The Federal Reserve is going to print more paper dollars, likely beginning shortly after the November elections. The estimates from the folks in the know is a minimum of $500 billion to $1 trillion. The U.S. economy is currently around $14 trillion and public debt is around $12 trillion - so a trillion in freshly printed greenbacks is not small potatoes. Recent comments from the likes of Federal Reserve Vice Chairman Dudley and the recently released FOMC meeting minutes all but assure that the Federal Reserve will act soon and in size. The September/October stock market rally is telling us as much.
Will quantitative easing(QE2) more effectively stimulate consumption the second time around? After all, the Federal Reserve is estimated to have bought $1.5 trillion in bonds and mortgages between 2008-2010 during the first money printing exercise. Nevertheless, and despite $860 billion in fiscal stimulus thrown in by Congress, final demand grew at only a 1.3% rate in the first four quarters of recovery.
Although the public might not fully appreciate it, the Federal Reserve is boldly going where no central bank has gone before - and the unintended consequences could be disastrous. But what exactly is the Fed trying to accomplish with its radical departure from orthodox central banking? According to a Goldman Sachs report covering a Q&A session with Vice Chairman Dudley, successfully pushing interest rates down will allow those who are able to borrow to do so at lower rates, freeing up some of the income now being spent on debt service. Perhaps more importantly, QE2 will work on other elements of financial conditions, including equity prices and the exchange rate.
And there you have it. QE2 is intended to push the U.S. stock market higher and the dollar lower. The Federal Reserve is targeting the stock market and the dollar... and the smart money knows it, which goes a long way in explaining the recent stock, gold, and commodities rallies. Furthermore, Wall Street investors are also front running the Federal Reserve in the bond market, pushing rates lower without help from the Fed, but with the understanding that the Fed has their backs. (Not coincidently, the Federal Reserve began to signal its intention of carrying out another dollar debasement campaign in early September, just as the S&P 500 looked ready to test the early July low at 1003.)
But what could go wrong? Well first, it is possible that the Federal Reserve QE2 program will be smaller than expected, which would likely result in a bond market sell off. Rising rates could quickly end the stock and commodities market rallies as an already sluggish (contractionary?) economy reacts poorly to a higher interest rate environment. Conversely, the Fed may move HUGE and actually succeed in pushing interest rates down to the point where a falling dollar begins to generate significant inflation. In the latter case, you can expect interest rates to once again start to rise as inflation takes hold. Private bond investors will run for the exits, once again front running the Federal Reserve (with its now even bigger inventory of government bonds).
Who will the Federal Reserve sell to in order to reverse its successful inflation generating policy? What private investor is foolish enough to step in front of that kind of supply? Not the Chinese, who've let Washington know in no uncertain terms that they are opposed to another round of dollar debasement. Yet, unless the Federal Reserve can find a willing buyer for its trillions in bonds, it can not start to drain money from the economy and prevent inflation from ripping out of control. Unfortunately for stock investors, the second scenario will also likely lead to a stock market sell off due to the negative impact rising inflation and interest rates will have on the economy.
All in all it seems to us that investors would do well to sell into the current stock, bond, and commodities market rallies, locking in profits and preparing for a better buying opportunity down the road. Biechele Royce Advisors continues to hold higher levels of cash than normal in its client accounts because we continue to struggle to find good businesses available at great prices.
(Fun Fact: The U.S. stock market has now lost about 80% of its value in gold since the secular bear market began in March of 2000. We see the trend continuing.)
Monday, October 11, 2010
Monday, September 13, 2010
Debt, Inflation, and Governments
The S&P 500 may motor higher if the Federal Reserve implements an aggressive Quantitative Easing program as is increasingly likely. The July bottom may hold and the S&P 500 may take another run at the April 1219 high. Or perhaps the Federal Reserve will wait too long and the combination of a weakening economy and (still) overpriced market will lead to further selling, taking the S&P 500 back to a three digit number in coming months. Predicting short term market movements is a difficult task at best, in part because policy decisions yet to be made can greatly influence the market's path. For the record: we are of the opinion that the probabilities favor a sell off back below 1000 as the market digests the implications of a weakening economy and weaker than expected corporate profits. However, we are far more confident about our prediction of rising inflation in the years to come...
Next year the Federal Government is expected to spend approximately $3.8 trillion, exactly twice as much as the 2001 budget of $1.9 trillion. Amazingly, the federal government has managed to double its size in just one decade. Further, the U.S. has almost doubled its national debt in just the past 7 years. It now totals almost $120,000 per taxpayer. Unfunded liabilities, such as social security and medicare, equate to approximately $355,400 per U.S. citizen. Clearly the United States will default on some of its obligations because there isn't any way that every man, women and child in the United States of America can generate that amount of cash in time to meet all of those obligations as they come due!
But the form of default is critical because it determines who bears the burden, since not all defaults are created equally. For instance, the U.S. government could choose to default on its public debt, leaving foreign governments and U.S. bond investors holding the bag while John Q. Public escapes unscathed. Another option is for the government to renege on some of its social security and medicare promises by curtailing benefits, which means the elderly and poor would bear the brunt of the default. Or the government could decide to let inflation run wild, thus devaluing ALL of the debt it owes to everyone. Savers bear the brunt of this defacto default while debtors cheer (paying debt back with cheaper dollars is much easier to do).
It should be obvious which option is easiest politically. And in fact, inflation has always been the choice of every government everywhere throughout recorded history when too much debt was accumulated. The Federal Reserve has ballooned its balance sheet from $850 billion to $2.3 trillion in the last year or so and will likely explode it again to around $4 trillion over the next year if QE2 is implemented, as is increasingly likely. What is highly unlikely is that the same Fed who failed to see the tech and housing bubbles form, will successfully pull off what amounts to a high wire artist performing without a safety net... blindfolded... as it attempts to siphon all of that extra cash back out of circulation once it deems the economy rescued....
Biechele Royce Advisors continues to overweight non dollar and real assets and under weight fixed income and financial assets. We also continue to strongly prefer dividend paying stocks, which make up the bulk of a stock investor's return in secular bear markets....
Next year the Federal Government is expected to spend approximately $3.8 trillion, exactly twice as much as the 2001 budget of $1.9 trillion. Amazingly, the federal government has managed to double its size in just one decade. Further, the U.S. has almost doubled its national debt in just the past 7 years. It now totals almost $120,000 per taxpayer. Unfunded liabilities, such as social security and medicare, equate to approximately $355,400 per U.S. citizen. Clearly the United States will default on some of its obligations because there isn't any way that every man, women and child in the United States of America can generate that amount of cash in time to meet all of those obligations as they come due!
But the form of default is critical because it determines who bears the burden, since not all defaults are created equally. For instance, the U.S. government could choose to default on its public debt, leaving foreign governments and U.S. bond investors holding the bag while John Q. Public escapes unscathed. Another option is for the government to renege on some of its social security and medicare promises by curtailing benefits, which means the elderly and poor would bear the brunt of the default. Or the government could decide to let inflation run wild, thus devaluing ALL of the debt it owes to everyone. Savers bear the brunt of this defacto default while debtors cheer (paying debt back with cheaper dollars is much easier to do).
It should be obvious which option is easiest politically. And in fact, inflation has always been the choice of every government everywhere throughout recorded history when too much debt was accumulated. The Federal Reserve has ballooned its balance sheet from $850 billion to $2.3 trillion in the last year or so and will likely explode it again to around $4 trillion over the next year if QE2 is implemented, as is increasingly likely. What is highly unlikely is that the same Fed who failed to see the tech and housing bubbles form, will successfully pull off what amounts to a high wire artist performing without a safety net... blindfolded... as it attempts to siphon all of that extra cash back out of circulation once it deems the economy rescued....
Biechele Royce Advisors continues to overweight non dollar and real assets and under weight fixed income and financial assets. We also continue to strongly prefer dividend paying stocks, which make up the bulk of a stock investor's return in secular bear markets....
Tuesday, August 31, 2010
Increasing Weakness
The S&P 500 is down almost 4% since we last blogged about the increasing likelihood of renewed recession and market weakness. Unable to retake the flattening 200-day moving average a second time, the market sold off and is now 2.5% below the 50-day moving average. Further, the 20-day moving average is set to fall below the 50-day, which would put the four main moving averages (200, 100, 50, and 20) in bear market order. The Japanese Nikkei is already in a bear market. The S&P 500 was down almost 18% at its low in early July and looks increasingly likely to retest it - and fall below 1000 on a failed retest. Our forecast is based on our outlook for the economy, which continues to show every sign of falling back into recession.
Our December 2009 forecast of at least a 20% pullback in the S&P 500 sometime in 2010 looks increasingly like another solid win for the home team. We had written that the spring of 2010 was the most likely time (missed it slightly as the pullback stopped at 18%) and that the fall was next most likely. Our belief in a 2010 bear market stemmed from a few basic observations. First, the 2009 market recovery went further and faster than any bear market recovery since 1933, leaving the S&P 500 about 35% overvalued based on a number of long term valuation metrics (metrics Wall Street doesn't like to acknowledge because it gets in the way of them selling product to the unsuspecting public). Second, the economic recovery touted by the Fed and the Obama administration just wasn't supported by the numbers. Inventory swings were the main factor in the positive GDP numbers in Q4 of 2009 and Q1 of 2010. Final demand remained punk, as you would expect given the huge debt load born by the consumer, the lack of credit formation, and unbalanced make up of GDP (the consumers' share had grown to a record 72% during the spending orgy and is likely to fall back to a more sustainable 66% or so in the coming years).
Pair an overvalued, overbought market with an under performing economy and you are likely looking at poor market action going forward - which was our call in December 2009 and remains our call today. Market performance in 2010 has more than justified our cautious stance coming into the year. And unless the Federal Reserve gets busy printing more paper, the S&P 500 looks increasingly like it will sink to new lows for the year. The market is unlikely to test new lows for the secular bear market that began in March of 2000 however, because the Fed is clearly targeting the stock market now as a source of wealth and will eventually get around to supporting it. The Fed is likely to act sooner rather than later with renewed quantitative easing - given Bernanke's latest statements - and that just might give the market a lift into year end, but perhaps starting from the 850-900 level....
Biechele Royce Advisors continues to advocate proper diversification among all major asset classes with emphasis on blue-chip dividend paying stocks in the U.S., tangible assets, and nondollar assets. We continue to believe that inflation will pose a major threat to wealth preservation over the next ten years. Finally, we offer another reminder that secular bear markets require a focus on capital preservation first and capital appreciation second…
Posted by Chris Norwood, CFA(R) at 8:42 AM
Our December 2009 forecast of at least a 20% pullback in the S&P 500 sometime in 2010 looks increasingly like another solid win for the home team. We had written that the spring of 2010 was the most likely time (missed it slightly as the pullback stopped at 18%) and that the fall was next most likely. Our belief in a 2010 bear market stemmed from a few basic observations. First, the 2009 market recovery went further and faster than any bear market recovery since 1933, leaving the S&P 500 about 35% overvalued based on a number of long term valuation metrics (metrics Wall Street doesn't like to acknowledge because it gets in the way of them selling product to the unsuspecting public). Second, the economic recovery touted by the Fed and the Obama administration just wasn't supported by the numbers. Inventory swings were the main factor in the positive GDP numbers in Q4 of 2009 and Q1 of 2010. Final demand remained punk, as you would expect given the huge debt load born by the consumer, the lack of credit formation, and unbalanced make up of GDP (the consumers' share had grown to a record 72% during the spending orgy and is likely to fall back to a more sustainable 66% or so in the coming years).
Pair an overvalued, overbought market with an under performing economy and you are likely looking at poor market action going forward - which was our call in December 2009 and remains our call today. Market performance in 2010 has more than justified our cautious stance coming into the year. And unless the Federal Reserve gets busy printing more paper, the S&P 500 looks increasingly like it will sink to new lows for the year. The market is unlikely to test new lows for the secular bear market that began in March of 2000 however, because the Fed is clearly targeting the stock market now as a source of wealth and will eventually get around to supporting it. The Fed is likely to act sooner rather than later with renewed quantitative easing - given Bernanke's latest statements - and that just might give the market a lift into year end, but perhaps starting from the 850-900 level....
Biechele Royce Advisors continues to advocate proper diversification among all major asset classes with emphasis on blue-chip dividend paying stocks in the U.S., tangible assets, and nondollar assets. We continue to believe that inflation will pose a major threat to wealth preservation over the next ten years. Finally, we offer another reminder that secular bear markets require a focus on capital preservation first and capital appreciation second…
Posted by Chris Norwood, CFA(R) at 8:42 AM
Wednesday, August 18, 2010
Recession Looming
We did get the short term pullback predicted in our 14 July blog. We referenced the 20-day moving average sitting at about 1075 as a likely destination. The actual decline bottomed on 20 July at about 1060 before the S&P 500 motored higher once again, retaking the 200-day moving average in the process. Unfortunately, the S&P 500 was unable to maintain above that long term trend line, peaking at 1130ish in early August, before sliding back below the 200-day (We had written about strong resistance in the 1100-1130 area likely putting a lid on the stock market for the foreseeable future).
The stock market has essentially gone nowhere since last October, validating our concerns about an overpriced market that had climbed too far and too fast after the March 2009 bear market bottom. We have stated repeatedly since last October that it is a high risk market and investors should proceed cautiously. We are even more concerned today because the market has now put in a ten month top and a broad decline is increasingly likely in the fall, or next spring at the latest. It increasingly appears as if distribution is occurring whereby professional investors distribute shares to the public, leaving the public holding the bag when the market decline starts in earnest. One indication of distribution is On-Balance-Volume (OBV), which is showing a negative divergence over the last few months, portending coming weakness.
But what is the fundamental case for a broad stock market decline? Well, how about a return to recession? The probability of another recession (or continuation of the one which started in early 2007) is quite high. Real M-3 (the broadest measure of money supply) is still contracting strongly year-over-year. Recession has followed 100% of the time when real money supply contracts on an annualized basis, typically with a six to nine month lag. As well, the ECRI is now contracting sharply and, again, recession has followed 100% of the time when the contraction is as sharp as now. Likewise, real retail sales are weakening with July real retail sales growth essentially zero - opening up the possibility that Q3 real retail sales will turn negative. Furthermore, a surprisingly bad June trade deficit number will result in a reduction in reported Q2 GDP. The deteriorating trade balance also increases the likelihood of a negative Q3 GDP number. Finally, a developing contraction in housing starts, along with deterioration in a slew of other housing numbers, adds further pressure to an economy already under siege.
Expect a retest of the recent 1010 low on the S&P 500 with a likely decline into the 800 to 900 area within the next six months. Investors should continue to proceed with extreme caution in a very high risk market.
(A major caveat: the Fed appears likely to initiate a new quantitative easing program sooner rather than later, which would provide major support to the stock market, at least in nominal terms.)
The stock market has essentially gone nowhere since last October, validating our concerns about an overpriced market that had climbed too far and too fast after the March 2009 bear market bottom. We have stated repeatedly since last October that it is a high risk market and investors should proceed cautiously. We are even more concerned today because the market has now put in a ten month top and a broad decline is increasingly likely in the fall, or next spring at the latest. It increasingly appears as if distribution is occurring whereby professional investors distribute shares to the public, leaving the public holding the bag when the market decline starts in earnest. One indication of distribution is On-Balance-Volume (OBV), which is showing a negative divergence over the last few months, portending coming weakness.
But what is the fundamental case for a broad stock market decline? Well, how about a return to recession? The probability of another recession (or continuation of the one which started in early 2007) is quite high. Real M-3 (the broadest measure of money supply) is still contracting strongly year-over-year. Recession has followed 100% of the time when real money supply contracts on an annualized basis, typically with a six to nine month lag. As well, the ECRI is now contracting sharply and, again, recession has followed 100% of the time when the contraction is as sharp as now. Likewise, real retail sales are weakening with July real retail sales growth essentially zero - opening up the possibility that Q3 real retail sales will turn negative. Furthermore, a surprisingly bad June trade deficit number will result in a reduction in reported Q2 GDP. The deteriorating trade balance also increases the likelihood of a negative Q3 GDP number. Finally, a developing contraction in housing starts, along with deterioration in a slew of other housing numbers, adds further pressure to an economy already under siege.
Expect a retest of the recent 1010 low on the S&P 500 with a likely decline into the 800 to 900 area within the next six months. Investors should continue to proceed with extreme caution in a very high risk market.
(A major caveat: the Fed appears likely to initiate a new quantitative easing program sooner rather than later, which would provide major support to the stock market, at least in nominal terms.)
Wednesday, July 14, 2010
Short Term Top
The S&P 500 continued to fall until finding support just above 1000 (big round number), which we suggested might happen in our 30 June blog. The S&P 500 then rallied furiously over the next nine days, gaining 9% before running smack into the leading edge of resistance yesterday. (Also noted in our last blog - 1100 to 1130). The S&P tested 1100 yesterday and again today but has been unable to punch through. A couple of positive earnings reports from Alcoa and Intel have probably helped hold the index aloft, but it certainly looks as if the market is getting ready to move lower very short term - likely back to the 20-day moving average sitting around 1075.
More broadly speaking, the S&P 500 is now firmly entrenched in a downtrend and would need to break above about 1130 to renew any semblance of short term upside momentum. To the downside, the recent low of 1010 is likely to be tested in the coming months as increasing weakness in the economy translates into disappointing earnings. We are maintaining our price discipline, selling stocks as they approach fair value and buying stocks only when we believe we have a sufficient margin of safety to warrant taking the risk of adding new positions in what remains a high risk market.
More broadly speaking, the S&P 500 is now firmly entrenched in a downtrend and would need to break above about 1130 to renew any semblance of short term upside momentum. To the downside, the recent low of 1010 is likely to be tested in the coming months as increasing weakness in the economy translates into disappointing earnings. We are maintaining our price discipline, selling stocks as they approach fair value and buying stocks only when we believe we have a sufficient margin of safety to warrant taking the risk of adding new positions in what remains a high risk market.
Wednesday, June 30, 2010
Market Top
We warned in our 1 June blog that the market was likely to test 1000 (big round number) and then 950 (top of the bear market base) by the fall. We think the evidence, both fundamentally and technically, has grown stronger for more downside testing since our warning. Real money supply, as measured by M-3, is still contracting sharply (May annual real contraction 7.9%). Real retail sales are softening, falling in May by 1.0%. There are indications that the housing market is softening once again and that home prices are likely to turn lower. For instance, May's existing home sales according to the National Association of Realtors (NAR) showed a monthly contraction of 2.2% when a strong upside gain had been expected. The Federal Reserve has taken note of the softening economy by inserting language in its most recent communique that, "Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad."
Rumors are already surfacing that the Fed is preparing to reinstate quantitative easing (QE), which would continue to sow the seeds of future strong inflation, but also put a floor under the stock market once again...
Quantitative easing is the process of buying our own debt in order to force more paper money into the economy. The Treasury issues bonds and the Fed buys them with money it prints expressly for that purpose. It is a sure fire way to create inflation.
Technically the market continues to weaken, with a breach of the 1042 level occurring Monday, 29 June. Tops take more time to form than bottoms typically, and the topping action is now about six months old, sufficient time to build up overhead supply to the point where the market is no longer capable of pushing higher without first selling off more substantively. Specifically, there is now stiff resistance in place in the 1100 to 1125 area that isn't likely to give way anytime soon. Meanwhile, downside risk is 800-900 at some point either later this year or by early next year, assuming our forecast of another recession is accurate AND the Fed doesn't go back into full blown QE mode. (Normally, I would acknowledge the likelihood of the S&P 500 moving below fair value - 850ish - as the secular bear market finally plays itself out completely and the market hits its ultimate low, but our activist Fed makes that scenario a remote one)
Investors should continue to proceed with caution in what continues to be a high risk market....
Rumors are already surfacing that the Fed is preparing to reinstate quantitative easing (QE), which would continue to sow the seeds of future strong inflation, but also put a floor under the stock market once again...
Quantitative easing is the process of buying our own debt in order to force more paper money into the economy. The Treasury issues bonds and the Fed buys them with money it prints expressly for that purpose. It is a sure fire way to create inflation.
Technically the market continues to weaken, with a breach of the 1042 level occurring Monday, 29 June. Tops take more time to form than bottoms typically, and the topping action is now about six months old, sufficient time to build up overhead supply to the point where the market is no longer capable of pushing higher without first selling off more substantively. Specifically, there is now stiff resistance in place in the 1100 to 1125 area that isn't likely to give way anytime soon. Meanwhile, downside risk is 800-900 at some point either later this year or by early next year, assuming our forecast of another recession is accurate AND the Fed doesn't go back into full blown QE mode. (Normally, I would acknowledge the likelihood of the S&P 500 moving below fair value - 850ish - as the secular bear market finally plays itself out completely and the market hits its ultimate low, but our activist Fed makes that scenario a remote one)
Investors should continue to proceed with caution in what continues to be a high risk market....
Wednesday, June 23, 2010
Picking Stocks Revisited
A friend suggested that I write about how to pick stocks in which to invest. Regular readers are aware that I frequently write about the economy and the markets (and have correctly forecast the current market turmoil in 2010). The reason that I shy away from writing about individual stocks is because I don't want my readers going out and purchasing them on their own. Knowing when to buy a stock is only half the investing equation. It is also important to know when to sell, and I can't be there to make that call for you - unless you are already a client of course. Nevertheless, I will update you on a stock I wrote about back in October of 2008 in order to better illustrate the art of stock picking, but first an update on the market.
Our most likely scenario for the remainder of the year is the continuation of an oversold bounce that takes the S&P 500 back to the 1150-1175 area before renewed selling takes us lower into the fall. Of course, it is also possible that the bounce is over already and we are headed lower now. Regardless of the eventual path, it is quite likely that the S&P 500 will test 1000 (big round number) and then 950 (top of the bear market base) before the year is over. Why? Well because it is quite likely that we are headed back into recession as the effect of the fiscal stimulus runs its course and the tremendous burden of U.S. debt reasserts itself. The stock market is merely a reflection of the underlying economy. A weak economy will eventually lead to a weak stock market - absent additional stimulus from the government (which can't be ruled out). Okay, now on to individual stock picking...
Below is an analysis I wrote of Intel in October of 2008. It well illustrates the thought process involved in seeking out good businesses at great prices. (Please skip down to the last couple of paragraphs of the blog for a summary if you aren't into the nitty gritty of analysis).
Our most likely scenario for the remainder of the year is the continuation of an oversold bounce that takes the S&P 500 back to the 1150-1175 area before renewed selling takes us lower into the fall. Of course, it is also possible that the bounce is over already and we are headed lower now. Regardless of the eventual path, it is quite likely that the S&P 500 will test 1000 (big round number) and then 950 (top of the bear market base) before the year is over. Why? Well because it is quite likely that we are headed back into recession as the effect of the fiscal stimulus runs its course and the tremendous burden of U.S. debt reasserts itself. The stock market is merely a reflection of the underlying economy. A weak economy will eventually lead to a weak stock market - absent additional stimulus from the government (which can't be ruled out). Okay, now on to individual stock picking...
Below is an analysis I wrote of Intel in October of 2008. It well illustrates the thought process involved in seeking out good businesses at great prices. (Please skip down to the last couple of paragraphs of the blog for a summary if you aren't into the nitty gritty of analysis).
INTC $14.28 Intel closed today at $14.28 per share, but not before touching $13.37 intraday – a new 52-week low. The company is paying a dividend of $0.55 per share for a current yield of 3.85% and is expected to raise its dividend to $0.61 per share in 2009, according to Value Line – should reality meet expectations INTC will yield 4.27% for anyone buying at the current price, or some 40 basis points or so more than the 10-year Treasury. Now, of course, Intel common stock is riskier than holding a 10-year Treasury to maturity (although that premise seems increasingly uncertain given our government’s loose spending habits). On the other hand, we get much more than a debt instrument that pays par upon maturity when we buy part ownership of a company. We also get a growing stream of shareholder cash flow that can be returned to us by management either with increasing dividends, share buy backs or both.In fact, INTC will pay out around $1.19 per share in 10 years if management raises the dividend 8% per annum during that period – only one quarter the growth rate of the last 5 years. Anyone buying and hold Intel’s stock for the decade will then be earning 8.3% per annum on their original investment. Now compare that juicy 8.3% to the measly 3.85% you can currently earn holding the U.S. 10-year note… and you quickly get it – Intel is a raging buy at the current price as long as the company is around in 10 years and as long as management is able to continue to grow the dividend. And our analysis doesn’t yet include the possibility of additional cash that might be available to oh, say, buy in stock, resulting in the dividend yield rising even faster.In Intel’s case, a quick check of current year estimates reveals that the company will have approximately $0.55 per share in excess cash after paying its dividend and meeting its capital expenditure requirements. A three year average is often useful in ascertaining a company’s ability to throw off excess cash consistently. According to Value Line, Intel has generated approximately $5.66 in cash flow from 2006 to 2008, while making $2.76 per share in capital expenditures and paying out $1.41 per share in dividends, leaving approximately $1.49 per share in excess cash available to buy back shares, or $0.50 per share per annum. Adding the $0.50 in excess cash to the current $0.55 dividend gives you a current dividend yield of 7.35% (what the dividend yield would be if INTC management devoted all of its excess cash to the dividend). Unfortunately, Intel, like many management teams, often choose to buy back shares with excess cash. We think it unfortunate, because managements tend to pay top dollar for their own shares rather than waiting to buy in shares after their stock takes a dive. Nevertheless, buying in $0.50 per share per annum retires 3.5% of the outstanding shares at the current stock price (call it 2.0% net of stock option issuance), raising current and future dividends accordingly.Yet another way to do the math without the distortion of a changing share count: Intel generated $34.2 billion in Cash Flow After Taxes (CFAT) during the three years ending in 2007, against $17 billion in Capital Expenditures (CAPEX), leaving $17.2 billion available to shareholders. The entire company was available for purchase for a mere $154 billion at the beginning of 2008 (you could buy it lock stock and barrel right now for $82.8 billion). Taking the three year average shareholder cash number of $5.7 billion and dividing it into the current fully diluted shares outstanding gets you $0.99 per share in stockholder available cash – a nice current yield of 6.9%, some 3.1% better than the 10-year’s current yield.A couple ways then of looking at the yield to shareholders currently and a decade into the future in comparison to the 10-year Treasury – all favorable. We just need to make a judgment on whether INTC is likely to be around and prospering a decade from now.The company is currently the world’s largest semiconductor chip maker based on revenue, according to its 2007 10K SEC filing. INTC develops advanced integrated digital technology products, primarily integrated circuits, for industries such as computing and communications. Intel also develops platforms, which they define as integrated suites of digital computing technologies that are designed and configured to work together to provide an optimized user computing solution compared to separately. Intel currently controls about 80% of the PC processor market.For starters, Intel has grown revenues from $30.1 billion in 2003 to an estimated $40.4 billion in 2008, or a little over 34% during the five year period. Net profit is forecast to hit $7.3 billion in 2008, up from $7.0 billion in 2007 but well off the company’s peak profit logged in 2000 ($10.7 billion). Nevertheless, profit has grown steadily, albeit erratically, since the bottom fell out during the last recession in 2001 (profits bottomed in 2002 at $3.5 billion).Clearly the company is likely to still be in business and growing earnings given its dominating position in the microprocessor industry and strong balance sheet (almost 13 billion in cash on the balance sheet at the end of 2007). On the other hand, just looking at the increasing variability in earnings leads one to the conclusion that the company is no longer a true growth company and should be bought after business conditions (and the stock price) have weakened and sold when investor enthusiasm carries the share price outside of the realm of reasonable valuation. We believe the current valuation is in the buying zone, given our discussion of dividend and shareholder yields.
Whew! So what did Intel do in the 20 months since I wrote that analysis? Well, it bottomed at around $12 per share
in November of 2008 and retested that low in March of 2009, before marching to a 52-week high of $24.36 in April of 2010. Investors who bought INTC on my recommendation in October of 2008 would have made a pretty penny, earning over 50% on their investment (including the dividend) during the 20-month holding period (assuming they still owned the stock, which currently trades at $20.81). Had they sold the stock last fall when the return hit 50%, they would have earned approximately 55% annualized on their Intel investment. (My personal investment hurdle is the likelihood of earning 50% within two years. I regularly take my profits when I hit my target because business valuations simply don't change that quickly, making it highly likely that my initially undervalued business is no longer cheap enough to hold for the long-term without taking on too much price risk).
One other thing about investing in individual stocks....
You don't find good businesses at great prices among stocks hitting 52-week highs. You do find them among stocks hitting 52-week lows. I'm currently building a rather large position in a big blue chip S&P 500 company that recently lost over half its value due to a short term (in my opinion) problem with its business. My math tells me that I have a high likelihood of earning my 50% hurdle over the next few years.....
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