Posts Tagged ‘Free Cash Flow’

The Folly of Stock Buybacks-Part II

July 20th, 2010

There have been more than a few stories making the rounds advocating share repurchases, in which the authors attempt to make the point that firms which repurchase their shares tend to outperform the general market.

What do Bear Stearns, Freddie Mac, Lehman and Station Casinos have in common? Their executives believed they were so well-funded they began very large buyback programs, even though they borrowed to do so.


IBM – Again, Pension Underfunding a Leading Indicator

July 19th, 2010

IBM, although a very strong credit, has been shrinking equity and buying back its shares (see our earlier articles: CFOs Making the Same Mistake and The Folly of Share buybacks).

It has also been underfunding its pension. When firms look to squeeze cash, the pension is an obvious target, and more often than not, disappointment, especially relative to expectations, is on the way. A couple of weeks ago we wrote IBM is underfunding its plans.

Please see our related articles on pensions and free cash flow implications of underfunding:

  1. Details Matter
  2. Pensions-Buyer Beware
  3. CNBC Strategy Session – Underfunded Pensions Earnings Bombshell
  4. CNBC’s Herb Greenberg – Underfunded Pensions are Red Flag for Investors
  5. The Next Shoe to Drop?
  6. The Other Shoe – Part 2
  7. With 3-, 5-, and 10-Year Stock Returns Negative: Why Are Pension Funds Assuming 8% Returns?

Disclosure: No positions

Kenneth S. Hackel, C.F.A.
CT Capital LLC

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For additional information on the implications of pension underfunding and its impact on free cash flow, cost of equity and return on invested capital, pre-order- “Security Valuation and Risk Analysis” out this fall from McGraw-Hill.

What Cramer doesn’t understand can hurt his viewers …

January 28th, 2010

Switching stations, I heard the first minute of his show this evening, saying “ investors are looking for a reason to sell.”

Someone please tell Mr. Cramer, large investors look to make money, and will sell if they have information not reflected in the current price of the security. If someone sells, someone who holds the opposite opinion buys.

But what he doesn’t really understand, and something I have been pointing out the past three months, is that current financial risk is greater than stocks are pricing in. When we called the market bottom in March, we did so as free cash flow increased, discretionary expenses were being reigned in, and valuations were low.

Over the past quarter, we are finding cash flows, adjusted for discretionary spending growing very modestly, credit health, as measured by our credit model (which incorporates everything from revenue and tax rate stability to yield spreads and off balance sheet debt, and everything in between), showing just minor improvement over the prior quarter. Yet, stocks were rising such that the free cash flow yield was approaching 4%.

And that is why stocks have, in general, declined. Not because “investors are looking for a reason to sell.”

We stated three months ago that although stocks almost never sell precisely at fair value, they were about 10% overvalued. Today, they are about 4% overvalued, based on a 3.6% 10-year Treasury bond, and a 8.4% cost of equity capital.