PE rises to 25.

It’s not infallible. PEs were high in early 2009 because earnings were so low. Some argue that it’s best to use earnings estimates, rather than past 12 months’ earnings, to measure PE. There’s some wisdom to this: The stock market looks forward, not back. On the other hand, earnings estimates are fiction, and historical PEs are a tad more fact-based. You can get both on Morningstar’s site.

All of which brings us to the Columbia Thermostat Fund (CTFAX), created by storied value investor Ralph Wanger. The Thermostat fund adds bonds to the portfolio as the market heats up, based on the market’s price vs. long-term earnings. When stocks become cheaper, it adds more to stocks and reduces its bond holdings. The fund also has rules to prevent big swings in its holdings.

What’s the fund’s current reading? It’s got just 7.31% of its portfolio in U.S. stocks, and 2.43% in international stocks. Even by the fund’s cautious nature, that’s pretty low. Here’s how the fund’s stock allocation has varied over the years:

Source: Columbia Threadneedle Investments

The fund’s return the past 10 years has been above its category —  conservative allocation, by Morningstar’s reckoning. Nevertheless, its absolute return hasn’t been particularly spectacular. The fund has gained an average 5.35% a year the past decade, in part because it has been so conservative during bull market years.

Nevertheless, the fund serves as a useful market barometer: It’s hard to argue that most stocks are cheap now. If you’re thinking of turning up the temperature in your portfolio, you might want to take another look at the thermometer.

The busy season for outlooks

Economists and money managers give forecasts because people ask them to, and this is the time of year when people like me ask people like them for their forecasts.

You have to take all forecasts with a grain, if not a block, of salt. Nevertheless, I got the chance to interview some smart people, such as Will Danoff, manager of Fidelity Contrafund, who’s bullish on the U.S. and technology. And then there’s Jerome Dodson, manager of Parnassus, who has the crazy notion that companies that treat employees well will prosper.

Anyway, here’s their outlooks for 2018, along with Mark Mobius of Franklin Templeton, Robert Doll of Nuveen and Joe Davis of Vanguard.

http://www.investmentnews.com/article/20180106/FREE/180109962/2018-outlook-in-equity-investing-is-mostly-bright?issuedate=20180108&sid=outlook20170108

A change of heart

A Christmas Carol is about a change of heart — in this case, the heart of Ebeneezer Scrooge: 

Oh!  But he was a tight-fisted hand at the grind- stone, Scrooge! a squeezing, wrenching, grasping, scraping, clutching, covetous, old sinner!  Hard and sharp as flint, from which no steel had ever struck out generous fire; secret, and self-contained, and solitary as an oyster.  

The spirit of Scrooge — pre-haunting Scrooge — has been alive and well in American business for a good many years. Just as Scrooge rolled up the profits of his lending business while his clerk froze, U.S. companies have only grudgingly doled out wages. The chart, left, shows average weekly wages, adjusted for inflation, the past decade. Annual rate of increase: 0.52%.

At the same time, profits, cash and profitability at major U.S. corporations have been hitting new highs. This isn’t terribly unusual: Companies typically don’t raise wages unless they have to, and they don’t have to until unemployment falls below 5% or so.

Nevertheless, workers’ share of corporate fortunes have been unusually small, especially in light of productivity improvements. Workers have produced more, but received far less of that improvement than in the past. (Keep scrolling past the graph, because I can’t figure out how to decrease the white space that follows).

 

 

 

 

 

 

 

 

 

 

 

The tax reform bill passed by Congress assumes that corporations will pass on their massive tax savings to workers, and also use that extra money to reinvest in other businesses. Will it work? It depends on who you ask, which means that no one really knows. A few companies have already announced bonuses and cited the tax reform measures as their reason for doing so.

Some, such as Wells Fargo, have waffled on whether the increase was because of the tax bill or not. Others, like AT&T, have also announced layoffs at the same time.

Nevertheless, it’s entirely possible that at least some of corporate tax savings will, indeed, make it to employee salaries, new hires or even new factories. Alas, there aren’t many funds that specialize in employee happiness. But here are a few suggestions on what might make a good investment in light of tax reform:

  • Parnassus (PSRNX). This fund takes the position that companies that treat employees well tend to do well in the long run. It’s not infallible — awful companies prosper sometimes, too — but the fund has gained an average of 10.5% a year the past decade, vs. 8.3% for the Standard & Poor’s 500 stock index.
  • Financial funds. Tax breaks plus looser regulation generally should benefit banks. SPDR Capital Markets ETF (KCE) is a good low-cost choice, as is iShares U.S. Financial Services ETF (IYG).
  • KKR & Co. LP. The private equity and real estate manager specializes in merge and acquisitions. Should companies use their newfound cash to buy other companies, KKR is a logical beneficiary.

A cynic would observe that companies have long had the ability to give their employees a raise, and have simply decided to keep most of that cash in the CEO suite. A big infusion of cash from the tax bill could simply increase those tendencies. On the other hand, we can all hope for a change of heart — although, as was the case with Scrooge, the proof was in actions, not theory.

 

 

Awash in cash

People who like dividend stocks might find that technology stocks are the type of stocks that they like.

For one thing, they have enough cash to buy several small European countries. “Companies have enough money to do whatever they want, and that’s before potential reparations” from the tax bill, noted Howard Silverblatt, senior index analyst for S&P Dow Jones Indexes. And how. All told, about $1.8 trillion is cooling its heels on corporate balance sheets, and much of that is on tech balance sheets. Here are the 10 companies with the biggest cash stashes:

Apple has another $195 billion in “long term investments” on its balance sheet, which skeptics might label as “pretty darn close to cash.”  And overall, IT is the second-largest dividend payer, behind financials.

Why does IT have so much cash, aside from being immensely profitable? One reason might be that IT went through a near-death experience in 2000-2002, and they have learned the lesson that cash is your best friend in hard times. (Banks, which have gone through several near-death in the past 50 years, never seem to learn that).

Another is that IT companies rely on innovation to survive, and innovation doesn’t come cheap. Either you have to hire top people (and pay them well to keep them) or you have to pay up to buy innovative companies. That requires cash, too, although having an extravagantly valued stock price is good, too.

What’s interesting is that many of these stocks aren’t insanely priced. Apple sells for 14.4 times its estimated 12 months’ earnings, and pays a 1.45% dividend, too. Cisco sells for 14.4 times earnings and pays a 3.0% dividend. Oracle pays a 1.48% dividend and sells for 15.3 times earnings. Only Facebook, which sells at 26.8 times its expected earnings (and doesn’t pay no stinking dividend) fits the profile of the gunslinging tech company of yore.

(The two biotech companies in the chart, Amgen and Gilead, also rely on heaps of cash to continue innovation, are cheap, and pay good dividends. Coca-Cola is, well, Coca-Cola).

During the 2007-2009 bear market, and for some time thereafter, technology was the sector with the highest dividends, precisely because it had the cash on hand to do so. Banks were too busy staving off bankruptcy. For investors who like dividends and dislike bankruptcy, large-cap IT seems to be a reasonable bet.

Naturally, there’s an ETF for that: The First Trust NASDAQ Technology Dividend Index Fund (TDIV), which currently yields 2.14% on a trailing basis. The fund doesn’t have the sizzling returns that an all-tech fund has — it’s up a mere 21% this year, vs. 36% for the technology sector — but that’s not why you buy a dividend fund. Assuming these companies don’t waste their money on something foolish, like buying several European countries, they could be a good long-term investment for dividend investors.

Taxes and the urge to merge

Tax reform, in whatever final shape it takes, is likely to put lots of money into corporate hands. While these companies already have lots of cash — a record $1.8 trillion in nonfinancial companies in the Standard & Poor’s 500 index — giving them more cash may give them an incentive to actually, you know, spend it. I talk about one likely option in my latest column, here. 

On another topic, the Baby Boom Generation spans the years 1946 to 1964. There’s a big difference between the early Boomers and their younger siblings: If you were born in 1946, you came of age with the Beatles, the Vietnam War, Lyndon Johnson and Richard Nixon. If you were born in 1964, you grew up with The Clash, gas lines, Jimmy Carter and Ronald Reagan. More importantly, older Boomers are more likely to have pensions and more likely to have taken a beating from the past two bear markets. Younger Boomers? They probably don’t have pensions, they face soaring college tuition costs for their children — and some will retire just as the Medicare Trust Fund runs out of money. You can read about it here.