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True Owners and the Next Move Higher?

September 13, 2010 | About:
crafool

crafool

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In these crazy days of CNBC hyping every negative or hosting every Casandra or just data mining for negatives, it is nice to remember that shares of common stock represent a "real" ownership interest in a a company. I realize this is a rather simplistic and cute reminder for investors that are bombarded almost by the second that the markets must be traded as espoused by entertainment shows like "Fast Money" or that stocks are pieces of paper and to be traded by the likes of "Cramer" a CNBC proclaimed stock guru on his show called "Mad Money". It is however a lesson taught by Benjamin Graham in his books Security Analysis and The Intelligent Investor, and the premise for why Warren Buffett counsels investors to approach the buying of a share of stock in the same manner you would if you were able to buy the whole company. Stocks do represent real ownership and an economic interest in a real business. Sure the prices of those shares will "fluctuate" in value and can do so with great variance (i.e. it is not uncommon to see them move by as much as 50% in any given year.). Of course, those drops allow investors if their research justifies to add to their positions increasing their percentage of ownership at more favorable terms.

Obviously the kick to any investor is whether or not their research was correct!!! It is never easy to know for it isn't the market that tells you but the company's own results later on down the road and period of time many investors do not posess. Buffett likes to quote Graham as saying something along these lines: You are neither right because your stock rose in value nor wrong because your stock fell in value, but because your research is right. Well since it is difficult to determine good research and as an exstension proper price many well respected investors us private sector valuations or valuations based upon what an informed/industry peer might pay for the company.

Well we are getting that in two ways know. The first, all cash corporate takeover acquisitions that seem to be being announced daily and more impressively in a broad range of industries. These acquisitions are showing that their is value in the market for companies within their industry. The yield on cash is obviously easy to increase when your hurrdle rate is less than 1%, and the store of value like to be eroded over the not too distant future. The second and what I consider major occurence that seems to just be gaining steam but will have a huge impact on coporate stock values and bonds is the practice of companies issuing corporate bonds at generationally low levels (i.e. IBM issued $1.5 billion for 3 years at 1%, DELL issued around $1.5 Billion for I believe 5-, 10- and 30-years FIXED rate for just 70 baisis points over the corresponding Treasury Bonds!!!!) and with "general purpose" provisions for the use of the proceeds including their own "stock repurchases". Corporate America is doing the right thing by utilizing these historically low interest rates and investor appetite to finance these share purchases which increases existing shareholders ownership interest and offers many other benefits. Just think IBM issued debt for 3 years fixed rate of 1% and can buy back its own common stock that has an over 2.5% dividend attached to it!!! That seems like a nice little arbitrage move for Big Blue.

It is smart that corporations take advantage of these low valuations in their common share prices and these once in a lifetime interest rate levels. The corporation is basically going on margin for shareholders except the rates are locked in and far more favorable than a retail investor could get on their own. Corporations are at risk in these leveraged trades if they don't get the right price for their shares, however they are the most appropriate to determine the right value. Also, corporations are getting out ahead of the almost inevitable avalanche of government bonds that will be issued to pay for all of our government's spending. This new supply of bonds will eventually mean interest rates on bonds go up as their supply increases past the demand and their prices fall to reach equilibrium, however the stock market has the benefit of seeing supply in shares declining (i.e. Are Corporate stock IPOs or secondary offerrings any where near corporate debt issuance?) and as investors receive cash in their portfolios in exchange for their shares in those buy outs that will need to be reinvested. I would assume an investor that receives cash for stock owned will have a greater probability of reinvesting back into equities than redirecting into say bonds.

These two moves by corporations sure seem like what Milton Friedman might call "animal spirits" the key ingredient needed to get the "velocity" of money to increase and along with all that newly created money (Thank you Mr. Bernanke.) the last component for growth to move in the economy and if not checked by our political leaders (Good luck with that!!!) the inflation that some thought was missing action to comeback center stage. The butter flies wings just flapped and the hurricane it will eventually create just might do the most damage to the market that many investors think Mr. Market has labeled safe. That Mr. Market is a funny guy!!!

Happy investing to all!! Even to those CNBC self proclaimed "All-Stars".


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