Tuesday, September 30, 2008

Mark to Market Accounting Clarification from the SEC

Reuters reports No need for Fire Sale Pricing which very possibly would've saved Wachovia Bank (WB). The substantial marks taken by JPM on the WM loans all but doomed WB. Now the SEC claims that a distressed sell wouldn't be classied as a market between willing parties and wouldn't count as a 'market'.

  • U.S. securities regulators provided initial guidance on fair value accounting and reminded financial services firms that they don't need to use fire sale prices when evaluating their hard to price assets, according to a document first obtained by Reuters on Tuesday.
  • U.S. accounting rule makers assume that fair value inputs are based on an orderly transaction between willing market participants. The SEC release indicated that the agency does not believe distressed, or forced liquidation sales are orderly transactions.
  • The SEC's guidance says that sometimes the level 3 inputs may be more appropriate than the so-called level 2 or observable inputs.

This is a good sign for stocks like MS and RF that could be ravaged by mark to market fears. Long term both stocks seem strong if they can get through this period. Both posted strong profits last Q and should be able to continue as long as they don't have to take distressed marks and this SEC clarification should help ease the accountants push to take overly conservative marks.

Disclosure: Long both MS and RF in personal account.

Stat of the Day: Money Market Assets at Record Levels


As of last week according to http://www.sentimentrader.com/, money market assets alone would amount to 27% of the value of the S&P500. This almost doubles the last housing crisis in the early '90s of 14%. It's also considerablely higher then the 22% reached after 9/11. In fact, after yesterdays historic drop we're likely over 30% now. All of these assets will have to leave the bomb shelter at some point.


Monday, September 29, 2008

Poll of the Day: Was the House correct to not pass the bailout bill?

It's interesting that as the day closes this Smartmoney.com poll is actually very close to 50/50. We've been led to believe over the last few days that 100:1 of constituents for these House members involved in this vote are against the bill. Ironically this poll tells a different story. CNBC.com also had a poll that earlier today actually showed more people in favor of passing the bill. With CNBC having more of hardcore investor following, I find the Smartmoney.com poll more compelling and reflective of the general population. Goes to show that people for a bill aren't as likely to complain. Or just maybe a lot of people changed their mind today after seeing the market reaction. With the markets being the ultimate real time polling mechanisms, just maybe we'll see a re-drafted bill approved. After all, these polls suggest the House members voting for the bill won't be in such bad shape come voting time after all.

Edit: The poll ended up at 46% for the bill. Maybe the public is still agains the bill, but the % for it is alot higher then we've been led to believe.

Stat of the Day II: Bonds fall more then equities

In what was a miserable day in the stock market, bonds fell even farther. While the S&P 500 fell 8.8% the index of investment grade corporate bonds (LQD) fell an astonishing 9.4%. Now who holds a lot of bonds...hmm. Let me guess that a lot of retirees might be a little disturbed to see their bond holdings decimated. Weren't we told this wouldn't impact Main Street. My guess is that a lot of people begin to change their tunes on this rescue plan. It clearly impacts everybody. See the chart at Bespoke, Bespoke - Corporate Bonds.

Lots of more once in a century stats if I had the time to post.

Stat of the Day: VXO hits 45 again

Not hardly a week removed from hitting 45 on 9/18/08 and the market is back to this extreme level. Usually hitting the 40 level has historically been a huge buy signal for at least the next 4-6 months. Below are the times that 40 has been hit and only 2 times did it exceed 45 in the prior 20+ years until this month. Guess time will tell if this one leads to a huge rally.


Date High
10/19/1987 152.48
8/24/1990 40.01
10/27/1997 40.04
8/27/1998 41.46
4/14/2000 41.53
3/22/2001 41.99
9/17/2001 47.7
7/11/2002 41.64
9/18/2008 45.81

Friday, September 26, 2008

The Money Making Bailout

It seems very ironic to me that while most of the media and politicians keep harping about the size and scope of the 'Bailout' proposal, alot of well respected investment pros continue to harp on how this deal would potentially be profitable to taxpayers. So while certain politicians want to protect the taxpayer, they are actually just pandering to the uninformed or at least thats what their doing according to these people.

Andy Kessler wrote the follow in the WSJ Mother of all Trades


My analysis suggests that Treasury Secretary Henry Paulson (a former investment banker, no less, not a trader) may pull off the mother of all trades, which could net a trillion dollars and maybe as much as $2.2 trillion -- yes, with a "t" -- for the United States Treasury.


You can slice the numbers a lot of different ways. My calculations, which assume 50% impairment on subprime loans, suggest it is possible, all in, for this portfolio to generate between $1 trillion and $2.2 trillion -- the greatest trade ever. Every hedge-fund manager will be jealous. Mr. Buffett is buying a small piece of the trade via his Goldman Sachs investment.



Warren Buffett on CNBC Explains GS Investment


If the government makes anything over its cost of borrowing, this deal will come out with a profit. And I would bet it will come out with a profit, actually.



Bill Gross in the Washington Post How Main Steet Will Profit


Critics call this a bailout of Wall Street; in fact, it is anything but. I estimate the average price of distressed mortgages that pass from "troubled financial institutions" to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent.

The Treasury proposal will not be a bailout of Wall Street but a rescue of Main Street, as lending capacity and confidence is restored to our banks and the delicate balance between production and finance is given a chance to work its magic


So why would taxpayers turn down this trade?

Thursday, September 25, 2008

Net Payout Yield Focus: Boeing (BA)

Another day, another drubbing for Boeing (BA). BA is now down 47% from its 52 week high due to plane delays, machinist strike, and a weak overall market. All of this is good news for somebody wanting a high yielding stock. BA has been buying back stock at a rampant pace of late. Over the last 12 months, BA has bought back nearly $4B of stock with a current market cap of just over $42B. This gives BA a buyback yield of nearly 9%. Add on the 2.7% dividend and you get a net payout yield of nearly 12%. This yield is incredible considering the market position and financial strength that BA claims.

It's possible the strike goes on longer than expected and causes huge financial disruptions to BA, or maybe the global growth story will continue to erode and plane order will be canceled and pushed out. Regardless, BA has the financial strength to outlast the issues and will continue to buyback stock at these lower levels and issue a nice dividend. The longer the stock remains this low, the more stock they buy back and the higher future earnings will be increased.

When extreme fear exists and long term prospects remain intact, that's the time to buy. My portfolio added BA yesterday and sold Dupont (DD). With DD only yielding 6% now, BA offers twice the yield, making it much more attractive.

Net Payout Yield Focus - Microsoft (MSFT)

Yesterday, Microsoft (MSFT) announced a significant share purchase program and an increase to the quarterly dividend. MSFT was up 1% yesterday during a horrible market providing a relative gain against the market of 480 basis points. Very impressive, considering that MSFT didn't annonce better results or a revolutionary product. It was all because MSFT has the financial liquidity to make shareholder friendly moves. This is one of the reasons a net payout yield portfolio can be very attractive.

Lets analyze what MSFT announced:
  • Declared a quarterly dividend of $0.13 per share, reflecting a two cent or 18 percent increase over the previous quarter's dividend.
  • Approved a new share repurchase program authorizing up to an additional $40 billion in share repurchases with an expiration of September 30, 2013.
  • Authorized debt financings from time to time of up to $6 billion. Pursuant to the authorization, the company has established a $2 billion commercial paper program.

The increase in the dividend now provides a 2% yield which gets MSFT to a level that starts making them attractive to dividend investors. This is an improvement

The $40B buyback over 5 years sounds significant but it really just continues what they've done in the past. This averages $8B a year and over the last 12 months they've bought back $9B. So again, the key to this portion of the net payout theory is too watch how much they spend on a quarterly basis.

Issuing debt to buy back stock is not appealing to me. Now I've not seen any studies on the impact of the stock prices, but it's definitely more appealing when the buyback comes directly out of earnings. The debt causes them to lose the liquidity that is so appealing. MSFT, on the other hand, has plenty of cash so I'm not sure why they would need debt unless they plan to be like Home Depot (HD) and do a huge buyback all at once.

All in all, this announcement isn't earth shattering, but it does solidify why MSFT is the primary tech holding in my Net Payout portfolio. MSFT currently yields 6% which is low for the portfolio, but high for a tech stock.

Disclosure: None

The Advantage of Net Payout Yields

The Dogs of the Dow Theory has long interested me in its simplistic nature of eliminating the emotion of the stock market and systematically investing in the out of favor or contrarian stock. What least interested me was that an investor was suppose to buy the 10 highest yielding stocks amongst the 30 stocks in the Dow Jones Industrial average on presumably January 1st and hold them for a year.


While this compelled to my ‘lazy’ nature and was tax beneficial, it seemed overly simplistic and too focused on larger stocks that underperform smaller stocks in the long run. Why not adjust on a monthly if not daily basis? Or buy smaller stocks? If Pfizer (PFE) increases 50% by June and the yield consequently shrinks below the top 10 yields why continue holding till January and potentially give back that gain.


Another compelling concept was to extend the selection beyond the Dow and into the S&P 500 where more growth exists and the selection widens. For this method to work, the underlying stocks have to be fundamentally sound so you don’t want to go too far down the food chain, but it seems logical that the S&P 500 stocks would satisfy that goal while providing for more gains.

Another issue I’ve always had is that a lot of companies now spend a considerable amount of money on stock buybacks instead of dividends. If company X spends 6% on a buyback and 2% on dividends shouldn’t its yield be 8% and considered a higher yield then a company with a 4% dividend only. Afterall, buybacks are more tax friendly and that could be a big benefit if Obama becomes President and raises the taxes on dividends.


A study last year in the ‘Journal of Finance’ On the Importance of Measuring Payout Yield revealed what my thoughts had been all along. Companies with higher Net Payout Yields (net buybacks + dividends) outperform those companies with just Dividends. The company is investing money in shareholders either way so an investor should be focused on the combination. It also showed that the Dogs of the Dow Theory is now dead having underperformed of late.


As with any theory, it must adapt to the changing times. The regulatory and taxing environment over the last couple of decades has made it easier to do buybacks and more beneficial as well. The study showed that Net Payout stocks outperformed the market by nearly 6%, 19.1% to 13.4%, over the last 35 years. It also handily outperformed the highest dividend only stocks.
Unfortunately the study only focused on the Dow stocks nor did it address market timing. Market timing seems more beneficial due to the buyback inclusion. Companies that pay dividends tend to always pay a consistent dividend so the amount paid doesn’t care about the stock price. It does impact the yield though (another slight case for market timing).

With a buyback, the company can dramatically adjust how much it pays each quarter. For example, Home Depot (HD) bought back over $10B of stock during its Q3 last year. That’s over 20% of the outstanding stock, but it’s hardly bought any stock since. As an investor, you’d want to keep an eye on the price HD paid in this case. With a 3.3% dividend, HD now has a whopping 24.5% net payout over the last 12 months. Would you rather own that stock or a 4% dividend payer? That answer seems simple, but you’ll have to keep an eye on the buyback amount and date which makes this theory more complicated yet potentially more rewarding.


Going down into S&P 500 stocks allows for a dramatically larger universe of stocks beyond the limited 30 Dow stocks. Unfortunately I haven’t seen any studies of how performance is impacted. To me it allows you to pick the better yield out of the original Dow stocks plus companies like UPS (UPS) as an example. UPS has a $65B market cap making it a larger company then even some of the Dow stocks. So I think moving into the S&P500 makes the theory less restrictive, but still financially sound as investments. For now though I’ve tried to limit stocks to at least market caps of $20B to remain conservative.


My own results of the last year back up why holding the stocks for one year and then recalculating isn’t exactly ideal. I’ve had several stocks that spiked and consequently the yields fell, but I held onto the stock thinking it was best to hold to avoid churn and expenses. In the end, those stocks fell back to the market and in some cases gave up most of the gains. While not scientific, it does suggest my theory of at least monthly adjustments is more prudent to maximize returns.


Some of my recommendations as of today that have high net payout yields of 7-9% are Caterpillar (CAT), Disney (DIS), UPS (UPS), and Verizon (VZ). It’s amazing that these large companies have such high yields and probably is a sign of the overall value in the market. Other companies with large yields due to large buybacks over the last 12 months include Home Depot (HD) at 26%, Texas Instruments (TXN) at 15%, and WellPoint (WLP) at 25%. These are extremely high yields for such large stocks. The management teams of these companies think their stocks are extremely undervalued to spend that large amount of money on stock. Investing close to the amounts they paid is probably a key in large buyback cases and why buying and holding for 12 months isn’t necessarily recommended.


With so many people approaching retirement, this investing method could be ideal for that group. Especially for an IRA or some tax advantaged account where more trading then the once a year plan isn’t impacted by high taxes. The focus on dividends also would provide income for retirees and plans could be shifted more toward the dividend payers for higher income. Also, the conservative, non-emotional approach is ideal for somebody needing less risk, but still wanting exposure to the stock market.


As with any method of investing, regulatory and tax changes could impact the results in the future just as it has with the Dogs of the Dow Theory. An investor always should test any theory on a regular basis to make sure it continues to work.


So good examples of attractive net payout yields as of the close on 9/10:



Stocks Dividend % Buyback % Net Payout Yield



Caterpillar 2.7 6.9 9.6

Disney 1.1 7.1 8.2

UPS 2.7 4.8 7.5

Verizon 5.3 2.3 7.6


Disclosure: long position in VZ