Dan’s Blog

Messages Stock-Splits Send

Dan Calandro - Saturday, April 26, 2014

Two companies have recently made drastic changes to their corporate identities via stock splits. On April 3, 2014, Google issued its first stock split, a 2 for 1 affair that saw the creation of a new class of stock and symbol. Google will now trade under two symbols: GOOG and GOOGL, both around $525 dollars per share. Before the split Google’s share price was over $1,000 – but even at half the post-split price, it’s still a high priced stock. And there’s a message in that. 

Google has been on an investment tare for quite a while. Like many companies, Google uses its stock as cash to invest, acquire new businesses, and compensate employees. As a result, equity positions for the founding members (Larry Page and Sergey Brin) got diluted every time a transaction like those took place. So to avoid losing control of their company, and while continuing to aggressively pursue and invest in growth opportunities, Page and Brin created a new class of stock (which will be traded under the original symbol GOOG) that will have no voting rights. Needless to say, new acquisitions and investments will be financed with GOOG stock, thus maintaining the sanctity and stability of ownership under the GOOGL symbol. 

Here’s how the two Google symbols performed since the split.

4-25-14a

As you can see, stock with voting rights has more value than non-voting shares do.  This is generally true with all companies. But the point to take away is this: Google made its stock split decision solely to maintain corporate ownership control by founding members, Page and Brin. The slim 2 for 1 split was a tactic employed to do simply that. 

This is much to the contrary of Apple’s decision to split. Just a few days ago on April 24, 2014, Apple made a startling announcement of a 7 to 1 stock-split to become effective on June 9, 2014. There will be no new class of share issued, which is to say that maintaining current ownership control had absolutely nothing to do with Apple’s decision.

Instead, the decision was made to "make Apple stock more accessible to a larger number of investors." In other words, their stock split decision was made primarily to increase demand for Apple stock, to thus raise the share price and produce a more robust return on investment to investors than otherwise would be had.

Apple’s stock climbed $43 to $567 per share, or 8%, on the announcement. News of the stock split was accompanied by a commitment to increase Apple’s dividend and stock buyback program. Positive earnings were also reported – all of which contributed to the upward move. If Apple stock were to split today its share price would be around $80 per share. 

The 7 to 1 split ratio is an interesting rate of change. Late last year MasterCard executed a 10 to 1 stock split that also brought its per share price down to $80 – about half the price of Visa, the most widely used card. A 10 to 1 split would make Apple stock even more accessible (around $55 per share) and, in theory, would create even more investor demand.

But creating demand wasn’t the only factor in Apple’s stock-split decision.

It is quite clear that Tim Cook doesn’t want Apple’s stock price to be anywhere near Google’s – they are two different companies, in two different modes. Cook wanted no part of an Apple–Google comparison.  They’re too different.

Instead, Apple took a page from MasterCard’s book and split to a ratio placing it properly to their nearest competitor. Microsoft, which is now trading around $40 per share, is half the amount Apple will be trading post-split. That’s where Tim Cook places Apple in the technology food-chain.

There is little doubt that Tim Cook doesn’t want to be the next Steve Ballmer (Bill Gates’ successor). Ballmer failed to innovate or successfully invest during his tenure at Microsoft’s helm, and investor ROI was pathetic – especially when considering Microsoft’s obnoxious cash balance and net worth during the time. Cook won’t make that same mistake. Aggressive stock buybacks, increased dividends, and a lower stock price are tactics employed to combat that specific case.

Decision points like IPO’s and stock splits send important positioning messages from management. It is the only place corporations can provide a starting price for its stock to trade. Free markets, of course, determine value once trading commences. 

That said, logic can only surmise that Cook is positioning Apple for pedestrian operating growth to be offset by strong stock performance via higher dividends and stock buybacks, and hopefully new demand driven by a lower priced stock. 

Google, on the other hand, is positioning itself to continue aggressively investing in future growth under the same ownership structure, while maintaining a premium image with a double dose of higher priced stocks.

Google has sent the stronger message; and is a component of the 15-51 strength indicator. 

4-25-14b

The market message remains the same: stocks are high, strength is higher, and gold is about fair. 

Stay tuned…

ShieldThe road to financial independence.™

What's Wrong with Yields

eugene ball - Tuesday, April 15, 2014

What’s the problem with low yields? They encourage more borrowing, lower the costs of business expansion, and in theory, create inflation – as the increase in debt (a.k.a. the amount of spending that income does not fully cover) produces upward pressure on pricing because natural demand has been inflated by the amount of new debt. So in a low growth low inflation economy, one where deflation poses some modicum of threat, low interest rates are warranted to ensure deflation doesn’t take root – right?

That’s where central bankers have it all wrong.

Indeed, monetary governors around the world are deathly afraid of deflation, the general decrease in prices. As a result, institutions like the Federal Reserve have long employed monetary tricks like QE to thwart deflation. But their efforts haven’t worked. Inflation is still well below normal levels and economic growth is dismal. Job participation persists at historic lows, consumer spending is sluggish at best, and central government debt is running rampant.

In other words, QE has failed on almost every front. It hasn’t spurred lending or expanded the economic base, and it hasn’t facilitated anything but runaway government spending. There’s absolutely no viable economic reason to continue keeping yields so low.

For instance, with rates being so low for such a long period of time, companies with access to leverage have already borrowed what they need to invest into their businesses. Persistently low rates can’t attract them to leverage more. It’s just not happening.

That’s the major problem with QE is that the new money never reached small to mid-sized businesses – those who truly drive the economic engine. That’s why job growth and consumer activity has been so lethargic. And it’s also why the recovery has been so weak. 

The reason banks aren’t lending to small and medium-sized businesses is because there isn’t enough incentive to compensate them for the higher costs, and higher risks, associated with smaller enterprises – and that includes smaller banks.

Market consolidation in the banking sector continues to be a major problem. Bank costs have risen dramatically under the legislative action known as Dodd-Frank, which was passed in the wake of the ’08 crash. This legislation levies regulatory burdens on all banks in the same exact manner – in other words, Dodd-Frank treats a local ten-branch bank group the same way it assesses mega banks like Wells Fargo, which have thousands of locations. This costly burden makes it impossible for local and regional banks to lend profitably to small businesses – let alone to survive. As a consequence, smaller bank groups are getting gobbled up by big bank chains (who use QE money to make the acquisition), which ultimately makes financial institutions that were already too big to fail even bigger. 

Yet again, Congressional action made matters worse and produced contrary results from their intention. 

As mentioned before, the easiest way to get money moving is to raise interest rates. Banks will lend more money and make more profit, and the economy will expand. The higher cost of borrowing will raise prices and produce more income to bondholders – all of which will deal a blow to deflation. But no, central bankers want lower yields and more QE – which is why the international bond market is so screwed up.

Consider the yields of two European pariahs, Italy and Spain, which have recently experienced a pleasant reversal in fortunes. It was just two years ago when yields for Italy and Spain were up around 7.5% – and Greece couldn’t borrow two nickels to rub together. Yet today Greece sold $28 billion of new five year bonds at 4.95%, and Italy and Spain are paying 3.2% – just a few fractions higher than the U.S. ten year bonds (now 2.7%) – while Germany is currently borrowing at 1.56%. 

What the heck is going on? Germany is safer than the U.S. and Greece is just a couple of points behind. Really?

Debt for Greece needs be expensive and difficult to get, otherwise that country will continue spending more than it could reasonably pay back. Artificially low yields (driven by the U.S. and QE programs) encourage irresponsible lending and borrowing practices – just as they did during the subprime mortgage boom. And that’s the larger problem.

The world is turning into one big subprime mortgage, where irresponsible borrowers (now sovereign States) are biting off more than they can chew. And just like what happened to subprime borrowers in 2008, Greece will someday run out of money and borrowing power to service their debt.

What many mutual fund owners don’t know is that they’re footing the international bill. In fact, 49% of Greece’s recent debt issue was purchased by asset managers (a.k.a. mutual funds) and another 33% by hedge fund managers (a.k.a. mutual funds for rich people.)

That’s why I advocate independent investment – so Greece doesn’t directly affect your portfolio unless you put it there. But make no mistake, a collapse or significant devaluation of sovereign state debt will indirectly affect your stock and bond portfolios. That’s why a multiple asset class portfolio is essential to mitigating that risk. 

Stay tuned…

ShieldThe road to financial independence.™

Same Old, Same Old - Again

Dan Calandro - Saturday, April 05, 2014

Stocks seem to have flattened out since reaching their December 2013 pinnacle. Sure there was a minor sell-off in January, but stocks have recovered from that. The point to takeaway from current stock market valuations is this: the average has been unable to top the performance of the economy (total market activity). See below.

4-4-14a

A stock market acting in Bull-like form is one where the Dow Jones Industrial Average leads the economy upward. But as you can see in the chart above, the Dow has been unable to outperform the economy (GDP) since its prior top – way back to October 2007. That’s not a Bull Market.

The reason many people refer to today’s stock market as a Bull Market is because of the Dow’s impressive reversal from the bottom of the ’08 crash. But regaining lost ground that was held prior isn’t a gain in land at all. It’s a return to the status quo – especially when considering the effects of inflation that have accumulated over the years. The chart below is the same one as above except it includes a trend-line for the DJIA that is adjusted for inflation (a.k.a. the Dow is Real terms.)

4-4-14b

Just as the Dow has underperformed GDP in current dollars (Nominal), it has also done so in Real terms, after inflation. To consider this market a Bull Market is a total misnomer. Stocks have barely recovered in Real terms since the last meltdown – which is consistent with the economy.

A Bull Market doesn’t need QE to sustain high stock market valuations. Interest rates don’t have to be artificially pushed lower and kept at historic lows for the better part of a decade to aid a Bull Market's underlying economy. Bull Markets are strong enough to handle market interest rates – higher rates, mind you, that would incentivize banks to lend and promote further economic expansion.

This is not to mention that Consumer spending during Bull Markets is vibrant. That’s so not the case today. Consumer activity grew at just 1% in Real terms in 2014’s first quarter, which prompted stocks to move lower by 1% during the time. 

Around the world the picture also remains in the same sorry state. Germany is reporting strong economic growth in the first quarter only to be followed by a "considerably lower" pace in the second. Growth is uneven at best. China continues to expect production to weaken; and the EU reaffirmed its easy money positioning by announcing that it was open to more QE. In this case, the EU is nervous about deflation and sees printing more new money (not higher interest rates) as the solution.

They are as foolish as American governors. 

Nevertheless, a weakening global position in major markets is also not indicative of Bull Markets. These added together are reasons why the Dow Jones Industrial Average cannot outpace economic output (Nominal GDP).

In other news, stock market corruption by so called high-frequency traders surfaced this week in the midst of the 60 Minutes feature on Michael Lewis’s new book, FLASH BOYS. Lewis is a great storyteller and expert investigator. And while large hedge funds and mutual funds risk losing billions of dollars with high-freq traders in the game (all of which are paid by dependent investors), it only marginally impacts independent investors following the Lose Your Broker method.

High-freq market participants look to shave fractional points from traders trading large blocks of stock. Most independent investors don’t trade enough volume to warrant their attention, and thus affect them less. Besides, if a couple of pennies per share are enough to throw a portfolio from gain to loss the problem isn’t high-frequency traders – it’s the philosophy behind the investment and the portfolio’s management.

The point I’m trying to make is this: invest in high quality companies and assemble them in a superior manner and a few pennies per share have absolutely no impact on long-term performance. These two tactics, superior construction and superior design, are the keys to financial success and independence. It is the Lose Your Broker way.

But this doesn’t mean that the stock market isn’t rigged like Michael Lewis suggests. It is; stock market corruption has been well documented in these blogs. To know this is to outperform the madness.

And in the same vein, the presence of high-freq traders in the marketplace doesn’t also mean that independent investors can’t easily make money in the stock market – at levels that greatly outperform professional fund managers. The 15-51 indicator is living proof of that. See below.

4-4-14c

The flattening of stock market prices can be seen most easily in the latest quarter of 15-51 indicator. It hasn’t moved in months. And just so you know, flattening trends that occur within the action zone high are automatic triggers to act if action hasn’t already been taken. It’s never too late to make a move.

Other than that it’s the same old, same old. 

Let me know if you have questions. 

Stay tuned…

Shield

The road to financial independence.™


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