Interesting Article on Russel 2000 and top 100 companies

[Running_Man]

https://www.thestreet.com/investing/stocks/will-the-real-pe-ratio-please-stand-up-14923577

I found in this article interesting informatino on the Russell 2000 that over 600 companies make no money, and if you take the earnings of all the companies divided by market cap you get PE of over 75, but if you do what ISHARES does you ignore the 671 out of 2000 companies that have no earnings to get PE of 17.

Even more interesting is from 1975 to 1995 small cap stocks (stocks other than 100 biggest) earned roughly one half of the total earnings of all companies in the US. Now the top 100 earn 84.2% of all money earned by publicly trading companies.

 

[Spock]

There was another article last week on how stock buy backs have twisted various traditional stock metrics.

Say you earn $1 in year 1 and $1 in year 2.
Earnings are flat.
But because you shrank your float via buybacks you can claim earnings growth.
$1 over 1 share = EPS of 1
$1 over 0.9 shares = EPS of 1.11
Look: 11% earnings growth. Magic.

And then it gave Apple as an example:

“With flat net income, the purchase of a net 1.2 billion Apple shares means that per-share earnings are slated to rise from $9.22 in fiscal 2015 to $11.51 this year”.

https://www.zerohedge.com/news/2019-08-10/do-investors-realize-how-much-risk-theyre-taking

 

[OldShooter]

There was another article last week on how stock buy backs have twisted various traditional stock metrics. ...

In the eye of the beholder, I guess. The whole point of buybacks (instead of dividends) that that the value of the remaining shares is increased. So of course EPS will go up.

The buyback does, however, make year-over-year comparisons of various parameters more difficult. I'm not sure I see that as "twisted," implying nefarious. It's just arithmetic.

The eyebrow-raising comes from the moral hazard where people holding options are making the buyback decisions. I just heard a radio piece where some liberal was sputtering about this (Bernie, IIRC) without recognizing that the managers usually hold a very small percentage of the float. So while they may benefit, the benefit to the rest of the shareholders may be enough to justify the decision.

 

[NW-Bound]

There was another article last week on how stock buy backs have twisted various traditional stock metrics.

And then it gave Apple as an example:

https://www.zerohedge.com/news/2019-08-10/do-investors-realize-how-much-risk-theyre-taking

Yes, the EPS growth by shrinking the shares with buyback is not the same as organic growth by the company being able to expand its business. Eventually, the company runs out of cash to buy back stocks, and that's when the music stops. I remember that GE did a lot of stock buyback too.

I have never owned Apple stock, but the above info is interesting. So, I looked into some basic fundamentals and saw that Apple's gross sales increased by 13.6%, from 2015 to 2018. Net earnings grew by 11.5% in that period.

How does that compare to the share price? It almost doubled from 2015 to 2018. Nice! I wonder what the market cap was. Due to stock buy back reducing the number of shares, the market cap would not double, and that alleviates the risk somewhat. But I am sure the market cap increased by a lot more than the 11.5% increase in earnings.

Thus, the observation in the above article:

“With flat net income, the purchase of a net 1.2 billion Apple shares means that per-share earnings are slated to rise from $9.22 in fiscal 2015 to $11.51 this year”.

What’s that mean for investors? Well, you’re paying a near double premium in share price for a company that hasn’t grown earnings in 4 years. That’s called multiple expansion. $AAPL’s forward earnings multiple in 2015 was 11-2, now it’s near 17.

 

[NW-Bound]

https://www.thestreet.com/investing/stocks/will-the-real-pe-ratio-please-stand-up-14923577

I found in this article interesting informatino on the Russell 2000 that over 600 companies make no money, and if you take the earnings of all the companies divided by market cap you get PE of over 75, but if you do what ISHARES does you ignore the 671 out of 2000 companies that have no earnings to get PE of 17.

Even more interesting is from 1975 to 1995 small cap stocks (stocks other than 100 biggest) earned roughly one half of the total earnings of all companies in the US. Now the top 100 earn 84.2% of all money earned by publicly trading companies.

Now, I feel better that there's an explanation for why small caps have been trailing the S&P so badly. And part of the split was because large caps also buy back their stocks to boost their shares even more.

Aye, aye, aye...

 

[NYEXPAT]

All the more reason I am triple short $SPX,EEM and IWM and will sleep like a baby!

 

[NW-Bound]

All the more reason I am triple short $SPX,EEM and IWM and will sleep like a baby!

Well, you can be right but too early.

 

[NW-Bound]

Looking at another huge company for a comparison with Apple, I saw that between 2015 to 2018, Intel gross sales grew by 28%, while net earnings grew by 85%.

Intel P/E is still a measly 11.

 

[NYEXPAT]

Well, you can be right but too early.

I don't think there is any question that I am to early! I closed out my prior shorts (ex. $spx at 2840, the other day) Today, I reloaded at 2888 with a target of 2820. If we break thru 2890 next week, I will be stopped out at today's high. If we get that impulsive wave next week over 2890 the market will top out around 2950 and I will be reloading just under that level. However if we break below 2865, we will drop to 2820 and rally again. Shorting the rally from 2820 back to the 2855 level is where the real money is as we will likely trade down to the mid 2600 LVL.

By to early, most of the Pro's will not do this trade and will wait to see if we hit the 2820 LVL before shorting with leverage on the subsequent rally.

 

[Spock]

In the eye of the beholder, I guess. The whole point of buybacks (instead of dividends) that that the value of the remaining shares is increased. So of course EPS will go up.

The buyback does, however, make year-over-year comparisons of various parameters more difficult. I'm not sure I see that as "twisted," implying nefarious. It's just arithmetic.

The eyebrow-raising comes from the moral hazard where people holding options are making the buyback decisions. I just heard a radio piece where some liberal was sputtering about this (Bernie, IIRC) without recognizing that the managers usually hold a very small percentage of the float. So while they may benefit, the benefit to the rest of the shareholders may be enough to justify the decision.

I wasn't intending "twisted=nefarious", but more of a way that results are skewed without either the sender nor the receiver being aware as in reporting the year-over-year comparisons you noted. The magnitude of the buybacks now days is distorting the comparisons.

 

[USGrant1962]

Yes, the EPS growth by shrinking the shares with buyback is not the same as organic growth by the company being able to expand its business. Eventually, the company runs out of cash to buy back stocks, and that's when the music stops.

This isn't exactly true. Any company that is making a profit (cash) can do one of three things with that cash - retain it, distribute it to shareholders via a dividend, or distribute it to shareholders via stock buyback. Lots of companies will never run out of cash to buy back shares.

The second and third are economically identical from the company's perspective. Except that the dividend usually creates an expectation of future dividends (except in the relatively rare case of a special dividend) while share buybacks do not. They are not identical from an individual shareholder perspective, but are identical from a "total shareholders" perspective.

I agree that share buybacks are distorting the market compared to the past, but I'm not convinced it is a problem. It is simply a slightly different way for the market to operate than was customary in the past.

 

[OldShooter]

This isn't exactly true. Any company that is making a profit (cash) can do one of three things with that cash - retain it, distribute it to shareholders via a dividend, or distribute it to shareholders via stock buyback. Lots of companies will never run out of cash to buy back shares.

The second and third are economically identical from the company's perspective. Except that the dividend usually creates an expectation of future dividends (except in the relatively rare case of a special dividend) while share buybacks do not. They are not identical from an individual shareholder perspective, but are identical from a "total shareholders" perspective.

I agree that share buybacks are distorting the market compared to the past, but I'm not convinced it is a problem. It is simply a slightly different way for the market to operate than was customary in the past.

+1

Buybacks are more tax-efficient and they do not set a precedent that declaring or increasing a dividend might. I guess you could use the word "distort," but any special P&L items or uneven YOY earnings also "distort" simple ratio calculations.

 

[NW-Bound]

I was spurred to spend a few minutes to look into Apple's fundamentals due to this thread. As mentioned earlier, I have never been an Apple shareholder and missed out on its wonderful rise ever since the original iPod (with hard drive) was sold.

TTM Revenue on 6/30/2015: $224,337B
TTM Revenue on 6/30/2019: $259,034B

TTM Net Income on 6/30/2015: $50,737B
TTM Net Income on 6/30/2019: $55,695B

The revenue increased 15% in 4 years. The net income increased 10% in 4 years, just a bit more than inflation.

If everything stays the same, then a fair value of the company should also increased with inflation. Share price was $125 in 2015, and $207 now. That's a 66% increase, not 10%. Of course, there's the buy back, so the price should be higher. But how much higher?

The number of outstanding shares was 5.773B on 6/30/2015, and 4.601B on 6/30/2019. The number of shares has shrunk to 0.8x of the previous number.

Then, the price of the share should be 1.10 x 1.25 = 1.375x, or 38% increase and not 66%.

If we look at the EPS (earning per share), it indeed has gone up by that 38%, instead of the 10% due to profit. Investors might look cursorily at that 38% EPS increase and thought that the company business is still growing, and award the company with a higher P/E ratio. That P/E expansion drives the stock price higher than it would have grown otherwise without the buyback.

I have not looked up how much Apple spent to buy back 1.172 billion shares in the last 4 years, but if we take the average price between the endpoints, the dollar amount is a staggering $195 billion.

This works out so well, hence Apple announced in May 2019 that it would buy back another $75B worth of shares. That is significantly more than their net earning in a year.

 

[NW-Bound]

I just looked at Intel for a comparison, using numbers over the same period.

TTM Revenue on 6/30/2015: $55.251B
TTM Revenue on 6/30/2019: $70.386B

TTM Net Income on 6/30/2019: $11.676B
TTM Net Income on 6/30/2019: $19.746B

The sales increase was 27%, and the net income increase was 69%. Both are more impressive than Apple numbers.

Intel also bought back stocks, but to a lesser degree. Outstanding shares decreased from 4.909B to 4.525B. The ratio is 0.92x, compared to Apple 0.8x.

If price/revenue stayed the same, then Intel share price should go up 1.27/0.92 = 1.38x.

I don't know if Intel had some special one-time things to boost earning, but if we use the net income ratio, then the share price should go up 1.69/0.92 = 1.84x.

Intel actual share price went up 1.42x. That compares favorably with the price/revenue of 1.38x above.

 

[copyright1997reloaded]

Yes, the EPS growth by shrinking the shares with buyback is not the same as organic growth by the company being able to expand its business. Eventually, the company runs out of cash to buy back stocks, and that's when the music stops. I remember that GE did a lot of stock buyback too.

I have never owned Apple stock, but the above info is interesting. So, I looked into some basic fundamentals and saw that Apple's gross sales increased by 13.6%, from 2015 to 2018. Net earnings grew by 11.5% in that period.

How does that compare to the share price? It almost doubled from 2015 to 2018. Nice! I wonder what the market cap was. Due to stock buy back reducing the number of shares, the market cap would not double, and that alleviates the risk somewhat. But I am sure the market cap increased by a lot more than the 11.5% increase in earnings.

Thus, the observation in the above article:

You are cherry-picking the starting date on Apple in terms of PE ratio. Apple's PE ratio was as high as 38X in late 2007, fell to 12X at the depths of the great recession, climbed after that but started falling again in 2013/2014. As is typical, some of a stock's PE is market based, i.e. compare Apple's PE ratio to the SP500. Some of the increase in Apple's PE is the perception that services revenues are becoming more important, this theoretically lessens the risk because there is less chance of a severe revenue decline due to a botched product cycle, and also because services revenue is generally recurring.

Disclaimer/Bias warning: Apple is my largest single-stock holding.

 

[NW-Bound]

I used 2015 because that was the date that the linked article used. I never even followed Apple stock, and simply looked for further info to check out the article statement. I saw that Apple business has not grown much for the last 4 years.

Out of curiosity, I looked at a couple of utility companies, which are slow-growth business that expand simply with population growth. I have not owned shares of these companies directly for a few years.

Duke Energy: From 2015 to 2019, revenue growth of 12%, earning growth of 17.6%, P/E of 20
Southern Company: From 2015 to 2019, revenue growth of 23%, earning growth of 107%, P/E of 13.7

PS. Perhaps Apple was undervalued in 2015, and fairly valued now. I guess that's not bad, but one should not expect the shares to keep climbing unless they find a way to grow.

 

[OldShooter]

... This works out so well, hence Apple announced in May 2019 that it would buy back another $75B worth of shares. That is significantly more than their net earning in a year.

I wouldn't expect buyback funds to necessarily bear any relation to current earnings. I don't follow this stuff closely, but IIRC Apple had a huge pile of cash parked outside the US and there was a recent tax bill that reduced taxes/encouraged US companies to repatriate cash. I'd guess that is the source of the cash. And, in theory at least, they kept cash that they felt that they could invest profitably and only used excess cash to fund the buyback(s).

In the long view, the only major sources of cash are earnings, depreciation, and liquidation of assets. The overseas cash presumably came mostly from past overseas profits.

 

[NW-Bound]

I wouldn't expect buyback funds to necessarily bear any relation to current earnings.

No.

But if you are using your cash hoard to buy back shares to boost stock prices and you are spending more than the earnings, eventually you will run out. You cannot keep on doing this forever.

 

[Running_Man]

I wouldn't expect buyback funds to necessarily bear any relation to current earnings. I don't follow this stuff closely, but IIRC Apple had a huge pile of cash parked outside the US and there was a recent tax bill that reduced taxes/encouraged US companies to repatriate cash. I'd guess that is the source of the cash. And, in theory at least, they kept cash that they felt that they could invest profitably and only used excess cash to fund the buyback(s).

In the long view, the only major sources of cash are earnings, depreciation, and liquidation of assets. The overseas cash presumably came mostly from past overseas profits.

Profits by large multinationals are earned in countries with lowest tax rates set up with royalty agreements, inventory agreements and technology transfer agreements and then charged through inter-company accounts. The cash basis can be earned anywhere and when inter-company accounts are settled a company only needs a treasury inter-company to set up loans to lend money anywhere across the world and document in the currency they want to, earning more money in interest from the low tax country and tax deductions in countries like the United States.

The financial statements any investor sees is with intercompany transactions eliminated so it looks like money is trapped.

Cash is NEVER trapped overseas and NEVER needs to be repatriated if the company does not want it to, you just set up a loan program. If a country needs more income you lower royalty or interest rates or change intercompany agreements. To have a very good one drawn up that survives audits costs about 6-8 million from any large accounting firm that will survive US audits.

 

[NW-Bound]

On the subject of stock buyback, I just looked at Home Depot because it just released quarterly earning report yesterday. The result was good, and stock price jumped.

HD has been on an aggressive stock buyback program. From 2.138 billion shares outstanding in 2005, it is now down to 1.106 billion in 2019. The only time they paused the share buyback was during the 2007-2009 recession. They retired almost 1/2 of the shares. Very impressive.

EPS (earning per share) has gone from $2.58 to $9.92, for a 10%/year average growth. Impressive!

But what is this measly sales increase from $79B to $110B? That's just 2.3%/yr increase, barely matching inflation.

Something interesting here. Did they get a huge earning increase from higher efficiency and better management? OK, gross profit increased from 26.5B to 37.6B, a 2.3%/yr increase. Hah!

If profit and revenue barely grow to match inflation, where's the cash to buy back stock? They borrowed money?

Let's look at the balance sheet. Ah hah! Total liabilities increased from 14.9B to 45.9B. while total assets did not keep up with inflation.

Result: shareholder equity has gone from 24B to -2B. Yes, it's now negative. The EPS looks wonderful though.

Very interesting!

 

[triangle]

https://www.thestreet.com/investing/stocks/will-the-real-pe-ratio-please-stand-up-14923577

.......

Even more interesting is from 1975 to 1995 small cap stocks (stocks other than 100 biggest) earned roughly one half of the total earnings of all companies in the US. Now the top 100 earn 84.2% of all money earned by publicly trading companies.

I am curious how mergers and acquisitions have affected this statistic. I remember being shocked decades ago when Exxon merged with Mobile. In every industry there has been a lot of consolidation, so much that it begins to stifle competition IMO. As compared to 1996 there are half as many companies listed on US stock exchanges.