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Wall Street Strategies has been providing independent stock market research since 1991 to individual, retail and institutional clients through a balanced approach to investing and trading. Charles Payne, our founder and chief analyst, is routinely sought after for his stock market, political,... More
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  • REAL CONFIDENCE REAL PAYOFFS - By Charles Payne 0 comments
    Dec 31, 2013 11:31 AM

    Hosting Cavuto on Fox Business Network 8:00PM EST
    Happy New Year!

    When Textron (TXT) announced it was acquiring Beech from two private equity firms, its share price surged from the previous close of $32.57 to $37.29, or 14.4%, the next session. The Street cheered the combination of two long-time rivals with products that should complement each other's portfolio. But, The Street has been cheering acquisition news for a long time.

    Historically when a corporate takeover deal is announced, shares of the acquiring company move lower, while the acquisition target moves higher. The reasoning is simple. The company extending the offer has to use currency such as cash on the balance sheet or its own shares, both of which have negative connotations. Cash used or borrowed isn't immediately replaced by the new business so on paper it lowers the value of the company.

    When shares are issued, it makes the value of existing shares lower (law of supply and demand). Yet, over the past three years there has been a new phenomenon- shares of the acquiring companies have gone up...huge!
    The reasoning for this seems to clearly point to market approval of A) management taking advantage of oversold rivals and depressed valuations, B) the implication that businesses are bulking up to meet demand and C) attempts to grow business in proactive manner rather than "sit on cash." Even though academic research has shown hoped-for synergies and cost savings rarely pan out, acquisitions done in the name of acquiring new business should be viewed differently and recently have been.

    Of course, as the overall market continues to increase in value, it's hard to argue there are any bargains out there, but that only slightly changes the interpretation of these deals. There comes a point however, when the knee-jerk reaction will see the acquiring stock down big time even when the deal "makes sense" on paper. For me, that reaction will be the kind of signal that points to overall froth, more so than a megaphone pattern or the VIX being higher or lower.

    (For the record, the so-called fear gauge seems to elude proper explanation in financial media which can't decide if it's bad when the VIX goes up or when it goes down. But, I digress.)

    There is a paradox to management's use of cash and stock as currency. In 2013 record dividends were paid out and share repurchase announcements surged to highest levels since the throes of the market meltdown five years earlier. After years of sitting on cash, management began putting it back to work, but not in ways that elicited confidence in the economy.

    Technically there are two ways companies reward shareholders.

    Buybacks makes the overall pie smaller, thereby making earnings per share larger.

    Dividend payouts are a direct cash reward to shareholders.

    According to Factset.com, through the third quarter, share repurchase announcements by S&P 500 companies tallied $448 billion over the trailing twelve months. This is the highest number from fourth quarter 2008 when the stock market was in freefall mode. During this same period,$339.3 billion was paid out in the form of dividends including $84.3 billion in 3Q13.

    The amount paid out in dividends over that trailing twelve month period is a 100% increase from ten years earlier, and more than 40% above the ten-year average. It is clear that management is putting a lot of money to work. The question is "What's the message?" and what are the implications. Politically, the market being at all time highs and companies buying back stock or offering generous dividends stokes the misguided message of inequality.

    On the other hand, it's critical that businesses begin to put money to work as a sign of confidence in the economy. Thus far, the Dow 30 companies have bought back $211 billion in their own shares, or three times the amount invested in research and development. This year, only 16 companies in the S&P 500 haven't either repurchased their own shares of paid out dividends.

    Real Confidence Rewarded

    In the immediate aftermath of the stock market meltdown, tepid investors sought out safety in dividend-paying stocks such as blue chips and utilities. That trend faded in 2011 as fear of a double dip recession began to fade, and more outsized rewards with less risk became the obvious path for investors. This year that has begun to change again. Over the past 18 months, non-dividend payers in the S&P 500 have seen their shares outperform dividend payers.

    Investors are pouring money into Amazon (AMZN) and Google (GOOG) on extreme confidence about their ability to generate handsome rewards in the future while building the right platforms today. Sure, companies that announced large buy backs at the start of the year have seen their shares perform admirably but special investment status is being afforded to companies putting money to work beyond traditional means of rewarding investors.

    It should be noted that 2013 is on track for $754 billion in share repurchases, which comes close to the record $863 billion established in 2007. Yes, companies were buying back their own shares right as the nation was heading into a massive recession. I don't think that's the case today, but it's very important that we witness a shift into business investments and even acquisitions in 2014. The good news is there is a lot of room for deals in the New Year.

    There simply hasn't been a lot of merger and takeover activity.

    (click to enlarge)

    Conclusion

    This brings us back to the original premise of why the companies out there buying other companies are being rewarded. This is a key trend that should pick up in the New Year even as interest rates increase. Sure, it's a sign of confidence when a business commits to large dividend increases and it rewards shareholders. The bigger rewards, however, come from carving out large swathes of market share and exhibiting pricing power that generates margin expansion. These developments send underlying share prices significantly higher- it's the real payoff for investors.

    https://www.wstreet.com/user/register.asp?source=3

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