• What Should a Company Do With Excess Cash?

    What should a company do with excess cash?


    It could (a) pay dividends, (b) buy back its own shares, or (c) sit on it.


    CNBC lists some cash-rich companies in this slide show, including Diamond Offshore (DO) with $1.24 billion, MetroPCS Communications (PCS) with $2.24 billion, and Gilead Sciences (GILD) with $9.9 billion.  


    From a Seeking Alpha article by Robert Broens (27 Feb 2012):


    While consumers and governments across the world are strapped for cash, corporations have plenty. Rather than signal long-term trust and pay more generous long-term oriented dividends, many of them have adopted share repurchases to buy back their own stock.


    Investors welcome these announcements as they boost earnings per share and provide a lot of support for the share price during the repurchase periods.


    … Cash-rich companies still refuse to significantly raise long-term dividends, which could send a powerful long-term trust signal. Rather, they use one-time repurchase agreements with far less signaling power as a dispersion tool of excess cash to its shareholders.


    For discussion:


    Select one of the companies identified as a cash-rich company by CNBC in the slide show above.  How does it compare in terms of liquidity and profitability with other firms in its industry? How does it compare with the market overall?


  • Who's To Blame for Rising Gasoline Prices?

    Oil prices drive gasoline prices.

    U.S. Crude Oil has increased in price by 40% since October, but gasoline has increased by only 9%.  Though gas prices haven’t risen as much as oil prices, they are still up. Folks are looking for someone to blame, and everyone likes to blame speculators.


    According to T. Boone Pickens, anyone blaming speculators is uninformed. He believes that investors are concerned because of the increased global demand and the “potential” loss of 2 million barrels of oil a day if Iran shuts down the Strait of Hormuz like they are threatening to do. 


    For discussion:


    1.      Who are the participants in the oil market?

    2.      What is the difference between speculators and hedgers?

    3.      Why would speculators be blamed for rising gasoline prices?


  • Berkshire Hathaway's Upcoming Letter to Shareholders

    Warren Buffett, Berkshire Hathaway’s legendary CEO, is scheduled to deliver his annual letter to shareholders tomorrow. And investors are expecting him to come clean about any investment mistakes this past year. 


    According to Bloomberg (24 February 2012)


    Buffett’s self-criticism is part of a leadership style that has helped him build a company with 270,000 workers and draw crowds of more than 20,000 to hear him speak. Buffett, 81, who’s scheduled to release his annual shareholder letter tomorrow, relies on his public persona as well as his record to set standards for Berkshire staff and retain investors in good years and bad.


    Buffett, a former hedge-fund manager, boosted Berkshire with stock picks like Coca-Cola Co. (KO) and takeovers including insurer Geico Corp. Berkshire shares soared about 38-fold in the last 24 years and Buffett’s fortune surged to third-biggest in the world. The company trades at about 1.2 times book value, indicating that investors believe the firm is worth more than its net assets.


    The Class A shares slipped 4.7 percent last year amid a surge in insurance catastrophe costs and questions about Berkshire’s succession planning. Berkshire’s profit declined 16 percent to $7.2 billion in the nine months ended Sept. 30, and Buffett was criticized in the media for his handling of the resignation of former manager David Sokol.


    For discussion:


    ·       Go to http://www.berkshirehathaway.com/letters/letters.html and read the most recent letter to shareholders.  How does Mr. Buffet describe the performance of Berkshire Hathaway?


    ·       In your opinion, would you invest in Berkshire Hathaway stock? Why or why not?


  • Netflix Competition

    Netflix (Nasdaq: NFLX) is facing competition from Comcast and from Verizon. Comcast has announced a new streaming service that is available to subscribers only for now, but may be something that will win the hearts of Netflix customer.  And as for Verizon, it teamed up with Red Box to provide a new streaming service that will also rival Netflix. 


    According to the video above, though Netflix has added subscribers, it remains to be seen whether they can hang on to those customer.  The final word from this video is “stay tuned.”


    For discussion:

    •  What trend has Netflix stock displayed recently?
    • In your opinion, what does the future hold for Netflix? Would you invest in this stock? 
  • Is Apple's P/E Ratio Too Low?

    Photo of Apple store, Upper West Side, New York City courtesy of http://www.apple.com/pr/products/apple-retail-stores/apple-retail-stores.html



    Apple shares (Nasdaq: AAPL) closed at $513 per share today, which is 14.6 times earnings. With a price to earnings (P/E) ratio so low, some suggest that Apple shares are too cheap.


    According to Bloomberg’s Jonathan Weil (16 Feb 2012):


    Many theories have been floated for why such a rapidly expanding company with such loyal customers would trade for so little. Perhaps investors believe Apple will cling to its $97.6 billion hoard of cash and marketable securities, rather than pay a fat dividend. Others have suggested a lack of confidence about the future. It’s a consumer-electronics company, after all, and competition is brutal.


    While each of those points has merit, here’s an explanation that hasn’t gotten enough attention: Thanks to an accounting- rule change for which it lobbied, Apple gets to book revenue from sales of bundled products such as iPhones -- which include hardware, software, services and upgrade rights -- more quickly than it used to. In short, one reason Apple’s earnings have been so high is accounting inflation, and the market realizes this.


    So what are we to conclude? Is AAPL undervalued or overvalued? Perhaps the explanation is that investors are not fooled by accounting complexities. Perhaps at the end of the day a P/E ratio of 14.6 is neither too high nor too low. Maybe it is just right.


    For discussion


    How would you determine the appropriate P/E ratio for a firm? If the P/E ratio is too low, would you buy or sell the shares of stock?



  • An I.P.O. for the Average Joe?

    Initial public offerings (IPOs) are a tremendous source of income to investment banks and offer profit potential to investors who are lucky enough to get their hands on the newly issued shares. Not all investors are that lucky, and Jim Koch, the founder of the Boston Beer Company which makes Samuel Adams beer, decided to do something about that when his company went public in 1995.


    According to the NY Times (18 Feb 2012):


    As Mr. Koch saw it, when an I.P.O. is controlled by investment banks, it is structured “to reward the banks and their favored institutional investors” and not the fledgling business or its customers. He realized that he “wasn’t comfortable letting Wall Street underwriters control the process, set the price and allocate the shares to their favored clients at a favorable price.”


    Instead, he said: “I wanted to take care of my Sam Adams drinkers. They were the people who were really important to me and who were going to continue to be.”


    So he improvised, hanging fliers on six-packs of beer that very carefully informed customers that they might be able to buy $500 worth of shares in an eventual public offering. “We were limited to what you could manage to say on a six-pack, and also by what the lawyers would let us say,” he recalls.


    “The laws and regulations were set up to make this kind of thing very difficult,” he says. “But I had a strong feeling that we should do this.”


    He sold shares at two prices. Some went to his customers, who, in a startling reversal, got a better deal than Wall Street insiders: $15 a share for the customers, versus $20 for those who bought at the opening price in a public offering run by Goldman Sachs.


    Little did he realize the demand that his customers would show. Instead of the 30,000 estimated buyers, “more than 100,000 would-be-shareholders sent in checks.” Mr. Koch used a lottery to select the shareholders and then returned the remaining checks.


    Turns out that it was a good investment for the lucky 30,000 customer-shareholders. Today, Boston Beer Company shares (NYSE: SAM) closed at $104.58 per share.


    For discussion:


    ·        What is the “modified Dutch auction” that was developed after the Boston Beer Co. I.P.O.?


    ·        According to the article, what I.P.O. method is Facebook likely to use?



  • New Lender for Small Online Businesses

    Small, online businesses who can’t borrow money from traditional bank have a new source of working capital: Kabbage. 


    Kabbage.com provides short-term working capital loans to small businesses based on their eBay or Amazon sales. Some might say that online lending to small businesses is risky because the lender doesn’t meet the borrower face to face. But Rob Frohwein, founder and CEO of Kabbage.com, disagrees. He believes that Kabbage knows its customers better than anybody because they rely on online sales data to make the lending decision.


    What if you have a great idea for a small business and want to sell your product on eBay and Amazon? Though you may not need an enormous amount of capital to get started, you probably need some capital. Now you too can get the cash your business needs to grow.


    For discussion:


    ·        What is the borrowing cost for the typical Kabbage customer?


    ·        What benefits does Kabbage offer clients?


  • Dodd-Frank: Will the Harm Outweigh the Good?

    The Economist (18 February 2012) describes the Dodd-Frank Act as “Too big not to fail” because the added costs and complexity imposed on the financial system may outweigh the risk-reducing benefits of the regulation.

    According to the article, the Dodd-Frank is a “mammoth law” compared to all prior bank regulations:

    Ø 1864 National Bank Act: 29 pages long

    Ø 1913 Federal Reserve Act: 32 pages

    Ø 1933 Glass-Steagall Act: 37 pages

    Ø Dodd-Frank: 848 pages

    From the article:

    When Dodd-Frank was passed, its supporters suggested that tying up its loose ends would take 12-18 months. Eighteen months on, those predictions look hopelessly naive. Politicians and officials responsible for Dodd-Frank are upbeat about their progress and the system’s prospects, at least when speaking publicly. But one banker immersed in the issue speaks for many when he predicts a decade of grind, with constant disputes in courts and legislatures, finally producing a regime riddled with exceptions and nuances that may, because of its complexity, exacerbate systemic risks rather than mitigate them.


    For discussion:

    Based on the Economist article cited here, what are some of the problems that are likely to be caused by the complexity of the law, that is, in addition to the costs of compliance?


  • What Will Help the Mortgage Market?

    In this interview with Wells Fargo’s CEO and JP Morgan’s Head of Mortgage Business, CNBC’s Mary Thompson identifies a couple of steps that may help revive the mortgage market:


    ·       First, the $26 billion foreclosure settlement is expected to “put money in state’s pockets and people’s pockets.” This is obviously not a fix-all, but it’s a start.


    ·       Second, a “concerted effort by government, investors, and banks” to rent foreclosed properties and take them off the market.


    Though these steps are not the perfect cure for what ails the mortgage market, these mortgage experts suggest that they are a start.


    For discussion


    How will is the foreclosure settlement expected to help the mortgage market?



  • GM Makes Progress but Not Yet at Sustainable Growth Levels

    With fourth quarter earnings only a penny or so below estimates, GM seems to be making progress. According to the interview with GM’s CFO, Dan Ammann, GM has “a lot more work to do in the business, a lot more work to do in Europe, more work to do in South America, more work to do all across the company.”


    Despite a loss of $600 million in Europe in the fourth quarter, GM reported a 2.9% profit margin in the fourth quarter and 5.5% for the full year.  In order to be competitive in the long-run, however, profit margins will need to grow to 9 or 10%.


    According to GM’s press release:


    “In our first full year as a public company, we grew the top and bottom lines, advanced our global market share and made strategic investments in our brands around the world,” said Dan Akerson, chairman and CEO.  “We will build on these results as we bring more new cars, crossovers and trucks to market, and make GM a far more efficient global team.  This includes reducing our break-even level in Europe and South America and driving higher revenues around the world.”


    For discussion:


    ·        From the press release, what is GM’s revenue, net income, cash flow from operating activities, and free cash flow for the 4th quarter and for the year?


    ·        Which measure is the most important measure of firm performance? Why?


  • More Criticism of the Volcker Rule

    We already know that U.S. banks aren’t happy about the Volcker Rule. And a recent post here showed that European governments aren’t thrilled with it either. Now we are finding additional opposition to this contentious section of the Dodd-Frank Act.


    The NY Times reports (15 Feb 2012):


    While Wall Street is the chief critic of the rule, which bars banks from trading with their own money, the financial industry is finding sympathy from some unlikely quarters.


    A patchwork of nearly 30 companies — from industries as disparate as retail, energy and medical research — has weighed in with their own anti-Volcker Rule sentiments. The companies, organized by the United States Chamber of Commerce, sent a letter to regulators on Tuesday that outlined their objections to a draft proposal of the rule. Goldman this week sent two letters to regulators.


    At the root of their disdain is fear. Adopting one of Wall Street’s central talking points, Corporate America is worried that the rule will suck liquidity out of the financial system, which provides financing to companies big and small.


    According to the letter sent to the SEC:


    The undersigned companies and organizations, representing a diverse range of industries, believe that the Volcker Rule will have far-reaching negative consequences that will impede our ability to raise capital and manage risk. As such, we urge regulators to refrain from implementing the rule in its current form, hold a roundtable with stakeholders representing different market participants, and re-propose the Volcker Rule to provide additional time to identify unintended consequences and craft policies to avoid them.


    The “undersigned” companies include such unlikely names as Abbot Labs, Caterpillar, Macy’s, and Safeway among others.


    For discussion:


    ·        What is the Volcker rule? Why are banks opposed to it?


    ·        In your opinion, are the objections by the firms named above legitimate or are they unfounded?


  • What are Market-Linked Certificates of Deposit?

    With interest rates near zero, savers are looking for a way to earn something on their investments. Banks are meeting this demand by creating “structured CDs” or “market-linked certificates of deposit” which are FDIC-insured CDs with returns that are linked to the performance of the stock market.  

    According to Bloomberg (14 Feb 2012):

    By tying interest rates to everything from the Dow Jones Industrial Average to precious metals, the pamphlet for HSBC’s Market-Linked Certificates of Deposits explains U.S. investors have the potential to earn “enhanced returns” over as long as seven years. A separate disclosure states that they also may earn zero, getting just their original principal back after the CD matures, while brokers may collect fees of 6 percent or more. Investors that need to get their money earlier must find a buyer for the CD, risking a loss.

    From the article:

    Sales of the investments may total $25 billion a year, Sean Gordon, who oversees distribution of market-linked CDs in the U.S. at Barclays Plc (BARC), said in a December interview. Banks sold a record 1,271 of them last year, according to StructuredRetailProducts.com, a database used by the industry, with some offering potential annual returns of as much as 24 percent by tying rates to everything from gold to Brazil’s real.

    Bank revenue from the investments more than tripled to $99 per million dollars in retail deposits in October from $30 in January, according to Kehrer-LIMRA Research compiled from approximately 30 lenders, including Wells Fargo (WFC) & Co. and SunTrust Banks Inc.

    With so many bells and whistles attached to these investments, investors are likely to be confused. Consequently, market-linked certificates of deposit are being checked out by the Financial Industry Regulatory Authority (FINRA) to be sure that they are “properly understood by investors.”


    For Discussion

    ·        According to this brochure for a market linked CD offered by HSBC, what is the investor’s upside if he/she chooses to invest in this instrument?  What is the downside?

    ·        What derivative is embedded in this market-linked CD? A call or a put?

    ·        For which types of investors is the market-linked CD appropriate?


  • Do We Need a U.S. Central Bank?

    Critics of the Fed want to see the U.S. central bank closed down for good. But if that were to happen (big “if”) then what would replace it?


    According to CNBC (8 February 2012):


    If history is any guide, having some sort of central bank may have been better than none. Out of 100 years of Fed control, the country has had 22 recessional years, including one depression. The 100 years before the Fed saw 44 recessions and six depressions.


    What's left is this: until someone thinks of a better idea than the gold standard or handing the economic keys to the Treasury Department, or just leaving a void, the Fed will probably have to stick around—flaws and all.


    To do away with the Fed, the Federal Reserve Act of 1913 would have to be repealed.  No small feat.  In the meantime, though:


    Maybe because of some political influence, the Fed has changed over the years. It's grown in power and created more critics along the way—but recently allowed a limited look inside its decision making. Some analysts believe it could do more.


    "While it may be far from easy, if not impossible to rein in the Fed," says James, "making it much more transparent in what it does would reduce the need for abolishing it and at least reduce the rumbling from critics."



    For Discussion:


    Check out the history of the Federal Reserve website here.  What events led up to the creation of the Fed? What controversies surrounded the establishment of a U.S. central bank?


  • Will the Foreclosure Deal Help the Housing Market?

    Banks accused of “robo-signing” fraudulent foreclosure documents settled with states’ attorneys general on a $25 billion settlement. According to Bloomberg:


    The agreement announced today includes $5 billion in cash for states to pay for foreclosure-prevention initiatives. Loan servicers will refinance $3 billion in refinancings to lower homeowners’ interest rates and pay about $1.5 billion to homeowners harmed by botched foreclosures.


    (Read the article here)


    Will this agreement have the desired impact? According to Bloomberg, the short term result could be an increase in the number of foreclosures in the near term:


    From the article:


    Lenders slowed the pace of foreclosures as they negotiated with attorneys general in all 50 states for more than a year over allegations of faulty and fraudulent paperwork used to repossess homes. With today’s agreement, banks are likely to resume property seizures.


    What about the long term? What will it take to fix the housing market? This agreement can’t make a house increase in value. And neither can the agreement help an out-of-work homeowner make payments on a delinquent loan. Furthermore, this agreement doesn’t apply to Fannie Mae or Freddie Mac owned loans, which are the majority of mortgage borrowers.


    Will the Foreclosure Deal Help the Housing Market?  Probably not in the short run. Maybe in the long run, but it is questionable. 



    For Discussion


    ·        According to the Bloomberg article, what is a “strategic default?” What impact is this agreement expected to have on such defaults?


    ·        According to this post from Jim Cramer, what are the primary benefits of the foreclosure deal?


    ·        In your opinion, what are the likely outcomes of the foreclosure deal?


  • What is Pre-IPO Trading?

    Facebook is credited with a relatively new phenomenon in financial markets: secondary market trading of privately-held shares of stock. The two biggest market places for pre-IPO trading are SharesPost and SecondMarket which sprang up in 2009 as a way for company employees to sell their shares of stock in spite of the fact that the company shares are not yet publicly traded. 


    Once the shares are traded publicly, investors (including employees) can then trade their shares on traditional exchanges and will no longer need the services of Second Market et.al. Consequently, Facebook will be “keenly missed.”


    According to the Financial Times (Feb 6 2012) (Read the article here)


    “There is no question that the void of Facebook will be felt dramatically in the secondary markets’ business; hugely,” said Manuel Henriquez, chief executive of Hercules Technology Growth Capital, which has bought Facebook stock on the private market. “There is no other juggernaut of that size out there.”


    Secondary marketplaces allow investors to trade common stock of private companies, giving ex-employees a way to cash-in their stock before a company’s initial public offering.


    Industry insiders in Silicon Valley have welcomed the markets as an important stepping stone for companies that are not yet ready for Wall Street, as they allow start-ups more time to grow and avoid the pressure of selling to an acquirer, while providing greater opportunities for investors as the number of IPOs has shrunk in recent years.

    For Discussion:


    ·        According to the FT article, what are some of the trading related issues that Facebook had to face in this new market?


    ·        Who are the main investors in shares sold in these secondary markets?


    ·        What other purposes do these markets provide to financial markets?


  • Betting Against Facebook

    According to Steve Sears of Barron’s, one way to gain from the new Facebook shares that will be traded will be to bet against them. We know that there are two ways to bet against a stock: one is to sell the stock short, borrow the shares from your broker, and then buy the shares back (hopefully at a lower price) and return them to the broker. This method requires that shares are available to be borrowed. 


    The second way to bet against the shares is to buy puts. 


    From the article:


    Puts, of course, give their buyers the right to sell, or "put," shares at a certain price to whoever sold the puts to them. A put's value increases as the price of the associated stock falls.


    If lots of investors suddenly want to buy Facebook puts, options dealers could be in trouble if they can't short the stock to hedge those sales. To discourage heavy put buying, the dealers are likely to effectively jack up the puts' implied volatility—the critical part of an option's price—which means that the puts would fetch a premium price and that the stock would have to move very sharply before it overtook the puts' implied volatility premium.


                (read the full article here)


    For discussion:


    ·        From the article above, why does the author think it will be difficult to short sell shares of Facebook?


    ·        What is a put option and how does it allow an investor to bet against a stock?



  • Consumer Debt Rose in December

    According to Bloomberg today, consumer borrowing increased in December, driven in part by “increased confidence in the economy.”


    From the article:


    Credit increased by $19.3 billion to $2.5 trillion, Federal Reserve figures showed today in Washington. The gain topped the $7 billion median forecast of economists surveyed by Bloomberg News and followed a $20.4 billion advance the prior month.


    (read the full article here)


    Non-revolving debt such as education and auto loans increased by $16.6 billion in December while revolving debt such as credit cards increased by $2.7 billion.


    This increase in consumer debt could indicate that consumers are optimistic about an improving job market. On the other hand, it could indicate an increased reliance on debt which may not outpace increases in income.


    For Discussion:


    What attitudes toward debt do you see among college-age students today? What about among those who are aged 30-50?


  • The Most Popular Course in Finance

    Risk management and quantitative finance courses are immensely popular on some college campuses.  According to Dennis Long, a recruiter interviewed in the video above, “Even through the crisis when head count is decreasing, risk management head count is increasing in a big way.”


    Before 2008, these are the students who would have sought jobs in financial engineering, creating the complex financial instruments blamed in part for the financial crisis.  Today, risk management is the career of choice. With starting salaries near $150,000, no wonder these jobs are so popular.


    For Discussion


    Check out http://www.wilmott.com/. What is quantitative finance?



  • Interest Rate Manipulation under Investigation

    The Swiss Competition Commission (Comco) is investigating manipulation of interest rates by 12 banks including UBS, Credit Suisse, Citigroup, Deutsche Bank, JP Morgan Chase, Societe Generale, HSBC Holdings, and the Royal Bank of Scotland (RBS), among others.


    From the statement issued today:


    COMCO has received information regarding potential unlawful agreements among banks. Specifically, collusion between derivative traders might have influenced the reference rates LIBOR und TIBOR. Furthermore, market conditions regarding derivative products based on these reference rates might have been manipulated too. Hence, COMCO has opened an investigation against UBS and Credit Suisse, as well as against more than ten foreign financial institutes and other companies.


    (Read the full statement here)


    According to the Bloomberg article by Leigh Baldwin, 3 February 2012:


    Libor is set daily by the British Bankers’ Association based on data from banks, which report how much it would cost them to borrow from each other for various periods of time. The rate is a benchmark for more than $350 trillion of financial products worldwide. Regulators in the U.S., U.K. and European Union have been examining how Libor is set.


    For Discussion:


    ·        What are LIBOR and TIBOR? How are they established?


    ·        What is the impact of the alleged manipulation on investors and financial markets?


  • Morgan Stanley Chosen to Underwrite Facebook IPO

    According to Bloomberg today, Facebook will be raising $5 billion or more in its initial public offering and has chosen Morgan Stanley as its lead underwriter.  The other members of the underwriting syndicate will include Goldman Sachs, JP Morgan Chase, Barclays, and Bank of America. 

    From the Bloomberg article:

    Getting picked for the IPO is a coup for Morgan Stanley and Michael Grimes, the global co-head of the bank’s technology investment banking unit. The securities firm won the biggest share of business underwriting U.S. initial offers by Internet companies last year, data compiled by Bloomberg show. Taking the lead on Facebook may catapult the New York-based bank to the top of the U.S. IPO league table for a third year running.

    The SEC filing for the new shares is expected as early as the close of business today.

    For Discussion:

    ·       How much in investment banking fees are the underwriters expected to generate from this IPO?

    ·       In your opinion, is Facebook a good investment or is the market headed for a new tech bubble?

    ·       What are the responsibilities of the members of the underwriting syndicate?