"Give me a place on which to stand, and I will move the Earth." Archimedes of Syracuse
Archimedes was discussing the lever. While Archimedes was clearly not the first to use a lever, and therefore not the first to understand the point of a lever, he was the first to explain it. Leverage multiplies the available force applied to an object.
In financial terms, leverage is a change in profits from a change in one of the components of profit. A factory with idle workers and excess capacity will gain operating leverage by an increase in unit sales. In this case, the cost of the next unit sold is much less than the cost of the first unit sold. Likewise, operating leverage can be gained by increasing productivity so that costs per unit fall. Earnings per share equals Units Sold times Profit per Unit times 1-Taxes divided by Shares. Increasing units sold, profits per unit, or decreasing taxes help increase profits. These are operating levers. Where possible, US companies have pulled all of these levers. Remaining unpulled is financial leverage, the reduction of the number of shares outstanding. Until now. See the news item below.
Intel Taking On $6 Billion In Debt To Buy Back More Stock With close to $10.5 billion in cash and short-term investments and another $4.4 billion in long-term investments, Intel could easily declare a $15 billion buyback plan if it chooses to. MarketWatch 24/7 Wall St.
By borrowing and paying interest, Intel raises its costs, but because interest rates are so low and because they intend to buy back stock, earnings per share should rise. US companies have been unwilling to pull the financial lever since the last recession. Huge amounts of cash have piled up at some companies as management has continued to fortify their balance sheets. Debt has become a much smaller part of corporate finance since the recession. Intel's move may be an early indication of a new trend in corporate finance.
We have worried for some time that earnings expectations for the US market in 2013 were over exuberant. We could not see how companies could cut costs much more, and we did not expect general economic growth would be sufficient to raise all boats. So how would earnings per share rise by 10% or more? Leverage.
Mr. Sullivan owns Intel shares.
Disclosure: I am long INTC.
Additional disclosure: Mr. Sullivan owns Intel shares. Please see disclosure below.©Regions Bank, Member FDIC. The foregoing represents the opinions of the author, Brian Sullivan, and not necessarily those of Regions Bank or Regions Investment Management, Inc. (RIM). RIM provides commentary to clients of Regions Bank, an affiliated company wholly owned by Regions Financial Corporation. The information contained in this report is based on sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be a complete analysis of the security, company or industry involved. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This report is designed to provide commentary on market strategy and the opinions expressed reflect the judgment of the author as of the date of publication and are subject to change without notice. The author may or may not own shares of specific securities mentioned within this report. RIM assumes no responsibility or liability for any loss that may directly or indirectly result from the use of such information by you or any other person. Investments discussed in this report are not FDIC-insured, not deposits of Regions Bank or its affiliates, not guaranteed by Regions Bank or its affiliates, not insured by any government agency, and may go down in value. Investment advisory services are offered through RIM, a Registered Investment Adviser. RIM is wholly owned by RFC Financial Services Holding LLC, which in turn, is a wholly owned subsidiary of Regions Financial Corporation.