Back in the 1970s, with interest rates hovering above 10%,
investors could earn a lot more money by simply owning bonds
instead of stocks. Now, with interest rates at all-time lows in the
modern era, the bonds vs. stocks debate is getting turned on its
yields stuck at low levels, stocks are comparatively much more
That point has been noted by the Chief Financial Officers (CFOs) at
a wide range of blue-chip companies. These companies are
increasingly realizing that they can alter their balance sheets to
provide some much-needed support to their flagging stock prices.
And that's a buy signal you shouldn't ignore.
When leverage is appropriate
For a long time, many companies (especially in the field of
high-tech) preferred to hold lots of cash and carry no debt. High
cash balances were seen as a sign of strength in case any major
economic slowdowns forced companies to burn cash to keep afloat.
(Memories of the imploding dot-com bubble of a decade ago die
hard.) Yet as we saw in the recent economic crisis, most large tech
companies such as
Microsoft (Nasdaq: MSFT), Dell (Nasdaq: DELL)
Cisco Systems (Nasdaq: CSCO)
stayed profitable. And their massive cash balances suddenly looked
like an unnecessary precaution -- especially when that cash is
earning almost no interest.
So we're now seeing an increasing number of companies issue debt,
and that could portend some real gains for per share profits and
share prices. To boost
earnings per share (
, many of these companies are using some of their borrowings to buy
back stock. With borrowing costs so low and stocks sporting such
low multiples, the math gets pretty compelling as the following
Each of these companies has similar sales and
. While the first has $100 million in cash earning just 2%
interest, the other has spent all that cash and borrowed another
$100 million at a 4% interest rate in order to buy back $200
million in stock. That move has helped to boost earnings per share
by more than +20% as the share count has fallen even faster than
Buyback Benefits --
|Shares Outstanding (in millions)
|Earnings Per Share
|*figures in $ millions
That's precisely what
is doing these days. As I wrote back in May:
"(An) improving profit trend led management to embark on plans to
issue debt simply to buy back stock. The $625 million plan,
announced last month, could reduce the share count -15% by the end
of next year. There is a precedent: buybacks reduced shares
outstanding by an average of -10% in 2006, 2007 and 2008. Put
another way, shares outstanding, which stood at 197 million in
2006, could fall below 140 million by the end of next year."
A Toy Maker That's Minting Profits
A bond bonanza
Just this week, U.S. companies have issued more than $50 billion in
debt, according to Standard & Poor's. Demand for these bonds is
very strong, as rates are low enough to be enticing for bond
issuers and high enough to provide a better return than
or government bonds. Healthcare firm
was able to issue 10-year bonds with a
of just 3.375%.
Home Depot (
just sold $1 billion in bonds at an interest rate below 4%. What
will the home improvement chain do with the proceeds? Buy back
stock, just as it has before. The retailer had 2.3 billion shares
outstanding in 2004. Six years later, the share count has dropped
by 700 million, thanks to ongoing buybacks. That's a sure-fire way
per share, and why many expect the company to post sharply higher
when the housing market is finally back on track.
As companies decide to hang on to less cash, they are increasingly
looking to buy back stock. August saw a flurry of new buyback
announcements, highlighted by a $10 billion announcement from
. In addition,
Intuit (Nasdaq: INTU), VeriSign (Nasdaq: VRSN)
Discovery Communications (Nasdaq: DISCA)
all announced buybacks of at least $1 billion last month, with many
more companies announcing smaller buybacks.
announced plans to buy back $2 billion in stock, which is going to
help boost per share profits at a fast pace, as I noted in this
This Company is Raking in the Cash
Action to Take -->
Look for this trend to continue. For a long time, investors
assigned little value to excess cash sitting on the
. But if you come across companies with lots of cash and a
depressed stock price, then a buyback may be in the offing.
Companies with small amounts of debt that have room to take
advantage of low rates and issue more debt could make a similar
move. Use the exercise above to figure out what earnings per share
would look like if your investment targets sought to buy back
stock. If the results are intriguing, then it's a good reason to
think about pouncing on the shares.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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