Contributor since: 2008
Hey Suzanne. I agree with you. We could definitely have a short pullback, followed by a final rally.
Mike, Thanks for the links. The articles provide a very fresh perspective on things. Reminds me a little of Noam Chomsky.
Much appreciated!
On May 10 01:12 PM Mike Stathis wrote:
> You might want to read my series of articles on Buffett. I'd say
> for most, it will be eye-opening. Others still might not get it.
> But all I can do is try to wake people up.
Thanks for the feedback. I'll keep your points in mind the next time.
@Stephen, I agree with you. This argument would have been even more persuasive at 200. But between 60 and 200 is where I see Apple for the next few years, or stuck in a range. You could have made the same argument for Microsoft anytime since 1998 and still been correct.
Look at Microsoft. The stock is where it was in 1998 (buy and hold). Net income in the meantime has gone up 400%, from 4.5 Billion to 18 billion. Apple could also quadruple it's net income without the stock going anywhere over the next few YEARS. That's the kind of growth to value stock transition I'm talking of.
I looked at Out of the 20 largest S&P 500 companies, the only ones not paying a dividend are Google and Apple. There’s a good reason for this.
@Mac'em X. Thanks for your valuable feedback. Yes, I think that number was changed. But still, 5.4 trillion is HUGE. I guess as far what is priced in or not is a matter of opinion!
Thanks for the feedback Mick. I'll look into adding that..
I really liked your points.
I'm just trying to point out that the opinions of experts are divergent on this issue, exactly what El-Erian calls for watching out in his introduction. There are excellent reasons why both sides could be right(like the fiscal stimulus should be inflationary).
Also note that I only mentioned a 'deflation scare' (like we had a few years earlier)(I admit it sounds very improbable right now) . The last para was just my opinion, and should be taken as such. The main reasons being the loss of the wealth effect, declining commodity inflation, slowdown in emerging economies, housing wealth destruction etc. Yields could also go down in a flight to safety. It's quite possible that I could be wrong. Hey, so would half the experts!
Good point. But remember that fuel subsidies in India and China distort the supply-demand picture. The fuel consumption in the emerging markets is insensitive to the oil price, and should go up this year as well, scaling with the GDP growth story..
Hi Alpha Seeker,
Thanks for the feedback. Most of them I think are relevant and timely. I'll be sure to put up the dates going forward.
The offering would have had no equity dilution for existing shareholders. The founder owns the remainder of the company and wanted to offload his stake by selling to the public.
Antoine Gerard: Thanks for the link.
I agree timing the business cycle is a difficult exercise. But I can say with certainty that two years from now most of these companies would be trading at higher valuations. MU for instance.. I see a downside of say 5, and an upside of 15+.. that's an attractive risk-reward tradeoff.
RB9652: That's an interesting trade. Except STX and WDC trade
at really low multiples. Mr. Market may be pricing a bit of that already.
Also, there's nothing stopping STX from getting into the SSD business. I believe STX has a fair amount of patents in the drive industry which they intend to use aggressively.
Refer to
omitsure, I think you'll find that with M&A activity, more companies would be collaborating on the R&D expenses in developing newer process fabs. It's already happening on the PC side with the IBM led consortium. Mergers are the only way to reduce supply and increase pricing power.
Thanks for the insightful comments everyone. I'm trying my best to keep up :)
BillyRayValentine: I agree with you.
If you were to include taxes, then you should compare after tax interest rate with earnings yield.
I agree that using a 20% tax rate in my example would imply breakeven in EPS. But if you were to bump up the P/E to 30 or increase the interest rates to 6%: you'd still get an EPS dilution.
The idea was to illustrate that dilution CAN occur.
MC: Valuations are a matter of perception. With cyclical stocks, the least you should do is use normalized 5-10 year earnings and then compute the earnings yield. Cyclical stocks always look the cheapest at the peak of the economic cycle because of earnings which have been inflated due to the business cycle. Using a 10% earnings yield based on the trailing 12 month PE may not be a valid exercise IMO.
To take your suggestion a step further, every company then should employ a trading division to trade their stock in the market!
When Buffet invested in Korea, stocks there were trading at an everage of 2 PE. In Japan right now, I believe the average stock is trading below book value. In 1982, with the market trading at low single digit PEs, you had several stocks trading at low single digit PEs.
Stonebluff: do you have a link to the S&P study?
drposhmoney: Two things:
1. You are assuming the company has the pricing power to pass on any inflationary increases. A lot of companies can't do that.
2. If you are adjusting the cash for inflation, you should also be adjusting the earnings for the same. A $1 in earnings today versus $1 in earnings in 2015 have different buying power implications.
We are talking in nominal terms here. Inflation adjustments to all the numbers should cause no difference to the buyback argument.
Hmm.. never say never, and never say always! There will always be companies where the buybacks made sense. (As InvestorsLive points out about IBM)

THofler: I'll keep your points in mind when I post a followup to summarize the excellent comment exchange.
RJW: I hope you'll excuse the fact that the article doesn't have statistics to refer to! This was a gut feel overnight writeup and I think it made some valid points.
I've looked at a few papers which studied the 'outperformance' of a buyback, and I agree they suggest a quantifiable outperformance. My point is I don't WANT to look at 1 month or 6 month returns. Anything less than 12 months is short term. If anything, a 1 month pop would be a good short fade. From a casual observance, I can tell you right away that I can think of many more companies whose stock prices are lower after a buyback than those where they are higher (I do think a good chunk of this is because they didn't see the economic cycle turning).
As the others rightly observe, what's the point of a buyback if the companies have to dilute the shareholder's equity? I'm also looking at some mature tech sector companies where a buyback of almost 40% of their float has not budged their stock price (eg. ADI)
InvestorsLive, fabien_hug, jimsep and kurt walter: thanks for the added insight.
Valuations and investing is a tricky business. Companies are best served to focus on their core competencies (eg. Google, Apple).
Your points sum it up very nicely. Thanks.
I'll be posting a follow up on my blog this weekend. Stay tuned.
I like the comments. Taking the opposite side of a well accepted notion does upset quite a few people!
Firstly, the opinions expressed by me are also shared by the McKinsey Quarterly article and the Audit Integrity report I linked to above. So clearly, I'm not in a minority here.
hhcramer: value is a matter of perspective. We've had periods in the world where markets went nowhere for 30-40 years, and stocks ended up trading at 2-3 times earnings multiple.
Buffett has a margin of safety to fall back on in case he is wrong. Even Buffett, despite the margin, has commited mistakes with his initial investment thesis. He has been right, on average.
The problem is you cannot really forecast industry trends, substitutes, competitors, pricing power, markets, economy too much into the future. A lot of times, companies don't have an intrinsic valuation to backup their claims.
Budh: Even though you are cynical, you are mostly right.
Theguy: I like LLTC, I do think using debt to buyback their stock was a smart strategy.
The analog sector is a great example to illustrate share buybacks. ADI MXIM LLTC TXN have all bought back stock, sometimes even buying back 40% of their float. This has been going
on for a few years now. Look at where the stocks have gone over the last 5-6 years.
Maybe Mr. Market is delivering a verdict on the undervaluation thesis here? If no one recognizes the undervaluation argument, and the stocks remain where they were for the past 5-6 years, maybe we need to revisit the argument? I intend to blog about financial engineering in mature tech sectors like analog in the future. I'll elaborate on a few of my thoughts there.
DSX Lover: Here's an example of how a buyback can be dilutive to earnings. Let's ignore effect of taxes for now. Say a $1 billion market cap company has 100 million in cash.
Interest rates are 5%. It's net income was 40 million, including 5 million in interest income.
Let's say the EPS is 2 and it had a 25 P/E multiple, giving it a stock price of 50.
The company completed a stock buyback with it's $100 million in cash, buying back 2 million in shares. The number of shares went down from 20 to 18 million. The new net income would be 35 million, giving it an EPS of 1.94. So the EPS just went DOWN from 2 to 1.94 after a buyback.
Result : dilution.
Hope this helps.
I don't think so. He does have a price target of 1550 for 2008, which is a ~17% upside on the S&P 500 from Friday's close to year end.