With this article, Seeking Alpha introduces Charles Biderman, the founder of TrimTabs Investment Research. Founded in 1990, TrimTabs has been tracking flows into and out of US stocks, mutual funds and ETFs in an effort to measure quantitatively the supply of and demand for shares of stock and the money available for investment. Charles welcomes your comments and feedback.
I am often asked by individual investors, what is the best way to invest for the long term?
My answer is to invest with the house. In all markets the house has an advantage over the players. No market would exist if the house did not have an edge. In the stock market, the house is represented by the public companies. They know much more than investors about what’s really going on at their companies. They have an obvious edge.
What I have discovered watching the markets for over 40 years is that when companies are optimistic about their future, they reduce the number of shares outstanding. When companies are pessimistic about their future, they typically sell more shares to raise cash.
To invest with the house, buy shares in companies where free cash flow is growing, the number of shares outstanding is shrinking, and where the debt to equity ratio is not growing.
You can also invest with the house by shorting a portfolio of companies where free cash flow is negative, the float of shares is growing due to secondary share offerings and/or the company is borrowing more money.
Some Definitions: Free Cash Flow & Trading Float
Free cash flow is the amount of cash left over after paying all expenses, research and development costs, capital expenditures, and adjusting for changes in working capital and depreciation and amortization.
The trading float of shares shrinks when companies buy back in total more shares then they sell. The trading float grows when companies sell and/or issue more shares than they buy.
To fully understand float change and free cash flow, let’s use as an example a hypothetical company, XYZ Inc.
XYZ Inc has one hundred million shares outstanding, trading at $100 per share. The overall market cap therefore is $10 billion. Let’s assume that XYZ Inc. generates $1 billion annually in free cash flow, an amount equal to 10% of the $10 billion market cap. Then let’s assume that XYZ Inc. uses $600 million of that $1 billion to shrink the float. XYZ Inc. could buy back sixty million shares, or 6% of the outstanding, for $600 million and still end the year with an extra $400 million in cash.
After the six million share float shrink, there are only 94 million shares left. If the stock price stayed the same $100 per share, that would mean that XYZ Inc is now only worth $9.4 billion. Yet XYZ is still generating $1 billion annually in free cash flow, and the only thing has changed is the number of shares is smaller. Therefore, it would be logical to expect the value of the remaining shares to rise by at least 6%, to $106 and change, which, times 94 million shares, leaves the market cap remaining at $10 billion.
For some perspective, there are currently only 750 companies in the Russell 3000 index that are shrinking their float, while over 2,200 companies are currently growing their float. Among the companies shrinking their floats are Amgen (AMGN), Pepsi (PEP), DirecTV (DTV), Wyndham Worldwide (WYN), and Plantronics (PLT) (see list below).
The healthy dynamic of companies growing cash and using that cash to reduce to the number of shares outstanding can work to provide support for a higher share price in all markets – bull (1993-2000; 2003-2007) bear (2001-2002; 2008-2009) and in between. The reason: the company is a consistent buyer regardless of the market downturn. Similarly, the shares of a company using a market rise to expand their float may very well appreciate along with the broad market, but at a slower pace than the cash-flow rich companies.
Currently, you could make up a portfolio comprised of the top 100 companies that are growing their free cash flow, shrinking their share float the most, and not borrowing to buy those shares: This group of stocks averages a free cash flow yield of 10.5%, are shrinking their trading float by over 8% annually, wand have a P/E ratio of 13.4 times earnings, and an average market cap of $16.2 billion. The full list is below:
Ticker | COMPANY NAME |
AAN | AARON'S INC |
ADTN | ADTRAN |
AAP | ADVANCE AUTO PARK |
AMG | AFFILIATED MANAGERS GROUP |
AKAM | AKAMAI TECHNOLOGIES |
AMGN | AMGE |
ACOM | ANCESTRY.COM |
APOL | APOLLO GROUP-A |
AZO | AUTOZONE |
AVT | AVNET |
BBBY | BED BATH & BEYOND |
BBY | BEST BUY CO |
BIG | BIG LOTS |
BMC | BMC SOFTWARE |
SAM | BOSTON BEER |
BPI | BRIDGEPOINT EDUCATION |
EAT | BRINKER INTERNATIONAL |
BKI | BUCKEYE TECH |
CA | CA INC |
CACI | CACI INTERNATIONAL |
CPLA | CAPELLA EDUCATION |
CBS | CBS |
CELG | CELGENE |
CRL | CHARLES RIVER LABORATORIES |
CAKE | CHEESECAKE FACTORY |
CSTR | COINSTAR |
CMTL | COMTECH TELECOMMUNICATIONS |
STZ | CONSTELLATION BRANDS |
MCF | CONTANGO OIL & GAS |
CPRT | COPART |
EXBD | CORPORATE EXECUTIVE BOARD COMPANY |
CXW | CORRECTIONS CORPORATION OF AMERICA |
CY | CYPRESS SEMICONDUCTOR |
DTV | DIRECTV |
DLB | DOLBY LABORATORIES |
DPZ | DOMINO'S PIZZA |
UFS | DOMTAR |
EXPE | EXPEDIA |
ESRX | EXPRESS SCRIPTS |
XOM | EXXON-MOBIL |
FCFS | FIRST CASH FINANCIAL |
FRX | FOREST LABORATORIES |
GILD | GILEAD SCIENCES |
GPN | GLOBAL PAYMENTS |
GHL | GREENHILL & CO |
GPI | GROUP 1 AUTOMOTIVE |
HRS | HARRIS CORP |
HLF | HERBALIFE LTD |
HD | HOME DEPOT INC |
IIVI | II-VI INC |
IBM | INTERNATIONAL BUSINESS MACHINES |
ESI | ITT EDUCATIONAL |
JPM | JPMORGAN CHASE & CO |
KLAC | KLA-TENCOR |
LMT | LOCKHEED-MARTIN |
LOW | LOWE'S COMPANIES |
LSI | LSI |
MANH | MANHATTAN ASSOCIATES |
MRO | MARATHON OIL |
MAR | MARRIOTT INTERNATIONAL |
MA | MASTERCARD |
MXIM | MAXIM INTEGRATED |
MHS | MEDCO HEALTH SOLUTIONS |
MW | MEN'S WEARHOUSE |
MCRS | MICROS SYSTEMS |
MCO | MOODY'S |
MYGN | MYRIAD GENETICS |
NVLS | NOVELLUS SYSTEMS |
ORLY | O'REILLY AUTOMOTIVE |
PEP | PEPSICO |
PLT | PLANTRONICS |
PRGS | PROGRESS SOFTWARE |
PSSI | PSS WORLD MEDICAL |
QLGC | QLOGIC |
QSFT | QUEST SOFTWARE |
SMG | SCOTTS MIRACLE-GROW COMPANY |
SNI | SCRIPPS NETWORKS INTERACTIVE |
SEIC | SEI INVESTMENTS COMPANY |
STEC | STEC INC |
SYMC | SYMANTEC |
SYNA | SYNAPTICS |
TECD | TECH DATA CORPORATION |
TPX | TEMPUR-PEDIC INTERNATIONAL |
TDC | TERADATA |
MHP | THE MCGRAW-HILL COS |
PGR | THE PROGRESSIVE CORPORATION |
TW | TOWERS WATSON & CO. |
VCI | VALASSIS COMMUNICATIONS |
VECO | VEECO INSTRUMENT |
VRSK | VERISK ANALYTICS |
VPHM | VIROPHARMA |
V | VISA INC |
VPRT | VISTAPRINT LIMITED |
WBC | WABCO HOLDINGS |
WPI | WATSON PHARMACEUTICALS |
WBMD | WEBMD HEALTH |
WU | WESTERN UNION COMPANY |
WRLD | WORLD ACCEPTANCE |
WYN | WYNDHAM WORLDWIDE |
XRTX | XYRATEX |
Disclosures: http://trimtabs.com/global/etf_ttfs_disclosures.htm
A list of all specific recommendations made by the firm for the past year is available upon written request.
TrimTabs Asset Management, LLC, owns shares in each of the companies listed above in the portfolio of its actively managed ETF, the TrimTabs Float Shrink ETF (TTFS).
