Peridot Book Club

For those looking for a good stock market read, I suggest Wharton professor Jeremy Siegel’s “The Future For Investors.” Siegel’s follow-up to “Stocks for the Long Run” (published the 1994) offers a very interesting and compelling outlook for stock markets throughout the world.

Not only are potential challenges addressed (selling pressures due to retiring baby boomers and the rise of China and India as global economic powerhouses), but Siegel also presents characteristics of past market winners and losers, and how they will be affected in coming decades.

While he offers portfolio asset allocation advice toward the end of the book, with which some will agree and others will prefer to deviate from, I think the real value of the text is in the quantitative evidence Siegel offers from his extensive research and his outlook on the rest of the 21st century. This definitely will help investors think about their investment portfolios in a valuable and comprehensive way.
All in all, a must read for those interested in hearing opinions of a brilliant professor who called the top of the Nasdaq market bubble months before the collapse began.

Despite Cash Hoards, Companies Aren’t Paying Out

With cash reserves of U.S. public companies sitting at all-time record highs, investors might think dividend payments would be booming as well. Combined with the relatively new 15% dividend income tax rate, investors should be reaping the rewards of record cash payouts. However, the average S&P 500 company is paying less than 2% annually out to its shareholders.

Why does the average large cap stock pay out less than 2% in dividends? Well as we’ve seen this year, M&A activity has been red hot. Corporate profit margins are at cycle highs, so further cost savings have to be squeezed out via merger synergies. So far in 2005, deals have been running rampant on Wall Street. One need just look at the recent earnings report from Goldman Sachs (GS) to see evidence of that.

In addition to mergers and acquisitions, the rise of stock option compensation over the last two decades certainly accounts for the reduction in dividend yields. In order to minimize the equity dilution from option issuances, companies need to instate massive share repurchase programs. The money to do so comes straight from free cash flow that would otherwise be widely available for cash payouts to shareholders.

Throughout history, stock market returns have come from the combination of equity price appreciation and dividend payments. Yields that have averaged about 4 percent historically, along with 6 percent annual growth in earnings, explains the 10 percent average annual return from equities since the 1800’s.

With 2% dividends and peak margins upon us, it’s no wonder that some suspect future stock market returns, say during the next decade or so, will fail to hit the magic 10 percent mark. Even if somehow peak margins can be sustained, which is unlikely, investors are only looking at 8 percent annual returns from stock indices in the near to intermediate term. While that kind of performance pales in comparison to the great bull market of 1982-1999, it will still mark the highest return of any asset class, so abandoning the stock market because of it makes little sense.

The Buyouts Mount

After Washington Mutual’s (WM) purchase of Providian and Bank of America’s (BAC) recent buy of MBNA, it was widely expected that smaller credit card issuer Metris (MXT) would eventually get a similar takeover bid. In fact, readers of this blog were alerted to the potential of Metris even before those deals were announced.

Below is an excerpt from our post “Metris Continues its Turnaround” posted in December 2004:

“With some analysts still bearish on the company’s future, combined with a staggering 24% of the float sold short, there are many reasons to think that Metris shares will continue their march higher in 2005. Contrary to popular belief, it’s not too late to get in, even at the current $11 price tag.”

Today’s $15 per share cash bid by HSBC closes the book on the Metris story. Fortunately though, there are still excellent values in the financial services area, making reallocation of that capital a very opportunistic redeployment. Investors who want to stay in the credit card space should turn their attention to long-time Peridot favorite Capital One Financial (COF).

An Interesting Take on Conference Calls

I’ve written here before that if I were running a public company I wouldn’t give quarterly financial guidance, but MicroStrategy (MSTR) is taking the focus on long-term business management even further (see below). Could this be a red flag signaling poor financial results in the future that the company would like to avoid having to talk about? There is no way to know, but I would not jump to such a conclusion without other information to back up that assumption. There is no doubt some investors will see this as a negative and bet against the stock because of it, but with 30% short interest already, that seems like a risky bet to make.

From a MicroStrategy press release issued July 21st:

“MicroStrategy Incorporated (MSTR), a leading worldwide provider of business intelligence software, expects to issue a press release on July 28, 2005, to announce its financial results for the second quarter of 2005.

MicroStrategy has recently reviewed its practice of holding a conference call to discuss its quarterly financial results. The Company believes that it is in the best interests of its shareholders to focus on long-term financial performance, which allows the management team to more effectively run operations and build long-term shareholder value. Accordingly, consistent with our decision at the beginning of this year to discontinue providing revenue or earnings guidance, the Company has also decided that it will no longer hold conference calls following the release of its quarterly financial results.”

Side note: MicroStrategy’s Q1 conference call from April 28th is quite entertaining, and might shed some light as to why that call was the last quarterly call the company hosted. Feel free to draw your own opinions and share them with me, as I think it’s an interesting topic of discussion.

Goodbye Takeovers, Hello Takeunders

Rewind the clock back to March 2000. Do you remember BroadVision (BVSN), that high-flying e-commerce software company that traded at a split-adjusted $840 a share? Maybe you even owned the stock back then. Well, let’s hope you don’t own it anymore.

In one of the worst examples ever seen of acting in the interest of shareholders, BroadVision agreed Tuesday to be acquired by a private equity firm for 84 cents per share. Nevermind that is 99.9 percent below the stock’s all-time high. It’s 36 percent below the $1.32 the stock was trading at on Monday!

CEOs: Just Run Your Companies

Did anyone catch the Cyberonics (CYBX) conference call yesterday? I would never have noticed it as I don’t follow the stock, but continuous coverage on CNBC got me wanting to mention it. The company’s CEO went ballistic after the stock got crushed on news that the Senate is investigating the FDA’s decision to recommend approval of the company’s product after initially suggesting it be rejected.

Now I don’t know the details of the story, nor do I really care, but I couldn’t help notice how irrate the CEO was on the call from clips I heard on CNBC. He blasted short sellers for supposedly starting rumors and was infuriated that people were contacting the FDA to learn more about possible pressures applied to get the CYBX device approved.

After screaming at people on the conference call, the CEO spent more valuable time writing emails to CNBC criticizing their reporting of the story throughout the day. With a very important product under review by the FDA, doesn’t he have more important things to do with his time than yell and scream at analysts, short sellers, and business reporters?

If you are a CEO, your job is to run your company. How well you do will determine where your stock trades. News reporters and short sellers do not determine stock prices over time. How much money Cyberonics earns does. Sure, a false rumor might send your share price down a dollar or two in a day. However, why be infuriated by this? As a CEO, it shouldn’t matter if your stock is $30 on Monday, $28 on Wednesday, and $31 on Friday. Leave that for traders to worry about.

It’s amazing how many CEOs hate short sellers and spend so much of their time trying to discredit them (’s Patrick Byrne comes to mind as a perfect example). If you want them to feel pain, fine, just hit your numbers and those betting against you will lose their shirt. That seems like the best gameplan for those who are doubting you and your company.

Just do your job well, run your company correctly, and the stock price will take care of itself.

A Tale of Two Buybacks

There have been a lot of big name investors in the news recently, including the trio of Warren Buffett, Kirk Kerkorian, and Carl Icahn. The media tends to lump all three men into the same group of people investors should pay great attention to. After all, when Buffett disclosed he bought Anheuser Busch (BUD) stock weeks ago, the stock jumped from $45 to $48 in a single day. Kerkorian issued a tender offer for General Motors (GM) shares that resulted in the largest one day gain in the stock in more than a decade.

Icahn perhaps deserves less attention. His track record is not as solid as Buffett or Kerkorian, and Wall Street evidently realizes that his shareholder activism efforts with the likes of Blockbuster (BBI) don’t always add any value for stock owners. In fact, when Icahn recently released a list of stocks in which he purchased stakes in recent weeks, most of the stocks barely budged.

Today I will focus on two stock buybacks, one of which was precipitated by Icahn’s discontent with the management of Kerr-McGee (KMG), and the other non-Icahn related buyback that resulted from a huge cash stash at Motorola (MOT). As you can see from the chart of today’s trading below, the stocks have reacted differently to the news of their respective buybacks.

First, the good news. Motorola has $6 billion of cash on its balance sheet currently, net of debt. CEO Ed Zander today announced that the company will buy back up to $4 billion in stock, about 10% of the total outstanding shares. Both Motorola and Nokia (NOK) have huge cash balances that have contributed to Peridot’s extreme interest in the stocks over the last year. Investors should always pay attention to balance sheets, in addition to earnings per share. When companies are flush with cash, they will usually do something good with it eventually, just be patient. MOT shares have been up between 3 and 4 percent today.

As you can see, Kerr-McGee shares are faring much worse today, falling by as much as 8 percent. Here’s a quick synopsis of the story there.

Icahn, unhappy with the management of KMG (despite the stock’s rise from $50 to $80 with the last 12 months), threatened last month to attempt to get elected to the company’s Board of Directors. Icahn agreed to abandon the effort after Kerr-McGee launched a “Dutch Auction” tender offer for 46.7 million shares. The move would cost $3.97 billion based on a purchase price of $85 for each KMG share, in order to avoid a proxy battle with Icahn.

With KMG shares trading at $74, Icahn basically has forced Kerr-McGee to buyback 29% of its total shares outstanding for $85 apiece. Today, the stock opened at $69. How exactly is buying back stock at $85, when your share price is $69, good for shareholders? That’s a $16 per share premium to the price on the open market. Icahn evidently thinks that is a good investment of nearly $4 billion for the company.

You know what makes it even worse? KMG doesn’t even have the $4 billion to buy the stock with, so they are borrowing the money. The company secured a $5.5 billion credit facility to fund the purchases. So, in addition to the $16 per share premium it is paying (an extra $747 million above market value) Kerr-McGee also has to pay interest on the entire amount.

Something tells me Warren Buffett would never force a company he owned a significant stake in to throw away money like that, let alone money they needed to borrow to do so.

What Bull Market?

I’m still trying to figure out why I keep hearing investment strategists proclaiming that the bull market remains intact. Do these people really think we are in a bull market? Do the numbers support that conclusion? Does this market feel like it’s going gangbusters? I have to say “no” on both counts.

First of all, the market is down since the turn of the millennium, and we’re more than halfway through the decade already. I hate to break it to everybody, but the bull market in stocks ended in 1999. It was the greatest bull market of all time, lasting a full 18 years beginning in 1982. During that stretch, the S&P 500 returned an average of 19% per year and recorded only 1 down year (a 3% loss in 1990).

It takes more than a couple of down years to get the bull running again. If stocks average 5% a year for the rest of the decade (which I think is entirely possible, if not probable), the average return for the decade will be 2% per year. When stocks fail to keep pace with inflation, it’s not a bull market.

That said, there is no reason investors can’t attain double-digit returns in a bear market. It just means that index funds won’t do the trick. Superior stock selection will.

Why Do Companies Give Guidance?

If I was running a public company, I would not give investors and analysts any type of precise financial guidance. Giving such sales and profit estimates stems from the implementation of Regulation FD, which required companies to divulge all meaningful information to the public, not just Wall Street analysts and boards of directors. No longer faced with having the luxury of “guiding” analysts to how a particular quarter was tracking, companies began issuing financial guidance in their press releases for everyone to see and interpret.

Unfortunately, earnings guidance plays right into the hands of those who focus too much on short-term financial performance, as opposed to building long-term shareholder value. CEO’s should not make business decisions in order to ensure they can make their numbers every quarter, but instead because it is in the best interest of the company and its shareholders long-term.

Making sound decisions that succeed in hitting both short-term and long-term goals is not always possible. Sometimes corporate managers have to make short-term sacrifices to ensure long-term stability and growth. Examples of these actions might be a dilutive acquisition, or price cutting to prevent a key customer from bolting to a competitor. Price discounts and dilutive deals will cause many companies to miss a quarter or two, but investors will be much better off five years later.

The fact remains that Wall Street focuses too much on quarter-to-quarter financial results. Investors see this every day when companies miss their EPS numbers by a penny or two and their stock drops 10, 20, or 30 percent in a single day. As a result, CEO’s begin to manage their business just to make sure they hit their numbers.

Taser (TASR) shipped out a $1 million order on December 31, 2004 to ensure they hit Q4 profit estimates. Pharmaceutical companies convinced wholesalers to take delivery of more product than they needed (a tactic called “channel stuffing”) so sales would be on target. According to court records, former WorldCom CEO Bernie Ebbers agreed to cook his company’s books because they needed to “hit their numbers to keep the stock price up.”

Finding companies that manage their businesses based on strategic plans, and not their public financial guidance, will do a much better job over the long term, and that’s something investors should look out for.

Taser Shareholders Stunned

Let the class action lawsuits begin. It appears the party for stun gun maker Taser (TASR) is ending. Two years ago, TASR stock traded at $0.35 (split-adjusted). After rising to more than $33 in 2004, the stock fell 30% today, to close at $14 per share. Taser is down 55% so far this year, and it’s only January 11th. As a result, lawsuits will be filed, lots of them. And soon, very soon.

Shareholders will scream of being had. Taser didn’t adequately update the public about its business, they’ll say. They will point to the company’s management; a father (Chairman) and two sons (one is CEO, the other is President). The trio sold more than $100 million worth of stock in 2004, all while touting their stun guns’ safety and growth potential to any TV station or reporter that would listen.

They will be accused of insider trading because they were selling stock as they were hyping their company’s prospects. Class action lawyers will conclude they knew business would fall short of their rosy projections, hence they sold, but didn’t tell anyone, leaving shareholders with a 55% loss in 11 days.

Can you blame them? Not the shareholders, they are to blame, but rather Phil, Tom, and Rick Smith. Are they bad people for taking $105 million in profits off the table when their company was being valued at nearly $2 billion, despite only having $68 million in sales? Are they crooks? No. Actually, they are smart. They didn’t know ahead of time when orders would be delayed or exactly when competitors would bring new products to market. What they did know was that companies aren’t worth 30 times revenues very often, and when they are, it’s not for very long.

How about Mark Cuban? Is he a crook? Most people (including myself) think he was a genius when he sold his Internet broadcasting company,, to Yahoo! for billions of dollars. He got Yahoo! shares in exchange, and even knew to sell those too. Mr. Cuban didn’t sell because he lost interest in his business, or because he doubted whether radio signals would be broadcast over the Internet. He sold because he knew was not really worth the $7 billion the equity market was pricing it at.

It’s the world we live in today. We do something stupid, lose money because of it, and we sue. We don’t admit we made a mistake and learn from it; vowing never to make the same mistake again. That’s what we should do, but not what most of us will do. Taser shareholders who will choose to join the class action suits are a perfect example.

If you paid 30 times sales for an overhyped pipedream company, you probably will lose money. It happens. We all mess up sometimes. But do yourself a favor. Learn from the mistake. Learn how to value companies properly, so as to avoid losing any more money. But please, don”t sue the people who understood concepts you failed to grasp.

The Smiths may be very guilty of overhyping their company. But not once did they hold a gun (no pun intended) to somebody’s head and force them to buy Taser stock. When they saw an asset they owned become grossly overvalued, they sold. They did what every good investment manager would have done, and is heralded for doing.

We shouldn’t sue people just because they’re smarter than us. I’m not against giving every human being their fair day in court. The problem right now, in 2005, is that we don’t only sue when somebody breaks the law. We sue when we mess up, to get revenge.