Tag Archives: yield

“Connecting America,” the FCC’s National Broadband Plan

March 17, 2010 By in Constructing a Portfolio, Current Market Thoughts, Entertainment, Industry Analysis, Stock ideas, Strategy, Technology, Wireless Tags: , , , , , , , , , , 3 Comments

Happy St. Patrick’s Day!!!

Connecting America

The FCC presented Connecting America:  the National Broadband Plan to Washington yesterday.   The report is the culmination of close to a year of work, mandated by Congress, of laying out a roadmap for government help in the development of broadband, both fixed and mobile, in the US over the next ten years.

remedial action

As almost any foreigner will cheerfully point out while visiting the US, the country is much closer to being the caboose of the broadband train than the locomotive.  As a result, a lot of what the FCC proposes is necessary for the US to catch up with the rest of the developed world–although, of course, that fact isn’t mentioned in the report.  On the other hand, some of the ideas proposed have already been tried elsewhere.  And the projections of economic benefits to be had from development of broadband, especially mobile broadband, are on surer ground than most economic forecasts, since they’ve already been realized elsewhere.

mobile broadband is the plan’s focus

The centerpiece of the plan is the goal of providing an additional 500 Megahertz of spectrum available for broadband over the next ten years.  A more immediate goal is to provide an extra 300 Mhz spectrum for mobile broadband over the next five years.

Of that latter figure, the FCC has 50 Mhz in inventory–meaning it has to find an additional 250 Mhz fairly quickly.  About half is envisioned to come from spectrum now licensed by over-the-air television.  More is supposed to come from getting government agencies (I think we’re supposed to understand that the FCC means the military) to free up unused, or very inefficiently used, spectrum for better social use.  Presidents have been asking Congress to allow this for the past ten years, though, without any success.

I’ll write more about the report’s findings in later posts.  For today, however, the main point I want to make is that the star of the FCC show is (and correctly so, I think) mobile broadband.

winners and losers Continue reading →

Government debt trap: how a country’s finances can go bad

December 11, 2009 By in economics, government debt trap, Japanese development Tags: , , , , , , , , Leave a comment

The debt trap

Long-time observers of the Japanese economy are beginning to worry publicly that the country is slowly falling into a government debt trap.  The last time I recall this sort of talk was in the late Eighties, when commentators worried that pre-Euro Italy was in the same bad shape.

What is a government debt trap?  The general idea is that the government debt situation spirals out of control as the cost of servicing government borrowings rises dramatically, through some combination of high interest rates and the volume of government debt outstanding.

Caveats

The easiest way to explain the phenomenon is to give an illustration.  I’m going to keep it very simple.  Governments have become very crafty at keeping items like the cost of a war, or of senior citizen benefits, or explicit or implicit guarantees for failing “government-sponsored” enterprises.  But I’m going to ignore that.

I’m also not going to have the country in my illustration grow over the years.  Naturally, if GDP–and therefore tax receipts–grow, but government expenditures remain flat (fat chance!), then the situation I’m about to describe may gradually improve.  If, on the other hand, government expenditures grow at the same rate as tax receipts, the situation becomes worse.

Also, in theory at least, governments run deficits in downturns and surpluses in upturns, so that over a business cycle they are breakeven.  I’m going to ignore this reality as well. (This is kind of scary.  It’s like I’m turning into an academic!  I hope it wears off soon after this post.)  Take the “years” I’m talking about as being an average of what happens over a business cycle.  Bear with me through the initial part.  I’ll inject a dose of realism at the end.

Here goes–

Illustrations

Let’s make the following assumptions about a country:

CASE  1

annual GDP         100

tax receipts             30

govt expenditures        35

govt debt        0

interest rate on govt debt       5%.

This situation is relative benign.  The government runs a primary deficit (tax receipts minus government expenditures, before debt service) of 5.  Interest expense on that debt is .25, so the overall deficit is 5.25.  Interest expense makes little difference to the overall deficit.  The deficit is also structural, not cyclical; that is to say, it won’t go away as the business cycle develops.

Let’s look at something more interesting.

CASE 2a

Everything is the same as in case 1, except that government debt is now 100.(this might arguably be the UK or US in a few years).

The primary deficit remains 5, but now we also owe bondholders another 5 in interest expense.  So the government has to borrow 10 to cover expenses.

In year 2, we have the primary deficit of 5, but government debt is now 110, so interest expense is 5.5.

If this same situation persists through year 10, then government debt is over 200 and interest expense alone is 10.

At this point, in order to get the budget into primary balance, the government would have to cut expenditures by about 15%.  To get into overall balance, expenditures would have to go down by 40%. What are the chances of that happening?

CASE 2b

The same as case 1, except interest rates are 10% and outstanding government debt is 150.  (This is, more or less, the Italy of the late 1980s.)

In year 1, the primary deficit is 5 and interest expense is 15, so the government has to borrow 20 to cover expenses.

In year 2, the primary deficit is 5, interest expense is 17 and total debt rises to 216.

If we follow this progression out to year 5, debt rises to 270 and interest expense is 24.

In year 7, interest expense exceeds tax receipts!!!

Who’s going to lend to this country, even in year 1?  Well, there are the people who lent to Nakheel in Dubai, but they’ve got enough trouble as it is.  And, PT Barnum’s beliefs to the contrary, would there be enough of them in any event?

CASE 2c

The same as case 1, except debt is 200 and interest rates are 1.5%.  (This is more or less today’s Japan)

In year 1, the primary deficit is 5 and interest expense is 3.  Total government debt rises to 208.

In year 5, the primary deficit is 5, interest expense is 3.6 and total debt is just under 250.

In year 10, the primary deficit is 5, interest expense is 4.2 and total debt is just under 300.

In this case, the overall government debt is gigantic, equalling 10 years’ tax receipts.  How will the government ever be able to pay this money back? Note, however ,that the government can achieve overall budget balance relatively easily, by cutting expenditures/raising taxes by a little over 10%.  The biggest danger is that bondholders decide not to roll over existing debt at current interest rates.  If interest rates–and therefore interest expense– go up, or if the government is unable to pay current maturities from the proceeds of new debt sales, big trouble arises very quickly.

(A little) realism injection

1.  If we can figure out, at least in general directional terms, the possibility of severe future trouble in just a few minutes, so too can any potential government bond investor.  So the government in question begins to have difficulty in rolling over existing debt long before the year 10 situations emerge.

2.  Legislators, or their aides, understand the developing problems as well.  But their desire to bring government largesse to their constituents–and thus assure their reelection–typically overwhelms and desire to cut expenditures or raise taxes.  In the “benign” case, they stick their collective heads in the sand.  In the worse case, they deliberately foster inflationary policies, on the thought that this lowers the real value of what the government needs to pay back.  This throws gasoline on the fire.

3.  Off balance sheet liabilities make the debt situation worse.

4.  All the bond issuance by itself is inflationary, as is the currency weakness that ensues as foreigners sell their holdings an repatriate the money, or simply hedge the local currency exposure they have.

5.  It makes a difference whether the government is bought by locals or foreigners.  In the first case, the current generation is borrowing from its sons and daughters, saddling them with debt that finances current consumption.  Foreign buyers can come and go much more quickly, so the need to finance a portion of the government’s debt externally usually makes the situation more volatile.  One exception:  my observation (and, remember, I’m a stock guy) is that in past debt crises in the US, domestic investors have been much quicker to withhold their funds than foreigners.

6.  Case 2b is the more “normal” development path of debt running wild.  Case 2c, Japan, is unusual in that Japanese savers continue to commit money to the bond market despite very low nominal interest rates.  Observers have attributed this to a self-reinforcing circle of economic weakness, as follows:

a.  Government policy expresses the social desire to preserve a traditional way of life.  So Tokyo’s actions tend to preserve the status quo.  In particular, highly inefficient, money-losing companies are not allowed to fail or to be bought by more competent management.  This action damages the prospects for healthier firms and results in low economic growth and possible deflation.

b.  To stimulate growth, the government engages in (basically worthless) public works projects, which require public borrowing.  Because the economy flirts with deflation, nominal yields are low.

c.  Citizens recognize the situation and save heavily, rather than consume, in order to have funds for retirement.  Since most publicly-traded companies have poor profit prospects, the equity market is seen as too risky.  Bank deposit rates are effectively zero.  This leaves government bonds, even with a 1.5% coupon, the best alternative.

The big risk to Japan, therefore, is that one day domestic savers find another vehicle for their savings and want their money back.  This is unlike the “normal” case, where rising nominal interest rates are typically the country’s undoing.


More on hybrid bonds and contingent convertibles

November 22, 2009 By in hybrid bonds/contingent convertibles, Vocabulary Tags: , , , , , , Leave a comment

Plato vs. Aristotle (the Greek version of Mr. T vs. Chuck Norris)

Ancient Greece, the cradle of Western civilization, lacked both bowling alleys and XBoxes.  This forced citizens to spend their leisure time debating the nature of reality.  On one side of the discussion were Platonists, who asserted that the physical world and all that is in it are imperfect copies of eternal, changeless and perfect Forms–the latter being the only truth. Aristotelians made up the other side.  They believed that truth was to be found through observation of the actual characteristics of things in the physical world–that there were no otherworldly Forms that worldly things aspired to be.

considering hybrid bonds

In looking at hybrid bonds (see my post earlier this week for a definition), Moody’s originally fell on the Platonist side.  In rating hybrids, the agency appears to have assumed that because the prospectuses called them bonds, that’s what they were.  It didn’t matter that they might have quirky characteristics–for example, not looking much like a bond at all (remember, too, that like all rating agencies, Moody’s was paid for its opinion by the issuers).

During the credit crunch, bank regulators have revealed themselves to be firmly in the Aristotelian camp, to a greater or lesser degree.  If it walks like an equity and quacks like an equity, they are saying, it is an equity and not a funny kind of bond.

Why does this make a difference?  In a reorganization or liquidation, equity holders generally lose everything but bondholders retain at least a part of their original investment.  Also, although I’m not aware that this issue has come up formally yet, investment management contracts with clients normally specify very clearly what kinds of assets a manager is permitted to buy.  Bond managers, who appear to be the majority holder of hybrids, are supposed to buy bonds, not equities.  If they buy a security outside their mandate and lose money on it, they expose themselves to possible lawsuits aimed at forcing the management company to compensate the client for those losses.

Moody’s has a new rating method for hybrids

Moody’s appears to have shifted to the Aristotelian side of the debate last week, although it is still referring to the securities as bonds.  It announced that it has developed a new methodology for rating hybrids.

The new scheme (unlike the original one) incorporates the  possibility that:

–the issuer might exercise its right to defer or eliminate payment of income on the hybrids and that

–in a reorganization an Aristotelian bank regulator would classify the securities, less favorably for the holder, as equities.

Individual hybrid results will be made known over the next three months.  It appears that the vast majority will be downgraded, some by more than one notch.  From the Moody’s announcement, it sounds like at least part of the downgrading will be a result of the differing behavior of bank regulators as to how they regard hybrids.

Contingent convertibles

The press is now calling them CoCo bonds.  Despite the cute acronym, the concept doesn’t appear to be going over well with bond buyers.  Over the past few days, regulators have been eager to say that they aren’t solely focused on CoCos, but have lots of other ideas as well.  Myself, I hope the other ones are better than this.  It’s a little disconcerting, though, that they talked about this one first.

Just for the record:  I think CoCos are non-starters in today’s world, where the chances of financial company restructuring are way higher than zero and where the scars of investor losses, in part due to carelessness, lack of analysis and excessive optimism, are still fresh.  Give it a few years though.  When the sun is shining every day and profits are rolling in, CoCos will likely come back–and be eagerly bought by bond investors with short memories (meaning almost everyone).

Dividends (II)–what to look for in a dividend-paying stock

November 19, 2009 By in Dividends, Industry Analysis, Retail, Stock ideas Tags: , , , , , , Leave a comment

A couple of caveats to start out with

I’m going to be talking about US stocks in this post.  Company attitudes toward dividends–and toward caring for shareholders in general, for that matter–vary from country to country.  So, too, do investor preferences for dividends.  Tax regimes are also important.  If a dividend recipient has to pay income tax at an 80%-90% rate on the distribution (as was the case in Japan in the Eighties), paying a dividend is an exercise in futility.

Before buying any stock, except if you’re hoping for a quick change of control, you’ve got to make sure that the company is viable and has decent management.  I’m assuming here that work is already done.

I’m not going to write here about highly specialized companies, like public utilities or REITS, where government regulations play a key role in what the company is able to do.

How a company determines its dividend

The dividend is recommended by management and approved by the board of directors.

In my experience, the dividend level is always set by looking a the firm’s past results, not its projections for the future.

Perhaps the most crucial consideration is whether the firm can maintain (not cut) the dividend, even in adverse economic circumstances.

Dividends are supposed to be paid out of profits. Because of this dividends are usually talked about in terms of the % of income that is paid out.  I’ve found, however, that it’s more useful to look at dividends as a % of cash flow from operations (basically net income + depreciation/amortization + deferred taxes) as a way of predicting their future course.

A two-pronged approach:  qualitative and quantitative

1.  qualitative. Like the products or services they sell, companies too have a life cycle.  When they’re young and expanding quickly to stake out territory for themselves, they typically need as much capital s they can get their hands on.  They shouldn’t–and don’t–pay dividends.  As the company matures, growth typically slows, the need for capital to fund expansion diminishes and the company begins to generate excess cash from operations.  In many cases, companies don’t recognize this shift at first.  It’s only when new investments show up with sub-par or negative returns that they start to work the new realities out.  In some cases, firms pigheadedly continue to expand, kind of like the professional athlete who wants to play “one more year,” unable to recognize that age has diminished his skills.

Ideally, you would want to find a company that is maturing, understands this and has adjusted its mindset.  It strikes me that WMT is a good example of this type of firm.  MSFT and INTC may be others.

2.  quantitative. All of the numbers I’ll be writing about can be found in a company’s annual report or 10-K.  Discount brokers may have either analyst reports or databases for customers’ use where they also can be found.  The Value Line Investment Survey, which is available in almost any library, is also a good source, because all of the historical data you’ll probably need are on a single page, with most of the ratios already calculated.

I’m going to be using WMT as an example.  I’m taking all but one of the following figures from Value Line. Here goes:

a.  dividend yield.  2.3% for WMT, slightly higher than that for the typical dividend-paying stock.

b.  dividends as % of profits.  WMT’s payout has grown from 17% of profits in 2000 to 28% in 2008.  There’s still plenty of room for it to grow safely.  The rising percentage implies, of course, that WMT has been raising its dividend at a much faster rate than profits.

c.  dividends as % of cash flow.  The growth here is from 11% to 18%.  Again, plenty of cushion to maintain the payout, as well as to grow it.  My experience is that a mature firm can easily pay out a third of its cash flow in dividends.

d.   has the dividend ever been cut?  In WMT’s case, no.  The recent times of greatest concern would be 1997, 2000-2002 and 2007-2009.  A company that reduced or eliminated its dividend during times of economic stress is, I think, more likely to do so again.

e.  when does the board usually raise the dividend?  In WMT’s case, the company has a pattern of raising the dividend with the June quarter payout.

f.  general indicators of company health.

Although WMT’s capital spending is about 2x its depreciation (i.e., it is expanding), the absolute amount of capital expenditure has been falling (source:  WMT annual reports).

Debt, at 1/3 of total capital, is reasonable and appears to be stabilizing at this level.

Returns on capital are high.

Interest expense is covered by income from operations ten times (an impressively big number).

Dividends (l): the return of the cash dividend

November 18, 2009 By in Basic Concepts, Current Market Thoughts, Dividends Tags: , , , , , Leave a comment

How dividends come to be

Company managements are stewards of the capital that the company owners, the shareholders, have placed in their hands.  One of the jobs of management is to decide what to do with the cash the business generates.

There are two main choices:

–reinvest the money in the business if profitable opportunities to do so can be identified, or

–return the money to shareholders.

The return typically takes two forms:

–periodic payment of cash dividends to shareholders, or

–stock buybacks (a more dubious alternative, in my opinion).

“double taxation”

In many countries, including the US, cash dividends are subject to what is called “double taxation,” meaning that although the dividend is paid out of the money that’s already been taxed at the corporate level, the recipient is also required to pay income tax on the amount received.

Corporate managements in recent years have preferred to have stock buybacks rather than cash dividends, citing the avoidance of double taxation as a reason.  I find this a bit disingenuous.  Many times, companies use the buybacks to soak up (and obscure the negative effect on ordinary shareholders of) new stock being issued to managers through stock option programs.   If you watch the money trail, the cash leaves the corporate treasury and winds up in the pockets of corporate executives.

Forty-somethings could care less about dividends

For the past twenty years or so, investors in the US have have worked up virtually no interest in stocks for their dividend-paying ability.   How so?  The Baby Boom was (relatively) young and interested in making its money grow fast, that is, in capital gains.  The coupon on government bonds was over 7% until the internet bust, and interest rates were steadily falling as the Fed drove inflation out of the economy.  So T-bonds were the natural alternative for individuals desiring income, offering high yield as well as the chance of capital appreciation.

In part because of this, stocks of companies whose main virtue was the ability to generate steady income fell to low price levels.  Many were taken out of the public equity market–first, in a wave of junk bond-related acquisitions, and more recently by private equity.

Now, fast forward to the present.

For retirees, it’s a different situation

The Baby Boom is reaching retirement age and starting to shift its investment preferences toward income generation rather than making its capital grow.  Long-dated government bonds are yielding half what they were ten years ago, and have in them the potential for capital loss as/when interest rates begin to rise from the current crisis-low levels.  Money market funds yield close to zero.

For the stock market, too

On the other hand, many integrated oil companies, utilities and telecom firms have stocks that yield about as much as the 30-year T-bond.  In some cases, the yield is higher–but that’s not necessarily a good thing (more about this in my next post).  In addition, many well-known large-cap leading lights, like WMT (2.0%), XOM (2.2%), INTC (3.1%) and MSFT (1.7%) have respectable dividend yields.

Individuals are still mostly oblivious…

I don’t see overwhelming evidence that individual investors have picked up on the attractiveness of dividend-paying stocks yet.  They see their investment issue, but not the solution.  In fact, I pointed out in a post in late February that some basic dividend-related investment concepts, like yield support (the idea that at some point high dividend yields would stop stocks from falling further), seemed to have faded from the market’s memory.

..but maybe not for long

That inattention may not last long.  It seems to me that financially and operationally sound companies have begun to signal their health by raising their dividends.  XOM and WMT did so near the bottom of the market.  INTC has just followed suit.  MSFT, which has shown a pattern of raising its payout in December, may be the next market titan to follow.  WYNN (which I own), a much smaller firm, has just made a very strong statement about its financial health by declaring a $4 a share (about 6%) special dividend to be paid next month, plus the initiation of a regular 20¢/quarter dividend.  Of course, part of the WYNN statement comes from the fact that its bankers have allowed the payouts to happen.  Sooner or later, the market is bound to notice.

In fact, Wall Street may already be taking heed.  Another, more subtle, indicator of the market’s attitude toward dividends is to examine what happens on the day a stock begins to trade ex dividend, i.e. the first day when buyers are not entitled to receive an upcoming payment.   Does the stock in question decline by the amount of the dividend, or more?  That’s bad.  Or does it “carry” some or all of the payout, i.e. not decline at all or decline by less than the dividend.  Tis is typically a strong sign of approval.

WYNN is a case in point.  It paid out $4 a share, but declined by $1.52 in a more or less flat market.  So it “carried” $2.48.  I interpret this as meaning that investors are not as unaware of dividend events as they were in February.  (Now, it may be that investors missed the fact of the payout completely, thought the bottom had dropped out of the stock at the open and stepped in to grab a “bargain.”  That would mean the stock’s rise would be a sign of ignorance, not approval.   Maybe so, but I’ve always found it a dangerous to underestimate the collective intelligence of the market.  Yes, LVS and MGM rose, too, but their financial conditions are so more precarious that I’m not sure they’re comparable.)

Naturally, the earlier we are in recognizing a trend toward buying dividend-paying stocks, the better it is for us–as long as somebody else follows.

That’s it for today.  In my next post, I’ll write about how companies decide on a dividend increase–because you want steady and rising income, and where to look for assurance the dividend is secure.