BLOG # 85- The Pros and Cons of Stock Buybacks- by Maxwell Murphy- February 27/12 edition of the WSJ

  Although this topic closely parallels the points I have just made in Blog # 84, there are certain observations the author has made which we as amateur investors should keep in mind when evaluating companies.  Although it appears both fund managers interviewed  in the article are at opposite poles when it comes to recommending what a company should be doing with its surplus cash, some of the points each of them raise closely parallel my own observations when considering share buybacks and acquisitions:

1. short term, share buybacks often help raise a company’s share price, no doubt due to reducing the number of shares available for trade.   Long term, share buybacks in general don’t have lasting effect on a company’s share price, likely due to efficiencies within the market system. 
2. share repurchases must only be made if there are ample funds in place and the company’s share price is selling below its book value.
3. shares should never be repurchased if the company is generating annual rates of return above its historical levels. Instead the surplus cash should be used within the company to stimulate controlled organic growth.
4. management should first strive to reduce debt, then fund organic growth, well before considering the payout of dividends and lastly buying back of shares.
5. short term, share prices of an acquiring company usually declines while share prices of the acquired company usually increase.  Long term, most share prices of acquiring companies usually regain previous values unless synergies cannot be achieved.

  What to do with surplus cash is an enviable position in which to be, especially when you consider the alternative. Just like sound management is required when deciding on levels of debt, the same is true when deciding on what to do with available cash. Jim Campbell.

BLOG # 84- In Search of Yield by Andrew Bary- January 31/12 edition of the WSJ. Investors must focus on more than just Yield-by Eric Lam of the Financial Post- February 16/12 edition of the Edmonton Journal.

  Although you will recall from my books Understanding eSap and eSap Manual that as an amateur stock investor, I don’t put a lot of importance on the dividend payouts of the company I am examining. Share price appreciation remains central to my stock purchase strategy. I would rather management invest that money to further expand the company instead of doling it out to shareholders.

  Over the last few years, characterized by low fixed income yields and stock market volatility, I have recanted my position slightly to reflect the changing times. Even though my primary objective still remains capital appreciation, I also realize that stock market volatility can have a negative impact on the upward movement of a stock’s share price, at least for the short term.  Furthermore, to own a stock with a steady dividend payout can help me fill the void, at least temporarily, left from a poor performing share price, even though eSap has convinced me that the stock’s fundamentals are indeed attractive and I have to declare receipt of the dividends annually on my tax return.

  Long gone are the days of consistent double digit returns. In fact, trading in today’s investment climate forces us to work hard simply to preserve the initial investment we make in a company. The press has documented far too many incidences where not only return rates have been wiped out, but also initial capital invested has as well. With preservation of capital front and centre in our minds, a 4% yield from dividend payouts sounds quite enticing compared to fixed income returns struggling to reach 1%. Factoring in free cash flow and company debt when examining dividend payouts, as one of the above articles suggests, makes perfect sense, given the fact that your eSap analysis will clearly identify these 2 concepts, among many others, when you are examining the company’s fundamentals.

  Also, if enough pressure is put on the corporate world to increase the dividends over time, that should make the dividend picture look that much brighter. Jim Campbell

  As you will recall from my book Understanding eSap, I have assigned 12 different countries or regions throughout the world as the EAP “monitoring stations”, which, when periodically tested by eSap, gives us a reasonably accurate reading of not only the individual economic performances of each of these 12 countries but, by combining these readings together, also a picture of the economic performance of the global economy itself.  With this EAP update and all future EAP updates, I will be using the above chart to pictorially describe the current state of the global economy.

  Following is a brief description of each of the 8 stages of an economic cycle incorporating the 3 elements which EAP uses to assess the current state of the global economy( more detail concerning the 3 elements can be found in my book Understanding eSap):

STAGE 1. exchange rate bottoming out(foreign confidence hits bottom)

                 deflation a threat(cpi flat)

                 s/t interest rate at a low point

STAGE 2. exchange rate showing no improvement( foreign investors lack confidence)

                 deflation no longer a threat but stagflation is(cpi tettering)

                 s/t interest rate flat

STAGE 3. exchange rate starts to ascend(foreign investors sense an opportunity)

                 inflation starting to strengthen(cpi increasing moderately)

                 s/t interest rate slightly increasing in response to inflation

STAGE 4. exchange rate accelerating(more foreign investors jumping on bandwagon)

                 inflation growth rate strengthening(cpi gaining momentum)

                 s/t interest rate strengthening to stay ahead of inflation

STAGE 5. exchange rate softening( foreign investors see a peak looming and start to retreat)

                 inflation continues its ascent(cpi continues to ascend)

                 s/t interest rate continues strengthening to keep ahead of inflation

STAGE 6. exchange rate softening further( more foreign investors bailing)

                 inflation strengthening further(cpi reaching the peak)

                 s/t interest rate continues its ascent to control escalating inflation

STAGE 7. exchange rate continues its descent(foreign confidence continues to slump)

                 inflation finally being contained(cpi reaches peak)

                 s/t interest rate peaks

STAGE 8. exchange rate continues its descent at reduced rate(investor bailout peaks)

                 inflation declining(cpi no longer a threat)

                 s/t interest rate declining in unison with inflation levels

  Based upon the data from EAP Quarterly and EAP Annual, the US, India, Japan, Russia, South Africa, Euro, and Mexico are all in varying degrees of Stage 2 of the economic cycle, while Australia, Brazil, Canada, and the UK are all in varying degrees of Stage 3 of the economic cycle. China is at Stage 6, indicating a slowing down of its economy. The global economy is currently in Stage 2.9 of the economic cycle. Jim Campbell.

BLOG # 83- Harrisburg files for Bankruptcy Protection- by Michael Aneiro and Michael Corkery- October 12/11 edition of the WSJ; Largest Municipal Bankruptcy Filed- by Kelly Nolan- November 10/11 edition of the WSJ; Pensions chopped but Investors Paid- by Michael Corkery- December 20/11 edition of the WSJ; Greek, Italian cash heads for the Hills- by George Georgiopoulus and Danilo Masoni from Reuters(Athens/Milan)- January 4/12 edition of the Edmonton Journal.

  Many facets of our global economic system have been affected by the 2007-2008 recession, characterized by slumping property values, escalating unemployment rates, and depreciating net worth, to mention a few. No one person, place or thing has been immune to the effects of that recession-effects which for the most part still linger. Our media headlines continue to remind us of the precarious position in which our economic world, particularly in parts of Europe and the US, currently rests, which leads me to the following questions:  1.what causes a sovereign nation to declare bankruptcy; 2.what effects does this bankruptcy have on the local economy and on the world economy; and 3. have any nations in the past ever declared bankruptcy? Not being an expert on the topic, I began to do some digging. This, in general terms, is what I came up with:

1. Possible causes: mismanagement of national government and/or national banks(eg. failure to act during economic downturns); inability of national banks to refinance short term debt due to lack of support by foreign banks; major imbalance between a country’s debt load and its gdp(value of nation’s goods and services); excessive investment risk taking on the part of national banks and/or the citizens during good economic times;  over issuing of government bonds(printing money) by the central bank to stimulate the nation’s economy; boosting short term interest rates to curb inflation, thereby resulting in an over inflated national currency(forced by foreign investors buying local currency).
2. Possible effects: national banks and/or the country experience significant drop in credit rating, resulting in higher borrowing costs; major run on national bank deposits; major depreciation in the national stock market(s); significant drop in the nation’s gdp(recession); freezing of all national bank accounts; huge spike in inflation, resulting in huge spike in short term interest rates; national currency tumbles; imposing of government restrictions to protect local industries; job cuts along with significant tax hikes; shrinking value of pension funds; forced resignations of some government officials and even parties; accusations of criminal activity levelled against some politicians and business people; involvement of IMF(International Monetary Fund) and the World Bank to try and help the country gain economic traction.
3. Yes, several nations(eg. Germany, Russia, Argentina, New Zealand, and Argentina) over the years have “fallen upon tough times”, with Iceland being the most recent, in 2008.

  Much of the content cited above aptly describes the Icelandic situation. Fortunately, with the financial assistance of the IMF(which comes with many stringent conditions) and some of the country’s global neighbours, Iceland continues to rebound, but not without having gone through a lot of pain and anguish. Although the global economy stands ready to support any country desiring to rebound from such a crisis, the longer the effects of the most recent recession(07-08) linger, the greater is the chance of the domino effect- several countries declaring bankruptcy.  Then, yes “Houston, we have a problem”. Jim Campbell.   

BLOG # 82- Bank of Canada issues Household Debt Warning- by Eric Lam of the Financial Post- December 14/11 edition of the Edmonton Journal; Baby Boomers living good life, while their children Struggle- by Sheila Pratt- December 19/11 edition of the Edmonton Journal; CMHC issues Debt Warning- by Kim Covert of the Financial Post- December 30/11 edition of the Edmonton Journal; Aging and Broke, more lean on Family- by E.S.Browning- December 31/11 edition of the WSJ; Do Canadians need 30-year Mortgages?- by Ray Turchansky- January 6/12 edition of the Edmonton Journal.

  You will recall in your eSap readings that a company cannot hope to survive long term  unless its revenues exceed its expenses. The same rule applies to a household as well. We can’t possibly hope to financially survive long term unless the income coming in exceeds the expenses going out. Although this concept seems obvious, based upon the above articles, many of us appear to have either missed this very important point or have chosen to ignore it for the time being. If the current economic malaise continues- and it appears it will for some time to come-  we could find ourselves in a deep financial hole of which we can’t get ourselves out.

  I don’t want to belabour this point since I did discuss this topic(accumulation of debt) at length in a few of my previous blogs, but now I am more concerned than ever about the accumulation of debt many of us have taken on. Whereas at the time of my writings I saw the spike in household debt to be attributable mainly to one taking advantage of depressed prices, I also realize now that perhaps we have taken on more debt than our incomes can comfortably handle. During economically stable times perhaps we can stretch our budgets somewhat, but unfortunately we are currently living in challenging times with not significant sign of a turnaround in the foreseeable future. The last thing I want to see is this budget stretching turning into a tear or worse an actual break.

  During these downtimes, just as good companies will take steps to ensure its long term financial well being( eg. rationalize and protect its assets, discern wants from needs, stay within a fixed budget), so should we as individual consumers also live within our means. Those non-essentials can wait until we can finally discern a light at the end of the economic tunnel. Please don’t lose sight of the basic financial principles which all of us have learned in eSap and which we apply everyday when analyzing companies. Jim Campbell.

BLOG # 81- Scientists’ Elusive Goal: Reproducing Study Results- by Gautam Naik- December 2/11 edition of the WSJ.

  According to the article above, the scientific community, which includes both academic and corporate elements, continues to be under pressure to produce favourable results- whether that be purely academic in nature or for financial gain, as in the successful discovery and production of pharmaceuticals. Academic credibility or financial rewards hangs in the balance until the tests prove valid.  Failed testing doesn’t sell, whereas successful testing does!!

  On a much smaller scale, this fact came to light for me several years ago when I had a frank discussion with a fellow choir member who happened to be recently contracted as a university professor at one of our local colleges. He was commenting on how pressured he felt having to publish, on a regular basis, journals relating to his area of expertise. Apparently, successfully publishing his academic works was part of his professorial academic responsibilities.  I gathered by our discussion that his main concern was not the formal teaching duties, which he obviously enjoyed, but publishing his works which stressed him the most. I surmised that his performance was for the most part evaluated based primarily upon the legitimacy(eg. acceptance by his peers and approval by his superiors) of his published works and not upon, as one would expect, the ultimate performance of his students. I found out later that the college did not renew his contract, for whatever reason(frankly, it was none of my business anyway).

  At one time, prior to my discussion with the aforementioned professor, I used to think a professorship was a ticket to longevity within the “halls of learning”. Never did I realize the pressure academics were under to produce positive results. Now I have a different perspective after talking to my professor friend. 

  Add the almighty dollar to the equation, and one can fully appreciate how the scientific community is indeed pressured to achieve positive results in research, since favourable outcomes can spell financial success for the company or the educational institution  sponsoring the research. Successful results are not only desired but expected by their powers that be. Is it any wonder that verification of research results is often lacking with this much stress put on the research community. Financial gain coupled with a competitive scientific industry and a competitive publishing industry can adversely impact upon those scientists who prefer to remain objective but can be put into a compromising situation.  Of course, lost in this discussion is the welfare of the patient relying upon successful drug discovery to either help the patient survive or live a reasonably normal life. We mustn’t overlook this all important point. Jim Campbell.

BLOG # 80- Investors Bullish on Fed Tips- by Susan Pulliam- November 23/11 edition of the WSJ; SEC lets some Investors Keep Quiet- by Scott Thurm and Jean Eaglesham- December 8/11 edition of the WSJ; Credit Raters join the Rated- by Jeannette Neumann- December 2/11 edition of the WSJ; Inside Capitol, Investor Access Yields Rich Tips- by Brody Mullins and Susan Pulliam- December 20/11 edition of the WSJ.

  So much for public disclosure and transparency within the investment community. Although initiatives such as the Sorbanes-Oxley reforms introduced after the stock market meltdown of the early 2000’s and most recently the SEC initiatives introduced after the recession of 2007-2008 have come a long way to cleaning up the shortcomings of the stock trading industry, I see, based upon the articles above, we still have a long way to go to make the industry absolutely credible. It goes without saying that when one mixes politics with friends in high places, only those well connected investors lurking in the upper echelons of the financial community get first dibs, thereby leaving amateur investors such as ourselves with just the leftovers. Total transparency will never be achieved until these loopholes have been eliminated. 

  Conflicts of interest still remain, it appears, within most facets of the security industry, even in the field of credit ratings, which I once held as sacred and impenetrable. Investment information must be stripped naked for all to view on a level plane. For how can we as amateur investors feel comfortable about analyzing a companies’ financial statements if we know that some elements of the company’s business- for example, their associations with some of their affiliates- have not been clearly identified within their financials due to weak guidelines set up by government. Will we ever truly come up with a hard line set of rules in which all investors, including the ones at the top of the food chain, will be forced to follow? Likely not, which makes it that much more important for amateur investors such as you and I to be armed with an investment tool, such as eSap, which has the ability to separate fact from fiction once the financial information eventually filters down to us.   Jim Campbell.

BLOG # 79- US Birthrates take dip Because of Recession- by Bloomberg Businessweek- November 22/11 edition of the Edmonton Journal; Generation Jobless: Young Men suffer worst as Economy Staggers- by Conor Dougherty- November 7/11 edition of the WSJ; The Toll on Parents when Kids return Home-by Joann Lublin- November 10/11 edition of the WSJ; Oldest Baby Boomers face Jobs Bust- by E.S.Browning- December 19/11 edition of the WSJ.

  You will recall from my book eSap Manual that once WWII ended and improving economic times reappeared, as a result of the rebuilding phase following the war, birthrates escalated dramatically as the reunited couples chose to share these improving economic times with their growing families. This set the stage for the surge in numbers of the so-called “Boomer” generation. Favourable economic times historically has had a positive effect on a nation’s population numbers.

  Unfortunately, during these economically challenging times(2007 to present), characterized by high unemployment rates(> 8%) and stagnant, and often times shrinking net worths of a nation’s citizens, the reverse is true. This is particularly evident in many European countries as well as in the US.  Not only are young couples waiting longer to get married and have children, because of this economic uncertainty, many Gen X’ers and Gen Y’ers are having to return home to their parents in order to make ends meet due to poor job prospects and unclear futures.

  Unfortunately, again plagued by these economically difficult times, many Boomers are not financially in shape to accept back their kids since they themselves have either been terminated or downsized from their long term job positions due to the still lasting effects of the 2007 recession. Many of these Boomers, desperate to find work while at the same time trying to find affordable accommodation for their adult kids who have found difficulty securing employment, find themselves digging into their retirement nest eggs to stay afloat. Who knows where these people, young and old, will end up if the global economy doesn’t soon improve. Without sounding too negative, although recently there have been some subtle signs, particularly in the US, of economic improvement, Europe, I believe, hasn’t seen the worst yet. I am convinced we will be battling this economic malaise for at least another 3-4 years before we can finally “see light”. Jim Campbell.

BLOG # 78- Deere and Company- refer to the section under eSap entitled “ Software Updates” on the website www.eSap .ca.

  Deere and Company(Deere) was one of those companies which intrigued me, albeit from a distance. On occasion, I would run across the company in a newspaper clipping indicating how well it had recently performed during its latest quarter. The fact that it was also the workplace of a distant neighbour of mine made me even more intrigued. It wasn’t until I ran across its latest quarterly results(Q3-2011) that I decided to run it through eSap to see if it was a buy. What I found out shocked me!!!

  In the 15+ years I have been examining companies using eSap, I have never run across a situation quite like the one with Deere. After feeding the company’s financial numbers into eSap, the purchase price eSap spit out was unbelievable. It was over 2.5 times the current market value of the stock. Because eSap factors in asset performance, debt management, and a multitude of other factors in determining its price, could this be the “motherload” I excitedly asked myself?

  Now, under normal circumstances, I would have immediately bought the stock( after the technicals were in line, of course), since it appeared the market price was grossly under valued. But digging further into the company using eSap as my guide proved my suspicions wrong. The analysis showed me, to say the least, lacklustre results over the 5 year(2006-2010) study period. I couldn’t believe it. Before my analysis, what I had thought would be a home run, based upon what I had heard about the company prior to my analysis, ended up being a major disappointment. The fact that the market share price was so low versus the eSap price, coupled with the positive results from Deere’s most recent quarterlies, still didn’t convince me that the company was a buy.

  eSap found too many negatives- poor revenue growth; mediocre asset performance; questionable debt management practices; poor rates of return;  issues with inventory and A/R; thereby resulting in poor premium numbers- to mention a few. It appeared the only saving grace was the decent growth rate of Deere’s earnings, which I concluded was not sustainable going forward as long as revenue growth continued to struggle. Far too many red flags for me to feel comfortable in buying any stock.

  Could it be that Deere’s future was looking up based upon the most recent quarterly results? After all, the company had just gone through and continues to go through one of the most difficult economic downturns ever. Still not enough to convince me, since many of the other companies I have analyzed recently also have gone through the same tough times but have managed to still produce favourable numbers.

  For now, I will lament my findings and go on to another company.  Jim Campbell.

BLOG # 77- International Business Machines(IBM)- refer to the section entitled “Software Updates” in www.eSap.ca  under eSap dated November 23/11

  I first took notice of IBM almost a decade ago when I was pondering its share price performance. Although its price was well over what my budget would allow, and I therefore didn’t run it through eSap, for several years(2003-2007) in a row its share price bounced up and down, almost predictably, between $70 and $100. Although, as you know by following the eSap program, my primary focus is on fundamental, and not technical, analysis, in the eyes of a technician, IBM was a textbook stock. 

  This fluctuating trend changed and the share price took flight surprisingly during one of the worst economic downturns the globe has ever experienced and continues to experience. With my curiosity getting the best of me, I wondered what was driving the price upward and so naturally I ran IBM through eSap to see what was fueling the rise.

  Frankly, I was very disappointed with the results. Although the company’s earnings growth rate was acceptable, there were far too many negatives in this 100 year old company for my liking. eSap only awarded IBM 14 premiums out of a possible 48, which ranks quite low compared to the rest of the companies I have analyzed over the years. If that wasn’t enough, the 2 rates of return over the 5 year study period(5-6%) are sadly lacking in comparison as well. Although I agree with management’s decision in 2005 to de-emphasize its hardware products( produced lower margins), and strengthen its business support sector(potential to generate higher margins), it appears that this new strategy has some ways to go before management can claim victory.

  Alas, management has at least one supporter- a major one at that- Warren Buffet, to whom I have introduced you in previous blogs. He just recently announced, as I was in the process of analysing IBM, that his company Bekshire Hathaway had made a $10.7b purchase of IBM shares. After recovering from the initial shock, I was curious what Buffet found in the company that eSap couldn’t find. Although the eSap price came in much higher than I had expected considering the low number of premiums eSap had awarded, IBM’s asset performance, for example, not to mention IBM’s debt management performance( both factors which play a key role in determining the final eSap purchase price), were mediocre at best.

  What was it then, I repeat, which motivated the purchase?  Buffet was recently quoted as saying he had been “hit between the eyes” by the advantages IBM enjoys in finding and keeping clients( Buffet Shifts into Tech with IBM Purchase- November 14/11 edition of the WSJ). Could the rise of the share price simply be a “flight to safety” for those investors wishing to invest in tech stocks but only willing to invest in so-called “Grade A”, established companies. Hopefully this is not the case!! Certainly not a logical enough reason to invest in IBM.

     Looking at the first 3 quarters’ 2011 performance, I noticed the revenue growth rate has improved, which as I said has been lacking during the 5 year study period. I also noticed, as I had predicted( refer to the analysis listed at the top), that the earnings growth rate has declined from its previous 5 year level.  Time will tell whether there is indeed value in IBM.  Jim Campbell. November 25/11.