Category Archives: Stock ideas

financial inversions are proliferating

May 28, 2014 By in Current Market Thoughts, financial inversion, Stock ideas, Strategy Tags: , , , , , , , Leave a comment

A while ago, I wrote about the financial or tax, “inversions” that have been sweeping the US pharmaceuticals industry.  Basically, a US company that pays a full 35% Federal corporate tax bill can reincorporate in a low-tax foreign jurisdiction–purely on paper–by taking over a foreign firm already set up there.  This is financial engineering at its finest/worst.  No one has to move; offices and plants remain untouched.  Certain conditions do have to be met, however.  The US acquirer must fold itself into the foreign acquiree so that the foreign entity is the survivor.  And foreigners must own 20% of the shares of the merged company.  Otherwise, it’s pure financial gravy.

Consider a US company that has $1,000,000,000 in pre-tax income.  After Federal tax, that’s $650,000,000.  If the firm can “invert” itself and end up with a 20% tax rate on that income, the after-Federal-tax number becomes $800,000,00.  That’s an annual savings of $150,000,000–a 23% jump in the funds that can be used for capital investment or paying dividends.

IHG

It’s no longer just drug companies, though.  Last weekend, media reports that Intercontinental Hotels Group, PLC (IHG) had been approached by a US hotelier, speculated to be Starwood (HOT), about a combination of this type.  IHG supposedly rejected a $10 billion takeover offer.  (IHG’s stock price indicates we may not have heard the last chapter of this story, since the quote rose to just about the reputed offer price after the news came out.

investment implications

1.  Back in the Stone Age (the late 1970s), when I entered the investment business, investors were very sensitive to the rate at which a company’s profits were taxed.  At that time, the prevailing view has that the higher the tax rate, the better quality the earnings were.  The rationale was that in order to be used for dividend payments, cash generated in low-tax jurisdictions would need to be repatriated and local corporate tax paid.  Therefore, the apparent profits generated in low tax areas were illusory and not to be trusted.

Now, that view seems very Austin Power-ish.  As I see it, for good or ill, over the past decade or more investors have been indifferent to the rate at which profits are tax.  It’s solely profit growth that counts.  Whether it’s achieved through selling more products or by astute tax planning doesn’t matter.

But the “modern” view has to be changing again, I think, as inversions become more popular.  It’s now a distinct investment plus to be a foreign company in a low-tax jurisdiction.  This means that, sooner or later, a US firm in the same industry will make a takeover bid.

2.  As the US corporate tax base begins to erode through financial inversions, there should be a response from Washington.  The rational one, in my view, would be to simplify the tax code and lower the levy on corporations to what’s normal in the rest of the world.

But no.  So far the only movement in Congress is to retroactively make inversions illegal.  This is the kind of thing that has helped give India its current reputation as a high risk area to do business in.

Still, reform of corporate taxes would potentially create a whole raft of winners and losers.  So it’s something to keep an eye out for.

 

once more on Amazon (AMZN)

May 6, 2014 By in Amazon, Current Market Thoughts, Industry Analysis, internet, Portfolio management, Recent Market Action, Stock ideas Tags: , , , , , , , Leave a comment

I’ve been doing a lot of thinking/daydreaming/musing about AMZN lately.  I don’t know quite why, since I’m probably not going to buy the stock.  But my mind apparently doesn’t want to let go.

The latest thing to pop into my head is something I’d seen on the Value Line page for the stock but hadn’t paid much attention to.  It’s that:

–during the bounceback from the 2000 collapse of the Internet Bubble, AMZN shares tended to trade at about 30x cash flow.  In the recovery from the Great Recession, its cash flow multiple expanded to 50x.  Both are mind-boggling figures, to be sure-the second more so.

What could cause this gigantic multiple expansion, particularly during a period when investors were scared out of their wits and therefore more cautious than usual?

…possibly a better appreciation of the transformative nature of the internet and AMZN’s premier position as online merchant.  Cash generation from operations continues to grow at about 25% a year, virtually the same as before the GR, despite the company’s larger size.  That’s both a plus and a minus.  It’s an heroic achievement to maintain growth in the face of ballooning size.  But that’s usually something that keeps the multiple from contracting, not that causes it to expand by 60%.

…so I can’t help thinking that a lot of the favorable move is due to the Fed’s super-accommodative money policy.

Which gets me to my point.

Let’s assume that the economy’s release from intensive care and a return to normal money policy cause AMZN’s cash flow multiple to shrink to a “mere” 30x.  In simple terms, this means the stock should lose 40% of its value–maybe not all at once, but ultimately.  Continuing relentless growth in cash flow could cushion the fall somewhat.

Since the end of January, when the Fed made it clear it would continue baby steps toward normal despite weakening economic indicators, AMZN shares have pretty much made the entire reverse movement already–they’ve lost 25% of their value in a flat market.  They haven’t been alone, either.  Every other story stock has fallen this much–or more.

This thought makes me want to speed up my efforts to dig through the rubble.

 

my take on Apple (AAPL)

April 25, 2014 By in earnings conference calls, Stock ideas Tags: , , , , , Leave a comment

In a comment on yesterday’s post, my friend Bruce asked for my take on AAPL. That’s my subject today.

The stock looks cheap to me.  Investors have had two big worries, I think.  One has been lack of recent earnings growth.  The other is the perception that the post-Jobs management of AAPL is completely at sea, cowed by the memory of Jobs and therefore unable to make decisions– as well as completely uninterested in whether the stock goes up or down.

However,

–growth appears to be resuming.  Yes, modest growth, but Wall Street has understood for years that the heady days of the last decade are gone forever.

–AAPL has a stellar brand name and many rabid fans.  New products may re-energize them.

–the recent announcement of a 7-for-1 split offers the hope that management is more the simply caretaker of the Steve Jobs museum.

–in addition, conditions are right for investors to look at AAPL again.  I think 2014 is going to be a sideways year from here for the US stock market.  So a big, low-multiple, cash generative company where earnings growth is resuming and where management practices may be taking a turn for the better has a great chance to be an outperformer.  A 2.3% dividend yield doesn’t hurt, either.

To me, AAPL feels like the MSFT story, only in an earlier chapter.  MSFT has a stronger business.  But Tim Cook arguably has greater freedom to act, since he’s dealing only with the legend of Steve Jobs and not the physical presence of Steve Ballmer.  (Also, to give him credit, Cook has already fixed one of SJ’s mistaken pronouncements–that 10″ is the only tablet size anyone will/should want.  He appears to be in the process of fixing another, similar one–that the original iPhone screen size is the only choice anyone will want/need.)

Personally, I prefer MSFT.  But that may be because AAPL has historically been so uncommunicative that it’s hard to figure out what’s going on inside management’s heads.  In the strange way investors think, my attitude is arguably an investment plus for AAPL.  Better communication from AAPL would come as a positive surprise to Wall Street–and by itself result in a higher stock price.

 

 

 

 

Apple (AAPL) is splitting its stock, 7 for 1

April 24, 2014 By in earnings conference calls, Recent Market Action, Stock ideas Tags: , , , , , , , 2 Comments

AAPL’s 2Q14 earnings report last night was full of mostly positive surprises:

–earnings per share came in at $11.62.  That’s about 15% more than the Wall Street analyst consensus had expected, and higher, by about the same amount, than results in the same quarter a year ago.  It’s the largest margin AAPL has beaten the consensus by in years.

–the company is raising its dividend and increased its proposed share buyback amount by $30 billion

–AAPL is going to split its stock by 7 to 1.

Of these developments, I think the most important is the stock split.

stock splits

Academics will tell you two things about stock splits:

1.  Stock splits have no direct economic significance.  Its’ simply paper shuffling.  Instead of having one share that trades at, say, $560 you’ll soon have seven shares, each trading at $80.

2.  The stocks of companies that have stock splits tend to underperform for a period after the split occurs.

 

The second comment, while true, is, well, silly.  All the outperformance comes between the period when the stock split is anticipated by the stock market or actually announced and the date when the split takes place.

The first is also true–particularly in the United States (but not in many foreign markets).  But this doesn’t mean that the AAPL split has no relevance.

(See my post on stock splits for more details.)

Two reasons:

–stocks with very high per share prices tend to underperform.  Why?  I don’t know.  I think it’s because retail investors prefer to buy stock in round” lots (usually 100 shares).  This may be an echo from the days a half-century ago when trading costs were very high and when the commission for an “odd” lot (anything that isn’t a round lot) was particularly expensive.  For AAPL, this would be a commitment of over $50,000–too rich for a single position for most people.

Yes, it makes no sense.  But, whatever the reason, retail investors like stock splits and respond positively to them.

–more important, studied management contempt for shareholders, who after all are the owners of the company, has long been a key feature of the AAPL persona.  It’s part of the Steve Jobs legacy.  But it’s not a good one.  To me the stock split is a sign that the current management finally realizes how poisonous the Just-Like-Steve mentality has been and is beginning to shake off its shackles.

I don’t think this means AAPL returns to the super growth of its past.  On the other hand, I do think that, if I’m right about the attitude change, that the JLS discount multiple Wall Street now applies to AAPL stock will gradually disappear.  Just achieving a market multiple would imply a 30% gain in the stock.

 

average wages in the US are back to pre-recession levels …the point is?

April 21, 2014 By in capital flight/brain drain, Current Market Thoughts, employment, inflation vs deflation, Recent Market Action, Stock ideas, Strategy Tags: , , , , , Leave a comment

Good news, but not great.

How so?

80% of the wage gains since 2008 have gone to the top 20% of wage earners, meaning those earning $190,000 a year or more (this is despite recent government allegations that top tech firms in Silicon Valley have conspired to hold down their employee wages).

In other words, the vast bulk of the workforce still isn’t as well off as six years ago.

In addition, the unemployment situation remains stubbornly high.

My conclusion is that what we have now is about as good as it gets in the domestic economy, without policy action from Washington.

Two data points suggest that structural changes in the world economy are at the root of a lot of this:

–the decline in the fortunes of the middle class in the US coincides with an improvement in the lot of the middle class in emerging markets, and

–anecdotal accounts are circulating of firms filling their vacancies by poaching from rivals, which would suggest we’re close to full employment.  I heard economist Paul Krugman the other day saying that the basic problem in the US is that there are too few jobs.  He means that necessity isn’t forcing employers to hire unskilled workers and train them.  In a sense, that may be right.  On the other hand, how long will it take and how much will it cost to train an average high school graduate to become a statistician or a web designer?   Why not relocate to a place where skilled workers are more plentiful and corporate taxes are lower (the latter meaning just about anyplace else)?

investment implications

The current domestic economic situation says, I think, that we should continue to focus on companies with worldwide, rather than simply US, businesses.  We should also avoid firms that cater to domestic customers with average or below-average incomes.  These will only be able to grow revenues by “stealing” them from competitors–persistent price wars will break out, in other words.

At the same time, this state of affairs has been around long enough that we should also be scanning the horizon for evidence of change.  I suspect that changes in education/training will come informally–not through intelligent government action–and will sort of sneak up on us.  On the other hand, reduction of the Federal corporate tax rate to a level more in line with the rest of the world would probably give a surprisingly large spur to job formation (more about this tomorrow).