Two ways to get paid...
Two ways to get paid... $1 trillion in cash to shareholders this year... ExxonMobil: fair-weather share repurchase... GE becomes a real company again... Booze giant announces its first-ever dividend, just as we predicted...
We're officially into the seventh year of the bull market that started back in March 2009.
I (Dan Ferris) am skeptical that it will continue... but won't be surprised if it does. I find myself thinking about the ways that shareholders get paid. Two come to mind: share repurchases and dividends.
Shareholders of the biggest U.S. companies will likely receive $1 trillion in cash this year, most of it in the form of share repurchases, according to S&P Dow Jones Indices. Investors got $903 billion last year – $350 billion in dividends and $553 billion through buybacks. S&P expects double-digit dividend growth this year, which would put dividends at $385 billion or more. S&P 500 dividend growth has averaged 14% a year the last four years. At that pace, 2015 dividends would total $399 billion.
Meanwhile, investment bank Goldman Sachs expects share repurchases to reach $604 billion this year, according to the Financial Times.
Putting all that cash in shareholders' pockets sounds wonderful. But remember... companies are just as bad at buying their shares as everybody else. They buy back tons of shares near market tops, when share repurchases create little value (or destroy lots of value). And they tend to buy back little or no shares near market bottoms, when it would create the most value for shareholders.
Companies and other investors have roughly the same excuse for their bad behavior: They have a lot more money burning holes in their pockets near the top, when earnings are highest, than they do at the bottom, when many companies are losing money.
ExxonMobil is a typical fair-weather share repurchaser. In the first quarter of 2008, around the time oil prices hit $150 a barrel, ExxonMobil generated $17 billion in free cash flow. It spent $9.5 billion on share repurchases.
In the fourth quarter of 2014, ExxonMobil generated $12 billion in free cash flow. It said in February that it would slash buybacks from $3.3 billion in the previous quarter to $1 billion in the first quarter of 2015. The company says it's looking for "bolt-on" acquisitions, a term that often means "small deals that won't make a huge difference to earnings." ExxonMobil is well-known as the best capital allocator in the energy industry. But it's a good example of how even a great capital allocator can still be a mediocre share repurchaser.
Share buybacks are hard to time well. They only work when a company buys back shares at a discount to the value of the business. That makes them especially tough for cyclical businesses, which tend to need all the cash they generate for capital spending and dividends (if they pay one).
To do share buybacks right, the first thing a company has to do is hang onto its cash when the stock is expensive. That's hard, because investors will criticize it for holding too much idle capital. Think of how bullish you and everyone else were in late 2007... right before the S&P 500 peaked that October.
Then, when the market finally falls, companies have to be brave enough to step in and start buying their own shares – hopefully at a discount to what the business is worth.
Think of how bearish you were in the spring of 2009, when everyone was scared to death that another Great Depression was coming. Well, the folks running big corporations are human just like you. They bought back their own shares like crazy at the top and bought back very little at the bottom.
It makes you wonder if all these buybacks aren't a massive sign of an impending market top...
S&P 500 companies spent a record of roughly $180 billion on share buybacks in the fourth quarter of 2007, right as the stock market peaked, according to the FactSet Buyback Quarterly. At the bottom in early 2009, the same group of companies spent around $30 billion on buybacks.
Warren Buffett's Berkshire Hathaway doesn't make that mistake (though as Porter has pointed out, it's not perfect, either). Berkshire will repurchase shares only when they trade at or below 1.2 times book value.
Besides preventing management from paying too much for shares, it also helps put a floor under the stock price. The whole world now knows that Berkshire will be a significant buyer of its own shares at 1.2 times book value or less. Today, Berkshire's book value is around $146,000 per share. Its share price $216,000 – around 1.5 times book value.
If the stock falls to $146,000 or less, buybacks are likely – especially considering how hard it is for Berkshire to move the needle on its $500 billion-plus (and growing) asset base these days.
General Electric announced a $50 billion share buyback program on Friday. It'll fund the buyback by selling its massive financial-services operation. GE expects the buyback program to reduce its share count to between 8 billion and 8.5 billion by 2018 (from 10 billion shares today).
GE is keeping finance units that serve various industrial businesses, like GE Capital Aviation Services, Energy Financial Services, and Health Care Equipment Finance. It's exiting most of its commercial lending and leasing business, and all of its consumer-finance businesses, including U.S. and international banking. GE said it will sell most of the assets of GE Capital Real Estate to private investors and to funds managed by private-equity firm Blackstone Group for $26.5 billion.
GE says it could return as much as $90 billion to shareholders through dividends, share buybacks, and the initial public offering of GE's retail finance business, Synchrony Financial.
GE is also doing something I wish many other companies would do: It's bringing $36 billion in foreign-earned cash home to the U.S. to help fund share buybacks and shed finance businesses.
Most companies leave as much cash overseas as possible, under the mistaken notion they're creating value by not paying U.S. corporate taxes. As I showed Extreme Value readers in the March 24 weekly update, that hasn't been true for software giant Microsoft. Had the company brought all of its foreign-earned cash home instead of leaving it overseas and making bad acquisitions like aQuantive, Skype, and Nokia, Microsoft would likely be trading well north of $60 a share instead of wallowing around $42 today.
All told, the divestiture, big buyback, and repatriation of cash signal the end of an era for GE. For a long time, especially when former CEO Jack Welch was in charge, GE would do anything to report favorable earnings each quarter. That included running a finance operation that borrowed at low rates and lent and leased whatever it could to whomever it could in search of highly leveraged yield. Ask anybody who worked for Welch and most will describe a shallow, ruthless culture of "hit your numbers or hit the bricks."
On Friday, GE announced that by 2018, it expects 90% of its earnings will come from big industrial businesses like power, aviation, and energy, versus 58% last year. GE has been a great company to bash, due to its massive interests in finance and past management's style. (GE Capital's finance and other receivables were $252 billion last quarter.)
Now that it aspires to become a pure industrial firm, GE might become a boring, far less "bashable" business... the kind that smart investors tend to like. And value investors tend to like companies in transition. The transitions are sometimes accompanied by the stock getting rerated. GE shares rose nearly 11% on Friday on the news.
Maybe value investing legend Warren Buffett will soon add significantly to his 10.6 million-share position in GE. Buying a much bigger stake in a pure industrial firm could help put Buffett back on track after numerous missteps (as Porter has previously described). Buying a big chunk of a transformed GE might be one way for Berkshire to move the needle on its giant asset base.
Can you guess which company is the biggest share repurchaser of all time? It's consumer-products icon Apple. Last year, Apple said it would buy back another $90 billion worth of shares, raising its overall buyback program to $130 billion. It spent $73 billion of that last year. It expects to spend all the rest by December. According to the Financial Times, financial-services giant Credit Suisse expects Apple to raise the overall buyback program 50% later this month.
I recommended shares of Apple to my Extreme Value subscribers in June 2013 back when it was trading at a split-adjusted price of around $62 a share. It's up 108% since then (including dividends) at around $127 a share. If it keeps buying back massive amounts of stock, shares could easily hit $150 within the next year.
Unlike most companies doing massive buybacks, Apple isn't overvalued. Lately, it's trading at an enterprise value (market cap + debt – cash) of around 15 times trailing free cash flow. Folks are addicted to the world's most valuable brand, placing orders for 1 million Apple Watches that won't be on their wrists until June. And it will continue to sell an absurd number of iPhones.
Share repurchases can work out well for shareholders in businesses that enjoy steady growth. Growth often makes up for share repurchases that took place at expensive prices. In other words, these companies' management teams are bad at timing share repurchases, but their underlying businesses are so good that it tends to not matter over time. Consumer-goods giant Procter & Gamble, payroll firm Automatic Data Processing, discount retailer Wal-Mart, and many other blue-chip names come to mind. These kinds of steadily growing companies tend to be good dividend payers, too. Dividends are far more important than most people understand. They accounted for more than 40% of the S&P 500's return over the last several decades.
These companies tend to generate large amounts of excess cash flow, which they can use to buy back shares and pay regular dividends. In a somewhat famous study, research firm Ned Davis Research found that companies that increase their dividends tend to outperform both companies that pay dividends that don't increase and companies that don't pay dividends at all.
In June 2011, we recommended Constellation Brands (STZ) in Extreme Value. It's the No. 1 premium wine seller globally and the No. 1 beer importer in the U.S. The alcoholic beverage business tends to do OK in recessions. (As Editor in Chief Brian Hunt often says, it's unlikely that having a beer after work will become obsolete.) Plus, there is often intense brand loyalty among customers. These companies tend to be excellent dividend payers.
But Constellation has never paid a dividend in its 70-year history. Yet when we recommended shares in 2011, we wrote a lot about dividends. Here's a little of what we said back then...
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Since we recommended Constellation less than four years ago, it's up about 473%. (It's also the top-performing open recommendation across all of Stansberry Research right now.) It might have even more upside ahead... Last week, the company announced its first-ever quarterly dividend payment. Shareholders as of May 8 will receive a $0.31-per-share dividend payment on May 22.
When we first recommended Constellation, it generated less than $400 million in free cash flow per year. After it finishes expanding its Mexican brewery, we think it could generate as much as $1.2 billion in annual free cash flow. Today, the market cap is around 20 times that amount. That isn't cheap, but it's not terribly expensive for that type of business, either.
We're telling readers who took our advice and bought Constellation shares to hold. But another stock in the Extreme Value portfolio recently initiated a dividend, as we predicted it would. And unlike Constellation, this company is a screaming buy today...
It's a small company, but it's the best allocator of capital in its industry. This company has been on an acquisition binge lately, using its substantial financial resources and investment acumen to build a world-class portfolio of assets. It's my top open recommendation today. I know this company's management team well, and I believe we can count on them to take excellent care of shareholders for many years to come.
Late last year, I wrote a special report titled "The Best Resource Opportunity of My Life" where I discussed this company in detail. Extreme Value subscribers can read more about this opportunity in the special reports section. You can gain access to this special report with a subscription to Extreme Value. Learn more here (without sitting through a long promotional video).
New 52-week highs (as of 4/10/15): AllianceBernstein (AB), Deutsche X-trackers Harvest China A-Shares Fund (ASHR), Blackstone Group (BX), Blackstone Mortgage Trust (BXMT), WisdomTree Japan Small-Cap Dividend Fund (DFJ), Energy Transfer Equity (ETE), SPDR S&P International Health Care Sector Fund (IRY), Prestige Brands Holdings (PBH), and Constellation Brands (STZ). Many of you wrote in with positive reactions to the announcement of our partnership with Dr. Ron Paul. We'd love to hear what the rest of you think. Send your e-mails – praise and criticism alike – to feedback@stansberryresearch.com. "Porter, in response to your April 10 Digest I have to say that I am not your peer. I do have to confess that I am one of the few who look forward to your Friday Digest. I am 56 years old and want to continue to learn. I have been a Stansberry subscriber since 2007. I made a goal to learn how to invest in the stock market. Stansberry has helped me on that path. I started out with The 12% Letter and worked my way up to a few of your other letters. I am proud to say that last year I became an Alliance member. Again Porter I am not your peer but because of you and your team of professionals you have earned my trust as an Alliance member." – Paid-up subscriber Mark Ristau "Porter, there is nothing quite like the delight one gets when working with a team dedicated to the same goal you believe in and then the euphoria of reaching that goal. The spirit that is generated spurs you on to share experiences and overcome the obstacles toward future goals. Money is a great reward and acknowledgement for one's accomplishments, but the true reward is the shared journey with colleagues that no explanation could ever truly reveal.
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Regards,
Dan Ferris
April 13, 2015
April 13, 2015
