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Market Buzz – The Highly Misused and Misunderstood Capital Allocation Strategy – Share Repurchases (Buybacks)

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Posted by Ryan Irvine: Keystocks

on Saturday, 10 March 2012 00:00

Over the years, we have discussed the various ways that companies utilize their free cash flow to generate a return for their shareholders. In our small-cap universe, we have traditionally focused on companies that reinvest their earnings back into the business to generate sustainable growth. More recently the markets have started focusing on companies that payout their cash flow to shareholders in the form of dividends or distributions. Even better are those companies that generate so much cash that they can afford to invest in growth as well as pay a dividend. But there is also a third method of allocating capital that is often misused and even more often misunderstood – share repurchases (buybacks).

The consensus is mixed on whether or not share repurchases are in fact a viable strategy for generating shareholder returns. When a company has excess cash and they believe their shares are undervalued, they will often issue a normal course issuer bid which allows them to purchase and cancel a predetermined maximum number of shares of their own company. The idea is that if you believe that your own company will provide you with the best risk-adjusted return on your capital then why would you invest your capital anywhere else.

Warren Buffet recently said in his 2012 letter to shareholders (http://www.berkshirehathaway.com/letters/2011ltr.pdf) that in addition to generating strong earnings growth he also typically hopes that the stock prices of the companies he purchases languish in the markets for several years after he buys them. Using an example of IBM, he explained that if the company were to spend $50 billion over a 5 year period to repurchase its shares that his current interest of 5.5% in the company would growth to 7% if the share price were to average $200 over the period, but only 6.5% if the share price where to average $300. Since Warren has no intention of selling his shares during that period his best case scenario would be if the cash flow remained strong but the stock price plummeted. This is a wide diversion from the mentality of many retail investors who require constant validation from the market in the form of appreciating stock prices.

The reason that share repurchases are often criticized is because they are very commonly misused. Very often companies will publicly disclose that they have received exchange approval to proceed with a share buyback but then fail to repurchase any shares. The hope is that the announcement alone will garner investor interest. The more common problem is when share repurchases are made by companies that are not undervalued. Warren Buffet said, “I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated. We have witnessed many bouts of repurchasing that failed our second test.” The CEO and Board of Directors commonly have a tendency to view their own company as undervalued, particularly if it has suffered a large decline in the share price. This bias can lead firms to repurchase stock when it is in fact overvalued, an activity which has the impact of destroying shareholder value.

The key to assessing a share repurchase strategy is to analyze the metrics of the individual situation. Does this company have the available liquidity to repurchase shares? Is the company clearly undervalued on the basis of free cash flow and will a share repurchase have the intended impact of improving performance on a per share basis? If the answer to these questions is yes then a share repurchase may be a very viable strategy for creating shareholder value long term.

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The Wall Street Whiz Kid on Bull Markets -Dangers & Critical Action to Take

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Posted by Peter Grandich on Money Talks

on Thursday, 08 March 2012 20:39

Peter Grandich  said very clearly to Michael Campbell in early December we would see a bull move in the US Stock Market and we did, 11 weeks in a row. He advised his readers to get long because:
 
1. The market had every reason to go down and it didn't.
 
2. We were entering a seasonally favorable period.
 
3. There was a belief we'd at least get a Santa Claus rally. 
 
Subsequently, once we got past Christmas it looked to him like the market still wanted to go higher, and he even suggested to his readers that in this rally we might even squeak out a marginal new all-time highs in the Dow & S&P. 
 

What Now

To be clear, he didn't think we'd have a 3-5 years bull market joy. Indeed, on friday March 2nd he put out the "yellow caution flag" to his readers. Peter sees danger in what he sees as an imminent and inevitable conflict with Iran that will hit this elevated stock market that has been getting within shouting distance of Dow and S&P all-time highs. 
 
In short he thinks we will see the end of what he thinks is "a countertrend rally in a secular bear market that actually started in the fall of 2007."

12-03-02-MWT-01b.ashx
 
Timing and signs that this scenario is in fact playing out. 
 
1. An inevitable  large scale military confrontation in the middle east occurs. Peter feels there is no way that Israel can live with an enemy that has sworn it wants to eliminate all of Israel with nuclear weapons. He thinks that whether or not Israel has to act alone, whether or not their action is successful, its only a question of when and it seems to him that the window for action is getting very small. A matter of weeks to a few months from Israel taking action. "That doesn't mean the that the day this happens the market will tank and never come back again, but it will be the beginning of a major geopolitical change that will take months if not years to play out and be a net negative simply because of the fragile economies that are in the world today. One fragile economy being the US and another is a good part of Europe." 
 
2. "The US is past the point of no return. The US doesn't produce enough cash flow after they pay for their bills to pay off the interest let alone the principle of the debt the US has outstanding. Inevitably one of three things has to happen, part of the debt will be reneged, part of it will be renegotiated, and part of it will be monetized as the Fed is doing now."  Bottom line, there is not a very bright picture for general equities past the next few weeks or months. "We've had a nice rally, if you are still long equities that are not related to metals congratulations, but now is not the time to be getting into them, now is the time to be selling." 
 
 Bonds 

"Over the next 10 years, the worst investment will be US bonds." He saw a study this week from a very independent, reliable group that inflation is running in the US between 5 and 7%. Peter believes that study and thinks no-one should believe that inflation is running at 1.6% as the government would have us believe. He doesn't see how over the next 10 years with bonds yielding 2%, how anybody that buys and holds could end up making money. He would sooner be in general equities, before he would have any ownership of bonds right now. 

"The dramatic lowering of interest rates far below where they should have been literally destroyed or seriously damaged 10's if not 100's of millions of Americans and others who would have normally been dependent on fixed income and been able to live out their retirement. The lowering of interest rates resulted in a quest, as Ron Paul said, of destroying the currency and destroying America."
 
This destruction of the Bond Market is the pivotal moment of our time, and we are seeing right now the ramifications of what happens when confidence leaves a bond market in countries like Greece, Portugal, Spanish and Italy. There is an absolute ticking time bomb waiting to explode in the states, and Peter doesn't see how people can think that it can happen in all of those European countries and not for some reason fail to happen in America too. 
 
One positive, Peter thinks that when bonds start to sell off it will probably initially support the stock market. 
 
The Eye of the Hurricane 
 
"The US is going to have to address the real political time bomb that's coming, and that is the changing of the US retirement system, changes that will be forced on Social Security and Medicare". Peter urges us to enjoy what he calls the eye of the hurricane, "we had our first wave in the financial crisis of 2008 and that we are now in this eye of the hurricane where the sun has popped out and things are starting to feel pretty good again. Noting that hope is a great spiritual strategy but also the worst investment strategy, he thinks that in the next several months to perhaps early in the next year "we will be back in the grips of something very serious and that its going to have to get a lot worse before it can begin to get better." 
 
"I refuse to leave our children with a debt they cannot repay"-Obama 02/29/2009
 
As low as interest rates are, the US is paying 4 billion a week on interest payments alone, and the kicker is that if they keep going on the trend that they are that figure will change to 10 billion a week within 4 years, or 552 billon a year in interest at a minimum (assuming rates do not rise). Given rates have risen tremendously in Greece, Italy, Spain and Portugal, it seem highly unlikely that rates will not rise in the US over the next 4 years and that weekly figure could be very low. 
 
How do Individuals Protect themselves?
 
Seniors in the States have seen all the worst things that can happen. They have seen fairly secure, good reliable interest income disappear, they have seen the value of their  housing go from always rising annually to collapsing to levels where a houses that cost $300,000 in 2007 can be bought for less than half that now. Even nice little 2  Bedroom Bungalows can now be bought for less than $35,000. Now they are being told that their AAA medicare plan is going to change and they are going to have to start paying a lot more for it. 
 
Action Items
 
1. He urges everyone, particularly young people, that debt is now more than ever a 4 letter word and if you do nothing more for the rest of your investment life than pare down your debt and get out of debt completely you will not only have a great financial reward but the mental aspect of being debt free can't be underestimated. 
 
2. Get out of the US Dollar since as the worlds reserve currency is backed by a country that is in even worse shape than Europe. Peter has recently converted "a bunch of my Capital" into Canadian dollars. 
 
3. The US is no longer the economic engine that pulls the rest of the world around. There are other countries, India, China, Brazil and he recommends that action be taken and investments made in equities that do the majority of their business in these countries. 
 
4. For preservation of Capital he recommends the Gold Market. Its been the best investment for the last 10 years and he thinks it has another 4-5 years to run. As for the Flash Crash, Peter believes it gave investors an opportunity to get involved in Gold at good prices. As an alternative, if you can't pull the trigger here then buy when Gold breaks the $1,800 level. 
 
5. While Peter thinks that Silver will outperform Gold over the next few months, ultimately he likes and recommends you buy Gold. 
To listen to the entire Peter Grandich interview with Michael Campbell go to this player you will find in the centre of the masthead of any Moneytalks page:
Screen shot 2012-03-08 at 4.20.20 PM
 
 
 
 

 


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The 3rd Richest Man in the World: Stock Investor Warren Buffett's Bursting Bubble

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Posted by Peter Schiff - Euro Pacific Precious Metals

on Thursday, 08 March 2012 15:42

The gold doomsayers have found their champion in the media's favorite financial advisor and one of the world's richest men. Warren Buffett, the man dubbed the "Oracle of Omaha," has repeatedly and publicly denied that gold is an investment, and called gold buyers "speculators" and people "who fear almost all other assets." In fact, Buffett claims that gold's rise has the same characteristics as the housing and dot-com bubbles, and it is only a matter of time before it reverses course. He doesn't mean that the price will decline because of austerity measures and a free-market interest rate, mind you. He just asserts that because he's deemed it a bubble, it will inevitably burst.

The financial world by-and-large views Buffett as an objective observer, a rare investor who still considers the best interests of common man when he speaks. Each year, there is much hullabaloo over the letter Buffett writes to the shareholders of Berkshire Hathaway. When Buffett makes a claim, the financial world coos and repeats it without question.

I concede that Buffett is a talented investor and a great communicator. He clearly has had great success and has much to offer. But that shouldn't blind anyone to the fact that Buffett is not a trusted observer. He's a crony capitalist who bends the truth to serve his long-held ideological commitment to big government.

In the early stages of the financial crisis, when I was writing and promoting my first book Crash Proof to warn private investors about trouble ahead, Buffett was accumulating shares in companies such as Goldman Sachs, Wells Fargo, Bank of America, and General Electric. I knew these companies were insolvent, so I wouldn't touch them with gardening gloves on. When the credit markets seized up, Buffett worked behind the scenes and in public to make sure each of his pet companies were bailed out. This was not by coincidence. Buffett actually stated in September 2008 that he would not have invested in Goldman Sachs if not for the implicit guarantee of federal assistance. As a result, he profited at the expense of taxpayers at the very time when they were losing their savings in the markets. Meanwhile, many "in the know" politicians bought Berkshire stock during the height of the crisis, making a profit from their votes, and giving them incentive to revere Buffett all the more. Buffett once said that if the government didn't bailout failed companies, he would be "having my Thanksgiving dinner at McDonald's instead of having a big dinner at my daughter's." Seems like there were two bloated turkeys at that meal.

If Buffett were a true capitalist, he would be in favor of gold. He has noted that the value of the dollar has fallen 86% since he took over Berkshire Hathaway in 1965 and even said in his latest shareholder letter that investors are "right to be fearful of paper money." But he continues to harp on gold. It seems the only unit of account Mr. Buffett approves are shares of his own company!

The adoption of an independent measure of value like gold presents two problems to Buffett. First, it would reduce the nominal returns of his dollar-based investing strategy. Second, it would restrict Washington's ability to goose the financial system in his favor.

In the 19th century, when gold and silver were legal tender, the outsized returns to which Buffett has become accustomed were much harder to earn. Most people kept their money in physical bullion or bank deposits - and earned a real rate of return. Now, under the fiat system, working folks are forced into the more complicated world of equity investing. This, too, can generate real returns, but it's a tougher playing field for the inexperienced.

Also, the fiat system artificially balloons the financial services portion of the economy. In the 19th century, fortunes were made more often by business owners than simple equity investors. People were more likely to be rewarded for providing a productive service than having direct access to the Fed's discount window.

A quick look at Berkshire's performance verses gold since the Credit Crunch goes a long way to explaining Buffett's antipathy toward the yellow metal:

1

But Mr. Buffett's lack of credibility goes deeper than a differing monetary philosophy. He has been in the press since last August claiming that he pays less taxes than his secretary - and urging Congress to pass a "Buffett Rule" mandating a 30% minimum tax on millionaires. The natural reaction is to say, "If you want to pay more, go ahead." But Buffett has gone on record saying that it's not enough for him to lead by example, and demanding that all of America's well-off bear the burden of Washington's reckless spending binge.

The problem is that Buffett's entire argument is constructed on deception. Buffett is rated as the third richest man in the world for managing the nearly $393 billion in assets, and he highlights that he only pays 17.4% of his income in taxes. But this is because he earns less than 1% of his annual wealth from his salary, while over 99% is earned as the largest shareholder of Berkshire Hathaway. Buffett claims that he discounts his Berkshire holdings because he plans to give it all to charity when he dies. So, it's not that the tax rates are so low, it's that Buffett plans to give away 99% of his wealth.

But even accounting for this clever accounting trick, Buffett is still grossly understating his personal tax burden. He owns roughly 1/3 of Berkshire's outstanding shares, the profits from which are subject to a 29% corporate tax rate. Last year, Berkshire paid $5.6 billion in taxes - and the IRS says they owe $1 billion more! In addition to corporate taxes, Buffett is also subject to an additional 15% capital gains tax on his stock when he cashes out, not to mention any future estate tax, leaving many to conclude that his share of taxes is certainly higher than his secretary's.

You might wonder what Buffett would hope to gain by understating his own tax rate. To answer that, you have to understand Buffett's ideological background. His father, Howard Buffett, was a US Congressman known for his staunch libertarianism. As has been recounted by biographers, Buffett resented being uprooted from his Omaha, NE home to move to Washington, DC and felt estranged from his stoic father. That is to say, Buffett's commitment to the nanny state runs very deep.

But also, as mentioned earlier, Buffett personally benefits from the current corrupt state of affairs. He gets prestige from nominal gains in his stock price. He gets bailout money to guarantee the insolvent companies in which he invests. Even that estate tax that will hit him when he passes currently allows him to buy out other businesses at a steep discount.

It also shouldn't be a surprise that humble Howard was a staunch advocate of gold and silver as money - nor that wealthy Warren rejects precious metals as having "no utility."

The media has built Warren up to be a demigod, a straight-talking Nebraska boy that can hold his own against the vipers of Wall Street. But he is just a man with a talent for making money, and his motives should not be beyond reproach. Is he advocating the use of taxpayers' money to bailout his business interests so he can profit? Is he being honest about what money is? Does he even understand the business cycle?

Gold prices will only go down when governments change course and make significant cuts. Until then, gold is not in a bubble. It's the only way to protect your wealth; and in the current economic condition, it's poised to go much higher. I think it's high time Buffett takes to heart his father's wise words: "For if human liberty is to survive in America, we must win the battle to restore honest money."

Peter Schiff
C.E.O. of Euro Pacific Precious Metals
email: info@europacmetals.com
website: www.europacmetals.com

Peter Schiff is CEO of Euro Pacific Precious Metals, a gold and silver dealer selling reputable, well-known bullion coins and bars at competitive prices. To learn more, please visit www.europacmetals.com or call (888) GOLD-160.

For the latest gold market news and analysis, sign up for Peter Schiff's Gold Report, a monthly newsletter featuring original contributions from Peter Schiff, Casey Research, and other leading experts in the gold market. Click here to learn more.



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Remember, the Money Has to Go Somewhere! - US Stock Market Update

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Posted by Peter Grandich - Grandich.com

on Friday, 02 March 2012 07:06

chart1

"The Bank of Japan and The Bank of England are also flooding their markets with newly printed cash. And this week, in comments before Congress, Federal Reserve Chairman Ben Bernanke also signaled he has no intention of stemming the flood of easy money coming from his central bank." - Money and Markets

US Stock Market Update

by Peter Grandich

Despite numerous bearish long-term fundamentals, I’ve stated the market’s least resistance is up. While not a card-carrying member of the “Don’t Worry, Be Happy” crowd, I’ve managed to avoid taking any bearish strategies and thus not becoming part of the perma-bear carnage that has grown since the bottom in March 2009.

Having said that, I do think it’s time to start preparing for the top in this massive countertrend rally in a secular bear market that began back in late 2007. Somewhere between here and the marginal new, all-time high I suggested the DJIA could reach, I feel selling non-metals related shares seems wise. I would like to be mostly in cash (except for mining shares) before years-end.

I know the question many now have – what about resource stocks? Selling in May and going away may just be wise this year but for now, all systems remain go.

I do believe on the first news of a large-scale military conflict with Israel and Iran, we shall likely expedite any selling still left to do.

Stay tuned!

 

ABOUT PETER GRANDICH

Though he never finished high school, Peter Grandich entered Wall Street in the mid-1980s with no formal education or training and within three years was appointed Vice President of Investment Strategy for a leading New York Stock Exchange member firm. He would go on to hold positions as a Market Strategist, portfolio manager for four hedgefunds and a mutual fund that bared his name.

His abilities has resulted in hundreds of media interviews including GMA, Neil Cavuto’s Your World on Fox News, The Kudlow Report on CNBC, Wall Street Journal, Barron’s, Financial Post, Globe and Mail, US News & World Report, New York Times, Business Week, MarketWatch, Business News Network and dozens more. He’s spoken at investment conferences around the globe, edited numerous investment newsletters, and is one of the more sought after commentators.

Grandich is the founder of Grandich.com and Grandich Publications, LLC, and is editor of The Grandich Letter which was first published in 1984. On his internationally-followed blog, he comments daily about the world’s economies and financial markets and posts his views on social and political topics.  He also blogs about a variety of timely subjects of general interest and interweaves his unique brand of humor and every-man “Grandichism” expressions with his experience gained from more than 25 years in and around Wall Street. The result is an insightful and intuitive look at business, finances and the world, set in a vernacular that just about anyone can understand. In his first year, Grandich’s wildly-popular blog had more than one million views. Grandich also provides a variety of services to publicly-held corporations on a compensation basis.



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Small Cap Gold Stocks Successfully Retest 2010 Breakout

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Posted by Jordan Roy-Byrne - Trendsman

on Thursday, 01 March 2012 07:54

Juniors are typically micro-cap exploration companies. Yet, GDXJ the junior ETF is comprised of companies with market caps in the $500 Million to $1 Billion range. There is nothing junior about that. We notice there is a gap in terms of terminology. If Juniors are sub- $100 Million, and large caps are over $1 Billion, then what do you call those that fit the gap?

We prefer to use the term “established juniors” or small cap. After all, small caps by definition are in market cap between $100 Million and $1 Billion. These terms are most appropriate for those in the middle of said range rather than the bottom or top. We prefer the established juniors as being established (which is open to interpretation) they have less risk than the true juniors and if successful can grow to $1 Billion or more in capitalization.

In our opinion, small caps are the area to focus on as they have a much greater likelihood of growth and leverage to Gold than the large producers. Historically, the large producers do not outperform Gold on a consistent basis. The law of numbers combined with the difficulty of the mining business explains why.

Our junior/small cap index consists of 20 stocks equally weighted with a median market cap of about 600 Million. In the second half of 2010 the market broke to new highs for the first time since 2007. With every breakout comes a retest. Heading into 2011 we predicted the retest would last into the summer. The retest lasted the entire year but appears to be successful.

gold-stocks-28-1

Our bet is that the small caps will work their way back to the high before the end of the summer. It will take the time to overcome resistance but the trend will remain higher. If and when the market makes a new all-time high it will be very bullish for several reasons. It would be the first sustained breakout to a new all-time high since 2005-2006. It would come at a time when the bull market is starting to transition out of the wall of worry phase. Finally, it would generate significant momentum when overhead resistance is basically nil.

This is possible due to a combination of Gold rising and present low valuations improving. In the next chart we graph our index and the ratio of our index to Gold. Gold companies are generating record profits and the price of Gold is near its all-time high yet leveraged small caps are trading near a low relative to Gold. That, in our view is a function of market sentiment and evidence of the wall of worry stage.

gold-stocks-28-2

f the ratio would rise back to its 2007 and 2010 highs at 0.065 and Gold would reach $2000, our small cap index would just about double. That is right, a potential 100% gain.

The bottom line is small cap gold stocks have completed a textbook breakout and retest. As we said, the market will likely have a hard slog for the next several months as it encounters supply from the 2011 correction. If and when the market nears its old high it will have built up the necessary strength and momentum to embark on an explosive breakout. Thus, now is the time to be doing your due diligence to find and research those candidates to lead the market in a potential rip roaring move into 2013.



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