Looking for the True Value of the U.S. Employee

The latest jobs report was rolled out by the U.S. Bureau of Labor Statistics last week. In case you haven’t heard, the unemployment rate in the U.S. hit 3.7%. That’s the lowest it’s been since December 1969.

Additionally, the closely tracked wage growth report signaled that wages grew 2.8% from 2017.

These statistics indicate an increasingly healthy labor market. And wages are being driven higher to attract an increasingly sparse supply of workers.

But we’re not quite there yet. Despite rising wages, the American worker is still undervalued.

The current rate of wage growth still puts us below the 3.5% needed to compensate for the Federal Reserve’s 2% inflation target and 1.5% productivity growth.

Today’s real average wage (which accounts for inflation) has about the same purchasing power as it did in 1978, according to Pew Research. So wages aren’t actually going up – but at least they’re holding pretty steady.

In the near term, companies looking for skilled employees in this tight labor market are going to need to provide incentives of some sort to fill open positions.

If the unemployment numbers hold steady (I know that’s a big if) and the search for skilled workers continues, we could be poised for a paycheck reckoning in certain sectors.

This becomes a big deal when you consider the coming retail holiday hiring bonanza. The economy is still strong. And because U.S. consumer confidence is at its highest level in 18 years, according The Conference Board, lofty holiday sales are expected.

This means stores busy with customers… and a need for employees to help them.

Seasonal holiday hiring needs are expected to call for around 650,000 employees, according to the National Retail Federation. That’s in addition to the already outstanding more than 750,000 open retail positions across the country.

So what’s a store to do?

Kohl’s (NYSE: KSS) and J.C. Penney (NYSE: JCP) started their holiday hiring pushes way back in June. And Penney’s will be ponying up paid time off to its seasonal workers for the first time ever.

Dick’s Sporting Goods (NYSE: DKS) is looking to bolster its staff to improve the shopping experience and distinguish itself from online-only retailers.

Target (NYSE: TGT) announced last month that it will be increasing its seasonal workforce by 20% compared with last year’s. And it will be paying employees a full dollar more per hour.

Other companies are offering incentives, like signing bonuses, additional training and better employee discounts.

Macy’s (NYSE: M) this year introduced a new plan that awards employees a quarterly bonus based on performance. Macy’s CEO Jeff Gennette recently stated that the program has helped bring down turnover and attract new workers.

Higher pay and incentive plans aren’t free though. They could cut into fourth quarter profits for retailers depending on whether sales expectations are merely met or exceeded.

If the lines are long this holiday season and you notice unstaffed checkout lines, it could be an indicator of how well these hiring plans are working out… and how Q4 earnings reports will look.

These are good problems to have for the American worker. …read more

The Formula That Made Buffett a Billionaire

When 24-year-old Warren Buffett received a phone call offering him a job in New York City, he accepted without asking about the salary.

It was arguably the smartest – and most profitable – decision he ever made.

That’s because Buffett knew the man who had just employed him – a man he studied under at Columbia University – held the proverbial keys to the kingdom.

His name was Benjamin Graham.

Years earlier, Buffett had offered to work for Graham for free. But Buffett was kindly turned down.

Years later, he finally got his wish (and with pay).

Even so, Buffett’s life was about to change in ways even he could not foresee.

For Graham was about to teach him something far greater: how to translate his knowledge into an abundance of riches.

The Godfather of Investment Analysis

Graham was a phenomenal figure in the history of investing. But his importance stretches beyond his relationship with Buffett.

Graham founded the value investing school. But he also gave birth to the field of security analysis.

He established himself as a first-class investor during his years managing the Graham-Newman Corporation with his business partner, Jerome Newman.

The firm had an annualized return of 21%, compared with the market’s 12% rate of return.

But the firm’s great success was due to Graham’s insight, which was the foundation of the firm’s investment strategy.

It was summarized in the firm’s 1946 shareholder letter: “To purchase securities at prices less than their intrinsic value… with particular emphasis on purchase of securities at less than their liquidating value.”

But the struggle of analysts has always been to determine a company’s intrinsic value.

Calculating the intrinsic value of a company requires thorough analysis. But such analysis is not always easy in a fast-paced market.

Graham knew that it was helpful to have a “guesstimate”… a simple method for estimating a company’s value on the fly.

In his book Security Analysis, Graham laid out his original pen-and-paper formula.

Intrinsic Value = EPS x (8.5 + 2g)

EPS stands for earnings per share…

The average price-to-earnings for non-growth stocks at the time was 8.5…

And “g” represents the long-term growth outlook of the company.

Once you plug in the numbers, the formula hands you an intrinsic value estimate. Then, all you do is purchase stocks trading at discounts to their true values.

But despite the success this formula handed Graham and his followers…

Almost no one uses it today.

Investment analysis has become a more complicated and competitive field. Most successful value investors have developed their own approaches to measuring value.

In fact, Graham himself noted that his formula was not perfect. He made revisions to the formula over time, acknowledging its flaws.

Even so, the principles and strategies of Graham still live today. And the basic idea of buying stocks below their true values is as important as it’s ever been…

Especially in today’s market.

As Chief Investment Strategist Alexander Green reported in Sunday’s Market Wake-Up Call, stocks are currently trading above their historic average price-to-earnings ratios.

“That doesn’t mean the market’s about to go down,” said Alex. “But what it does …read more

Teddy Bulls for Christmas?

With Halloween about a month away, my apologies if the mere mention of Christmas induces a groan.

But next week marks the beginning of the fourth and final fiscal quarter of the year… and that inevitably means holiday chatter.

Whether you’re practicing your best Grinch impression or joyfully anticipating Michael Bublé’s return from hibernation, the Ghost of Christmas Past has an important public service announcement.

The chart above shows that 38 of the previous 50 fourth quarter returns for the S&P 500 have been positive.

That bodes well for the seemingly endless bull market run we’re in… especially considering the S&P is on the cusp of a double-digit increase year to date.

As we enter what’s typically the three best months of the fiscal year for the Dow and the S&P, for some companies – especially in the retail sector – more than 40% of revenue will come during the final 45 days.

So what can we glean from the Ghost of Christmas Future?

Malls may be losing steam, but traditional brick-and-mortar retailers like Macy’s still bring in lots of Q4 cash. And the savvy shareholder can still be rewarded with some short-term gains in this sector.

Even the mall-averse type need to buy Grammy and Pap Pap a little something for the holidays. To cater to this segment, most retailers have long since been pivoting toward delivering an online shopping experience.

That’s where a transportation company like United Parcel Service (NYSE: UPS) comes in. Like Macy’s, UPS also gets its hands on a quarterly revenue boon at the end of the year.

To hammer home the good news, U.S. consumer confidence unexpectedly rose in September, according to global research by The Conference Board. The recently released figures put the index close to levels not seen since 2000.

The bottom line is current market conditions remain favorable thanks to a strong economy and robust job growth – both harbingers of further good news.

If this wasn’t a rosy enough forecast for you, there’s also good news waiting on the other side of the world.

The trade war hasn’t been very friendly to the Chinese economy. Chinese electric vehicle maker NIO (NYSE: NIO) had an underwhelming IPO this month. Video streaming service iQIYI (NYSE: IQ) has seen a mixed year. And e-commerce titan Alibaba (NYSE: BABA) has been on a mostly downward trajectory for the past three months.

But Q4 is a pretty big deal in China too. The consumer buying frenzy that Black Friday and Cyber Monday trigger in the U.S. doesn’t hold a candle to China’s Singles Day.

The November 11 holiday (which doubles as both a celebration of being single and in a relationship) has become the largest shopping day in the world. Consumers spent upward of $25.4 billion on Alibaba alone during last year’s celebration.

As we head into the holiday season knowing all of this, there’s reason to believe we’re on track for this rally to continue. Teddy bulls all around!

Good investing,

Matthew …read more

Does More Risk REALLY Lead to More Reward?

We’ve all heard it before: Higher risks demand higher rewards.

Most investors take this statement as gospel. But it was only until the 1950s that the idea became popular, when economist Harry Markowitz laid the foundation for Modern Portfolio Theory.

The theory describes the proper relationship between risk and reward in portfolio construction.

Today’s chart shows that theory at work in the real world.

To do this, we’re taking another look at the corporate bond market – again comparing default rates per bond credit rating to their effective yields.

Last week, I broke down the corporate bond market to reveal how increasing levels of default risk correspond with increasing levels of reward in the form of yield.

I also emphasized that the generalizations of comparing “investment-grade bonds” with “junk bonds” didn’t show the middle ground of high-yielding bonds and relatively low-default bonds.

Today’s chart presents the same data in a different way.

It also reveals just how nonlinear the relationship between risk and reward is, suggesting not all risk-taking is worthwhile.

Here’s what I mean…

Look closely at the left side (or low-risk section) of the chart. You’ll notice that slight increases in risk result in much larger increases in returns.

This shows that taking modest degrees of risk is generally best for investors looking to maximize the long-term growth of their portfolios.

But as the line moves further to the right, you’ll notice that increased risk yields diminishing increases in returns.

In fact, at some point, even large increases in risk result in almost negligible bumps in returns.

There’s an important lesson in this…

There are limits to how much risk an investor should take on in order to maximize reward. At some point, taking on excess risk no longer makes sense.

But adding a modest amount of risk is perfectly reasonable – and occasionally essential – to growing your wealth over time.

Taking large risks on speculative bets can be alright here and there, but the core of your investing should balance risk and reward.

And, of course, this is also true outside of the bond market.

Take stocks as an obvious example.

Small cap stocks are typically more volatile than your blue chip, large cap stocks. Yet it’s exactly this volatility that gives small caps their appeal for generating above-average gains.

Year to date, small cap growth funds have returned about 18.7% to investors while their large cap growth peers have risen just 13.7%, according to Morningstar.

That said, the stock return spectrum has an extreme end as well.

Much like the C rated corporate bonds that flirt with default, penny stocks are notorious for promising sky-high gains… but most end up losing all value.

But the point is this…

The best way to maximize returns is to manage risk and diversify your investments.

Keep your risk modest and you won’t lose your shirt on a gamble gone wrong.

And even if you do choose to speculate now and then, be sure to limit your portfolio’s exposure so that one bad apple doesn’t spoil the whole bunch.

Good investing,

Anthony …read more

Don’t Buy Another Bond Fund Until You See This Chart

Junk bonds… We’ve all been taught to avoid them.

Common opinion suggests junk bonds are loaded with too much risk. But has the “junk” moniker turned conservative investors away from otherwise good investment opportunities?

The truth is much of today’s junk bond market is anything but junk.

If you take a closer look, you’ll find there’s a treasure trove of corporate bonds on the market right now, delivering high yields with favorable levels of risk.

And while some may be called “junk,” deeper inspection reveals that they’re burdened by an unduly bad reputation.

According to standard rating schemes, a junk bond is any bond with a credit rating of BB or lower by Standard & Poor’s (or Ba or lower by Moody’s).

Ratings of BBB- or higher are considered investment grade, or extremely low risk. And those lumped into the junk, or high-yield, category have varying degrees of risk.

But are all junk bonds really that risky? Let’s find out…

I went ahead and dug into some data from Standard & Poor’s to break down the default rates of bonds in each credit rating category.

Today’s chart illustrates my findings.

It shows the five-year average annual default rate of corporate bonds in each of the S&P’s credit rating categories.

It also shows the effective yields for each category. From left to right, the degree of risk increases. The bonds most likely to default are concentrated on the right. It’s no surprise that those bonds also offer the highest yields.

Investment-grade, or nonspeculative, bonds are those with ratings in the AAA to BBB categories. Anything with BB or lower is a high-yield, or junk, bond.

As you can see, virtually none of the investment-grade bonds have defaulted over the past five years (hence no green bars there). You can see why bonds are regarded as extremely safe investments.

Now let’s take a deeper look at the “junk” side of the bond market…

Over the past five years, junk bonds had an average default rate of 2.63% each year. That’s less than 3 in every 100.

But if you look closely, you’ll see most of the defaults came from the extreme end of the junk bond spectrum. The higher-rated junk bonds were – as one would expect – far less risky.

For example, according to the data, the average annual default rate of bonds rated BB, which are considered junk, was just 0.18%. That’s less than 2 in 1,000 bonds.

Moving on, bonds rated B had an average 2.13% default per year, or just about 2 in 100.

It’s not until we reach the CCC/C ratings that we see risk really rise, which correlates to higher potential yields (nearly 10%). It’s here that true speculation takes place.

Even so, these risks can be easily managed with a sound portfolio allocation strategy.

With the potential income boost that high yields can provide, bond investors shouldn’t be too scared to hold these assets as a limited part of their portfolios.

As always, it’s a matter of diversification and risk management.

Good investing,

Anthony …read more

Thoughts on Quitting While You’re Ahead

What’s the first thing you think about when you read the word “quit”? In American vernacular, the word’s had a bad rap for a long time.

Quitting is often seen as a sign of cowardice. And like Gen. George S. Patton famously told his troops about to storm into German-occupied France some 74 years ago, “Americans despise cowards.”

But quitting and cowardice are not necessarily one in the same. Quitting is not a bad thing if done for the right reasons.

We’re in the midst (some say the end) of the longest bull market ever. The unemployment rate is looking good – and so is the GDP. Based on this, would you consider quitting the stock market right now?

Put another way… picture September 2008. If you could go back and pull out any money you had in the stock market, would you? Or would you let it ride until it was too late?

Perhaps that’s a softball question, but it should still give you pause, especially if you’re the risk-averse type. Foresight isn’t quite as clear as hindsight. But we can mine the past for recurring events that shape the future.

Take today’s chart, for instance. While the market was peaking, interest rates were bottomed out, effectively at 0% for seven years.

But in the past two years, the Federal Reserve increased interest rates five times. And it has signaled that two more hikes are in store before the end of the year.

When that blue line starts to go up again, it signals more volatility in the market… and more risk. For some investors, that risk is simply unmanageable.

And this isn’t a new phenomenon. Historically, when the Fed starts compensating for low inflation with a quick succession of upticks, bad news in the market often follows.

The 35 interest rate hikes implemented in the 1970s definitely didn’t do the markets any favors. The S&P 500 was subsequently cut down to size… by half. And it took almost 15 years to recover.

An even clearer correlation to what we’re currently experiencing happened in the 1990s. It took only 11 interest rate hikes to prompt the market uncertainty that sent the S&P tumbling.

The end isn’t necessarily nigh, but a market correction is in the future.

So ask yourself this: Can you afford to lose 10% of your nest egg? How about 20%? Nobody knows how big the coming correction will be. But as long as the Fed keeps meddling, it’s just a matter of time.

The markets will forever go up and down. It’s how we’re able to benefit financially. But the best time to quit and pull your money out is right before you wish you had.

Good investing,

Matthew …read more

Trump’s Trade War With China Is Heating Up

It was announced this week that the U.S. and Mexico are very close to settling on the next version of their trade policy. But don’t get distracted. The real trade war is going on with the great red dragon.

Since 2017, China has been by far the biggest exporter to the U.S. It accounts for more than 20% of total U.S. imports (almost double that of each Mexico and Canada). With few labor laws and regulations in China, its goods are often much cheaper than American alternatives. This makes it difficult for U.S. companies to compete, so tariffs are meant to even the playing field.

Democrats and Republicans agree that U.S. trade policy with China has to change. American businesses should not have to step into the ring against Chinese counterparts whose lack of human rights regulations gives them weighted gloves. Even Sen. Elizabeth Warren, one of the president’s toughest critics, admitted, “Tariffs should be part of America’s trade policy moving forward.”

Last Thursday, the U.S. put in place another $16 billion in tariffs on Chinese imports. This brings the total active tariffs on Chinese goods to $50 billion. That’s almost 10% of the overall $506 billion that is shipped in each year from China.

The new tariffs affect everything from bridge parts to speedometers. And they are further proof that the U.S. is not backing down from this trade war. President Trump is serious about bringing down the trade deficit (total value of imports minus total value of exports) – and for good reason too.

The Bureau of Economic Analysis found that the trade deficit grew from $504.8 billion in 2016 to $568.4 billion in 2017. This is a direct result of the U.S. importing more than it exports. In order to reverse that growth, the President’s plan includes another $200 billion in tariffs on Chinese imports in the near future.

On the other side, China has placed tariffs on $16 billion of American goods. Many American exports going into China, including cars, motorcycles, coal, grease and plastic products are now assessed a 25% charge right off the bat.

Though we aren’t hearing about it much in the States, the Chinese are feeling the heat from the new tariffs already. After the latest round of U.S. tariffs were levied, Chinese Finance Minister Liu Kun acknowledged they’re already affecting Chinese jobs and causing noticeable problems for the economy as a whole.

It seems fitting that this Labor Day weekend we are talking about American businesses and the American worker, both pillars of our society. The scales of world trade have been out of balance for a while, and our government is within its rights to pull what levers it can to protect U.S. workers and businesses – and coerce the red dragon to comply.

Remember, this is just the beginning. Even after this latest wave of tariffs, there are still $150 billion in Chinese imports that will be hit with tariffs down the line. That is sure to be a great boon to American businesses, and the stock market …read more

The Meat-Free Set Has an Unlikely Ally


In the 1960s, Harvey Comics (best known for Richie Rich and Casper) entered the superhero genre. It was a brazen attempt to cash in on the popularity of the Batman TV show. The outcome was the creation of “Bee-Man.”

The character was singularly focused. He had bee powers. He dressed in bee armor. He ate honey (‘cause you know, bees) and stole gold… because it looks like honey?

Slightly less conspicuous (but no less fixated) is the modern-day vegetarian – or their overzealous relative, the vegan.

Dietary fanaticism (or passion, to be a little less critical) is on the rise. According to GlobalData, in the last three years, there’s been a 600% increase in people who identify as vegan in the U.S.

This isn’t just an American trend. Vegetarianism rose by 400% in Portugal over the past decade, according to Nielsen Holdings. And plant-based diets are growing across Asia as well. Research from Euromonitor International suggests the Chinese vegan market will grow 17.2% between 2015 and 2020.

There are several triggers causing this rise. For some, it’s health related. For others, it’s an issue of ethics. And for others still, it’s a matter of sustainability.

Regardless of the motivation, there is a burgeoning market to cash in on. High protein, plant-based food sales are on the rise. Nielson reports that in the year ending July 2017, sales of plant-based foods and beverages in the U.S. increased 14.7%. Prepared foods containing tofu (like the stuff in the frozen food aisle) grew 2% and drove $91 million in sales last year. And by all accounts, these numbers are expected to increase.

In fact, plant-based food sales are growing four times faster than meat sales. And it’s more than vegetarians and vegans driving that rise. NDP Group reports that 70% of meat eaters are swapping in nonanimal proteins at least once a week.

Enter the improbable CEO preparing to seize on this data. Tyson Foods’ (NYSE: TSN) head honcho Tom Hayes recently told Bloomberg Businessweek, “I took this job to help revolutionize the global food system.” And he’s living up to that promise.

Last May, Tyson became a seed investor in Future Meat Technologies, a Jerusalem-based biotechnology company developing “cultured meats” from cells in petri dishes. Likewise, the company has invested heavily in Memphis Meats, which is also developing lab-grown beef, poultry and fish. And it jumped in on a round of financing last December for plant-based protein provider Beyond Meat.

There’s also been movement within the walls of Tyson’s own test kitchens. Cooks have been formulating protein bowls full of quinoa, lentils and chickpeas for the company’s vegetarian Green Street brand, set to hit shelves in 2019.

So despite the rise of chicken consumption in the U.S., Tyson isn’t waiting for the birds to come home to roost. A solid diversification strategy and its foray into forager foods bodes well for its success in a fast-growing market with increasing demand.

There’s a reason Bee-Man lasted only a few years. Even Batman knew when to pump the brakes on the whole bat thing and show …read more

Protect Your Portfolio... With Bitcoin?

A recent study by the University of Technology in Sydney, Australia, came to a remarkable conclusion…

The study attempted to model and forecast the volatility of bitcoin returns and analyze its correlation to other markets.

Using statistics and machine learning, the study found, “The correlation analysis of bitcoin returns and the financial indices, particularly DJIA for the U.S. market and ASX for the Australian market and the exchange rate of AUD/USD, has shown the bitcoin price movement does not follow any of these instruments.”

In layman’s terms, the price of bitcoin is not correlated to stock market moves or the value of other currencies.

This may not sound like headline-worthy news, but it could completely change how you look at cryptocurrencies – and how you invest. After all, a lack of correlation can be a valuable characteristic for any investment.

Take gold for example…

For decades, analysts, hedge fund managers and personal financial advisors have suggested putting a portion of your portfolio in gold. It’s generally considered a safe investment.

You see, gold is not a particularly volatile commodity. And what makes gold special is its lack of correlation to the market. If there is a crash, gold will fare much better than most investments. A 2010 Forbes article found that gold was a strong investment in a weak market…

Amid the chaos [of the Great Recession], gold not only outperformed most of these alternative investments but also was one of the few assets, along with government-issued securities, to deliver a positive return on the order of 4% in 2008.

Gold retains its value regardless of what the market does. So when the market turned south, those holding gold did not take the losses that those holding commodities or real estate did.

And that brings us back to bitcoin… It too could soften the blow of a correction.

Check this out…

A perfect correlation is a 1-1 ratio, whereas perfect negative correlation is -1 to 1. The closer you are to zero, the less correlation there is.

As you can see, bitcoin’s 90-day correlation to the S&P’s daily returns averages between just -0.1 and 0.1.

Not being correlated to the market makes bitcoin an ideal reserve currency to hedge against inflation or market crashes.

When institutions, advisors and investors start adjusting their portfolios to reflect this discovery, look for crypto to boom like nothing we’ve ever seen before!

Good investing,

Benjamin …read more

Climate Change Boosts Lennox International

This year is on track to be the fourth warmest on record, and the effects are being felt across the globe from Northern Europe to the Pacific Northwest. People are dying of heat exhaustion in Japan, and nuclear reactors are being shut down in France, Germany and Switzerland due to the extreme temperatures.

But where there is excessive heat, there is demand for air conditioning.

For our purposes today, let’s focus on the U.S. In July alone, according to Brandon Miller, meteorologist for CNN International, we broke 41 heat records across the United States and are well on our way to breaking more. California is suffering from the largest wildfire in state history, and we’re seeing record-breaking highs in places like Oregon that aren’t prepared for consecutive weeks of 90-plus-degree weather.

With that in mind, air conditioning supplier Lennox International (NYSE: LII) is having a fantastic year. In the most recent quarter, Lennox posted earnings of $3.67, well beyond the $3.56 that analysts predicted.

Chairman and CEO Tobb Bluedorn announced the following as well:
Revenue and profit hit new highs on strength in both replacement and new construction business. Residential revenue was up 9% at constant currency, and profit rose 9% as segment margin remained at the record 21.5% level.
Lennox is seeing strong numbers out of the commercial sector as well, hitting a new record of $292 million in revenue for the second quarter. Everything is pointing toward record business and growth.

If the average temperature around the world continues to rise the way it has for the last 10 or so years, so will the value of air conditioner suppliers. And Lennox stands to make their shareholders very happy for the foreseeable future.

Good investing,

Benjamin …read more

Are Industrials Like Caterpillar Still Market Movers?


The correlation between the S&P and industry is traditionally a tight one. Historically, as industrials perform well, the market follows suit.

However, over the past year or so, the S&P has outperformed industrials, due in no small part to the overperformance of tech stocks. This is worrying analysts who fear a market correction will be necessary to return the correlation to traditional levels.

Before we jump to any conclusions, let’s consider Caterpillar (NYSE: CAT), which is one of the major holdings of the Industrial Select Sector SPDR Fund (NYSE: XLI), an $11 billion industrial-themed ETF. In the past, Caterpillar has been a bellwether for future performance of the sector and the market overall.

Based in Deerfield, Illinois, Caterpillar is the world’s largest maker of heavy equipment for mining, construction and energy companies. Last month it beat analysts’ expectations, reporting a second quarter profit that was more than double that of the same quarter last year. And equipment sales were up 25% due to rising demand natural gas, oil and mining companies, as well as Chinese construction companies.

Since 2011, Caterpillar and the global economy as a whole have enjoyed a long run of escalating activity. This most recent earnings announcement brings renewed hope that robust global economic activity will continue through 2019.

It’s also good news for  Caterpillar’s business model. Selling to more than 190 countries, the overseas markets account for half of its sales. Despite the looming tariffs that threaten to destabilize material costs, Caterpillar continues to book more orders and deliver higher profits.

The short-term future is bright for Caterpillar.  Although the stock is still roughly 30 points below its 52-week high, it’s sitting on a backlog of $17.7 billion in orders, up $200 million from the first quarter. And company executives expect product prices to more than offset looming cost increases.

Hopefully, Caterpillar’s performance is an indicator that industrials are catching back up to meet the market and return it to its traditional correlation with the sector. It’s a better scenario than the market dramatically dropping to do the same.

Good investing,

Benjamin …read more

Buffett’s Big Berkshire Buyback

Earlier this month, Warren Buffett’s Berkshire Hathaway (NYSE: BRK.A) stirred up the market with a big announcement – it’s changing its share repurchase policy to be more “flexible.”

The framework previously allowed for the buyback of shares at prices “no higher than a 20% premium to book value.”

This is not the first time Berkshire has updated this policy. When it announced its first repurchase plan with Buffett at the helm in 2011, the program limited the premium to just 10% over book value. With the current price hovering around a 40% premium to book value, a buyback now would be double the previous policy’s limit.

Investors saw shares rise more than 8% with that announcement seven years ago, and it seems like they’re setting up for a repeat in 2018. Since this most recent policy change, Berkshire’s stock is up 5% on the news.

What does this mean for Berkshire?

Announcing a willingness to buy back company stock at more than a 20% premium to book value is a stimulus for investors to get in beforehand… and see the value per share go up when the buyback takes place.

We saw this in 2011 when Berkshire announced its first repurchase program change:

In the opinion of our board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares, benefiting shareholders who retain their interest.

This time, it’s not all good news, though. Berkshire built its empire through acquisitions. But now, that model is slowing down. It’s currently sitting on more than $100 billion dollars in cash. Buffett and his group have been looking to pick up something new but have not found anything large enough to spend money on.

When the main business strategy is to buy companies and improve their value, not executing on that strategy slows growth and chills investor sentiment. This new buyback plan may just be a short-term fix for a longer-term problem with Berkshire.

In the meantime, you may want take advantage of the unique opportunity to buy Berkshire before the buyback boosts its stock performance.

Good Investing,

Benjamin …read more