Tuesday, December 28, 2010

Share buybacks

Saj Karsan has published a blog post on the poor timing of corporate share buyback programs. He observes that companies often repurchase their shares when the market is most enthusiastic about their prospects, and the share prices are correspondingly high. While Saj makes an excellent and important point, I want to defend some of the companies Saj sites as examples in his post.

A share buyback is a way for a company to allocate capital that cannot be productively deployed in its operations. The company can pay the money out as a dividend, or use it to repurchase some of its stock. By reducing the number of outstanding shares, the company increases the share of future earnings that an ongoing investor will receive. Is this increased share of future earnings worth the money spent on the stock repurchase, or would shareholders be better off simply receiving a dividend?

The decision by a company to repurchase its own stock can be viewed as any other investment decision. Instead of buying its own shares, the company could have purchased shares of another business, which would have also contributed to future earnings of the company's shareholders. So, whether a buyback is a good investment comes down to price. Companies should only repurchase their shares if those shares are undervalued.

As Saj points out, the overall record is not good. Companies tend to repurchase their shares at the wrong time, when the share prices are high, and to slow down their repurchases when the share prices are in fact attractive. This is understandable: prices are generally high when companies have strong earnings and thus have money to spend on buybacks. But it is not excusable, as it wastes shareholder equity.

At the same time, long-term buyback records are quite rational for several companies Saj sites as examples of poor buyback timing in the near-term. Let's look at Lowe's (LOW). Here is how the number of outstanding shares of LOW has been changing over time:

We see that Lowe's has been buying back its shares between 2006 and 2008, and then again in 2010. Share buybacks were apparently on hold from 2008 till 2010. This timing is indeed imperfect, since LOW shares were cheaper between 2008 and 2010 than in the years immediately before or after. However, let's put this in the longer term perspective. Here is a look at LOW's price-to-book ratio for the past 16 years:

Since 2007, the price of Lowe's shares has been low by historic standards, compared to the value of underlying shareholder equity. While Lowe's may have started buybacks too early, and not have perfectly timed them to the short-term market swings, their long-term timing is quite reasonable.

A similar picture emerges when we look at Walmart (WMT).

WMT had significant buybacks between 2003 and 2005, in 2007, and after 2009. Looking at their P/B ratio, we conclude that the relative price may have been too high in 2003, but certainly looks reasonable in the more recent years.

Timing of corporate share buyback programs is an important consideration in making stock investment decisions. Companies that overpay for their own stock destroy shareholder value, and should be avoided. Companies that repurchase shares when the price is right, create additional value for their investors, above and beyond the value generated by the underlying business. At StockPup.com, you can find tools to evaluate share buyback programs over the long-term of 15 years or more.

Friday, December 17, 2010

Staples and OfficeMax – same business, different results

In this article we compare two office product distributors – Staples (SPLS) and OfficeMax (OMX). Both sell through retail stores, web and mail catalogs, as well as delivery contracts with larger customers. With annual sales of $24B, Staples is more than 3 times larger than its rival, which generated $7.2B in sales last year. But the differences go much deeper than size. From the perspective of long-term shareholders, Staples exemplifies a consistently profitable business that is good at allocating and growing its capital. OfficeMax, on the other hand, is a story of capital tied up in barely profitable operations, and diminished by corporate actions

Over the past 14 years, Staples has nurtured the equity of its shareholders from $1.27 per share to $9.37 – representing a compounding annual growth rate (CAGR) of 15.3%. Including dividends, the shareholder wealth grew from $1.27 to $11.18. That’s a solid CAGR of 16.8%.

(circled letters are corporate event indicators that you can explore on the StockPup.com web site; "M" indicates M&A activity)

The equity of OfficeMax shareholders, in comparison, has been mostly flat, with no compounding to speak of, and significant equity destruction in recent years.

OfficeMax as we know it was formed in 2003, when Boise Cascade Corporation, a paper and wood products manufacturer and office product distributor, acquired the original OfficeMax, Inc. (data prior to 2003 is for Boise Cascade). The paper and wood business was spun-off in 2004, and the company changed its name to OfficeMax Incorporated. Neither before nor after the 2004 merger, however, was the company able to grow shareholder equity.

The 2003 acquisition loaded the OfficeMax balance sheet with goodwill and intangibles, which were subsequently written off in 2008. The $1.3B write-off represented the entire purchase price of the original OfficeMax! OfficeMax has further demonstrated an ability to decimate shareholder equity via corporate action: in 2008, in addition to the aforementioned $1.3B write-off, the company recorded a $735 impairment charge on a note guaranteed by Lehman Brothers, in the wake of the Lehman Brothers bankruptcy.

The growth of Staples has not been entirely organic either – Staples acquired Quill Corporation in 1998, bought the European mail order businesses of Guilbert SA in 2002, and acquired Corporate Express in 2008.

While the Quill acquisition diluted Staples shareholders by some 20%, and the Guilbert SA and Corporate Express acquisitions added close to $1B and $3B of goodwill and intangibles, respectively, to the balance sheet, neither has resulted in write-offs or significantly affected the company’s ability to generate returns. The median ROE is around 16%, and the median ROA is 7.3%.

Staples is under significant pressure due to the recession. Its Retail segment (about 40% of overall sales, and half the profits) was hit by a 2% year-on-year decline in same store sales. A similarly sized Delivery segment has grown sales at a modest 8% last year. And the faster growing (13% y-o-y) International segment remains relatively small (21% of sales and 7% of profits). Despite this challenging environment, Staples remained profitable and achieved a respectable ROE of 12.6%, giving hope that ROE will recover to its historic 16% level when conditions improve.

By comparison, the median ROA for OfficeMax is a meager 1.1%, and the ROA is close to zero.

Throughout OfficeMax history, years of modest profits alternated with periods of losses. Keeping this long-term perspective will protect investors from extrapolating a good year or two into future earnings growth.

Compare this with the consistent earnings history of Staples:

We believe that Staples is attractively priced at a historically low price to book ratio of 2.4. Given its healthy balance sheet and limited growth opportunities, we would like the company to continue its share repurchases, suspended after the Corporate Express acquisition.

Examining long-term fundamentals of companies such as SPLS and OMX, and considering their long-term records in handling shareholder equity, is critically important for investors who want to select the winning investment in a particular industry, or make long-short pair investments. Staples and OfficeMax make for one such potential long-short pair, as do Walgreens (WAG) and CVS Caremark (CVS) – two companies we compared in a previous article. At StockPup.com, you can find a wealth of long-term analytical charts and data covering over 15 years of corporate fundamentals, including all charts and corporate events mentioned in this article. Registration is free.

Monday, November 22, 2010

Bargain hunting - Gladstone Capital (GLAD)

A friend asked me to take a look at Gladstone Capital (GLAD) the other day, so I added it to the site (you need to sign in to view it; registration is free). Gladstone is a small cap - not something we've covered so far, but happy to on request from a frequent user.

A few observations. GLAD is trading below its book value, currently at price to book (P/B) ratio of 0.96. They've been in this territory for a few quarters now, with the valuation dipping below half the book value at times:


A drop to P/B of 0.5 may present an opportunity for a Graham-style bargain basement investment. I have not researched the balance sheet, so do not know if there are any skeletons in the closet. From a longer term perspective, however, GLAD does not look appetizing - they are barely eking out earnings, with ROE and ROA numbers in the 5 to 8% territory.



Personally, I much prefer companies with strong earnings compounding, even at P/B of 2 or so - and there are quite a few of those around nowadays. If you know about GLAD and why they are valued below book, please comment!

Disclosure: no position.

Monday, November 1, 2010

Walgreens and CVS Caremark - same business, different results

Walgreens (WAG) and CVS Caremark (CVS) operate in the same business - pharmacies - although present a very different picture to investors. In this article we examine each company, and compare their performance and position from the long-term shareholder perspective.

Walgreens has one of the cleanest financial track records that easily lends itself to fundamental analysis. Over the past 15 years, the company has been compounding shareholder equity per share at the rate of 15.4%. Adding in accumulated dividends, we get the compound annual growth rate (CAGR) of 16.9% in shareholders wealth – very respectable wealth compounding.



In the case of CVS, shareholder equity CAGR over the past 15 years is at 11.2% (12.3% with dividends) – average for a large US company. The story, however, is more complicated. The company underwent a major merger in 2007 – the one that brought CVS and Caremark together – shown as the “M” indicator in the chart above.

If we look at the 10 years prior to the merger, CVS equity had been compounding at the rate of 15.2% (17.7% including dividends) – performance similar to that of WAG, although achieved by using some leverage, whereas Walgreens had no long-term debt at the time (see the Long-term Debt to Equity ratio charts for Walgreens and for CVS). In fact, by looking at the returns on total assets, which eliminate the effect of different capital structures, we can see that WAG has always been better at operations, consistently maintaining ROA above 10% (with a 10.7% median), while median ROA for CVS is at 6%, and the firm never got ROA above 10%:


The elephant in the room, however, is the 2007 merger between CVS and Caremark. Events like this are rare, but their impact is disproportionately large. The total consideration for the Caremark purchase was $26.9 billion. Of that, $3.2 billion was in cash, and the rest was CVS shares. Shares outstanding thus jumped from 828 million to 1,564 million – dilution of 89%. What should we think of this merger?

From the top level fundamentals, we cannot be certain yet whether the merger was a mistake. However we see it as a worrisome development. The merger brought $30 billion of goodwill and intangible assets to the CVS Caremark balance sheet. That’s right – Caremark had no tangible equity. And neither does CVS now:


There is a significant risk of goodwill impairment, which would be a major hit against CVS shareholder equity, all of which is now intangible. Many investors apparently agree: before the merger, CVS had been valued at around 3x its book value; after the merger, the P/B ratio dropped to 1.5x, and has remained below 2x since. The “quality” of equity has significantly declined, and the merger made the CVS balance sheet more vulnerable.


CVS has been using the low stock prices of the past 2 years to buy back some of the shares issued in the acquisition. 13% of shares have been bought back since 2007. While we applaud this shareholder friendly action, concerns over intangible equity and a low ROA, brought down to 6% by the acquisition, give us pause.

The picture is very different with Walgreens. Intangibles comprise a minute share of the book value of its equity, and leverage is very low.


The ROE and ROA have been hurt by the condition of the economy, but remain decent, and there are reasons to believe that they will recover to their pre-recession levels. The company has also been taking advantage of the recent low share prices to buy back its stock – a good way to allocate capital:


And by historic standards, WAG is rather attractively valued, with the current P/B ratio at 2.3:


We believe that a long-term view of companies such as WAG and CVS is critically important. We strongly prefer WAG, which grows organically, to CVS, which makes disruptive acquisitions introducing uncertainties and vulnerabilities, as the 2007 CVS Caremark merger demonstrates. At StockPup.com, you can find a wealth of long-term analytical charts and data covering over 15 years of corporate fundamentals, such as the charts in this article.

Thursday, October 21, 2010

Long-term fundamental data available for free Excel download

We've just made our fundamental dataset available for free download in Excel. The data covers 15 years of quarterly corporate fundamentals, and is the same that we use for our own charts. For now, we only cover the S&P 100, but the plan is to expand to the S&P 500 in the near future, and to add additional data fields. To check it out, navigate to any company on StockPup - like this page for Wal-Mart (WMT).

We've also announced a partnership with Factual. These guys have a cool web-based system that allows people to review the data, propose corrections, and audit changes. Obviously, the quality of data is crucial, and we've heard complaints from users of other commercial datasets that there was no systematic way to improve the data. Well, with Factual there is. Here is a link to the Factual finance page, which includes our dataset: http://www.factual.com/topics/show?topic=Finance.

In addition, Factual provides a Web API for third party developers who want to build their own charts or apps using our data. We are using it too, to develop convenient ways to preview the data directly on the StockPup web site. If you are a web developer, definitely check out Factual and their API.

Monday, October 4, 2010

Bargain hunting vs long-term compounding

Greg Speicher published an interesting post today comparing two strategies practiced by long-term value investors: Graham-style small stock bargain hunting, and Munger-Buffett-style investing in large caps with strong compounding.

I feel that it is a bit unfortunate that Buffett's statement that with less money to manage he "could generate annual returns of 50%" is commonly taken as an endorsement of the bargain hunting approach. In fact, Buffett's investment approach has shifted from looking for mediocre companies at bargain basement prices to looking for excellent companies at fair prices, largely under the influence of Munger. Anyway, this is a major topic that deserves more attention, and I hope to revisit it in a more detailed post some time in the future. For now, though, check out Greg's post.

Tuesday, September 21, 2010

LOW: solid long-term returns at an attractive price

In this article, we take a look at Lowe's (LOW) from the perspective of a Warren Buffett-style long-term investor. After analyzing Lowe's quarterly fundamentals going back 15 years, we conclude that LOW can provide investors with solid long-term returns at an attractive price.

Over the past 15 years, Lowe's has consistently demonstrated an ability to generate wealth for its stockholders. It increased equity from about $1 per split-adjusted share in 1994, to $13.30 in 2010, and paid out a total of $1.70 in dividends per share (that's an 18% compound annual growth rate):



This growth in equity per share has translated into a share price increase from $3 in 1994 to around $21 today, plus dividends - a compound annual growth rate of about 14%. LOW significantly outperformed the S&P 500 index, which grew at 8% from 1994 to the beginning of this year.

The source of this wealth is a business generating returns on equity (ROE) with a median value of 16% per year, well above the cost of capital:



Furthermore, the ROE is of good quality, because the company does not use significant leverage, as evidenced by a consistently high return on total assets (ROA) - see also the debt-to-equity ratio below.

This kind of a consistent above-average ROE is a strong indicator of a sustainable competitive advantage, a "moat" around Lowe's business, to use the terminology of Warren Buffett (who is an investor in the company). In the aftermath of the housing bubble, ROE has dropped to 10% - average by S&P 500 standards. A key question in making an investment decision is whether the ROE can recover to its historic levels. We think so, based on the following considerations:
  • the strategic competitive position of the company - a duopoly with Home Depot (HD) - has not changed,
  • the home improvement retail market has not been structurally altered, and
  • Lowe's had a good ROE even before the housing bubble (prior to 2002).

What gives us further confidence in LOW is the fact that the company has a safe balance sheet with a low debt-to-equity ratio of 0.3, and no goodwill or intangible assets to speak of. The company can withstand a prolonged downturn with little risk to its financial health:




LOW is trading at P/E ratios of around 20. So, why do we think that Lowe's is attractively priced? For one, current earnings are depressed by the state of the housing market, and do not reflect the long term potential of the firm. Another reason is that LOW is trading at the price to book ratio of 2, which is close to the lowest it has been in 15 years:



While P/B of 2 is not a bargain in the Graham sense of value investing, it is a low price for a company in great financial condition, and earning solid returns on equity. After all, if the company restores its long-term ROE, it will double its shareholders wealth in less than 5 years, and the price will follow.

Couple that with smart capital allocation decisions by the company - with its stock price depressed, Lowe's has been buying back its shares since 2006:



...and you got a stock that will reward patient long-term investors.

The charts used in this article come from StockPup.com. Today, StockPup opened a preview beta version of the site to the public. StockPup provides fundamental stock analysis tools to individual investors who follow the long-term investing philosophies of Warren Buffet, Benjamin Graham, and David Dodd. Registration is free, and you can use StockPup charts in your own blog or articles, or simply use the research to gain deeper understanding of stocks you invest in.

Disclosure: long on LOW

Monday, July 5, 2010

Happy 4th of July!

Sorry for the radio silence over the past few weeks. I've been very busy preparing the main stockpup.com web site for launch. That's coming together nicely, so I will try to publish some more interesting fundamental analysis charts / insights soon. Hope you had a great 4th of July!

Tuesday, June 15, 2010

Shareholders' perspective: Archer Daniels Midland (ADM)

In last week's video we took a look at Microsoft (MSFT) from the perspective of a long-term shareholder. Lest you think that kind of track record is common, I wanted to contrast it with what is more commonly found among large publicly traded companies. Looking for a good comparison, I remembered watching "The Informant!" - a movie in which Matt Damon plays an FBI informant inside Archer Daniels Midland (ADM). ADM is a 100 year old behemoth of agribusiness. The company generates revenues of some $70 billion a year, processing soy and corn into oils and other food ingredients. And... it makes for a perfect case study.

Despite remarkable scale and, presumably, market power, ADM has not done much for its shareholders over the past 15 years. The equity of common shareholders has been more or less flat from 1995 till 2004. There has been a modest 1.9x increase in the past 5 years, which works out to a reasonable 14% per year, but the overall record leaves much to be desired.


As we saw with MSFT, before drawing conclusions from the equity charts, it is important to check whether the company has been returning wealth to its shareholders, which could explain a flat equity chart. Indeed, we find that ADM has been buying back its stock, and reduced the number of outstanding shares by about 10% since 1995. While commendable, this anti-dilutive policy does not fundamentally change the flat shareholder outlook.

Of course, what lies behind this meager performance for shareholders is a commodity business in which high returns are hard to come by. The average return on equity (ROE) for ADM over the past 15 years stands at 9.5%, which is a bit below the average for the S&P 500. The average return on all assets (ROA) is at 4.2%.

Would I want to be a shareholder of ADM, and have ADM deploy my equity in this way?  Definitely not. Why would anybody possibly invest? Perhaps at a low enough price ADM could be attractive as a dividend stock. At the current price levels ($26), however, the annual dividend payouts ($0.56) mean a dividend yield of only 2% - not interesting.

The optimists among you might observe that over the past 4-5 years ADM has been able to achieve ROE rates of above 15% - so there might be hope for improved performance. Unfortunately, it looks like ADM's ROE basically tracks the food commodity prices, which have been high recently. So, betting that ADM will continue earning decent returns is akin to speculating on commodities - not our game.


This story of ADM illustrates the importance of looking at long-term historic records of shareholder performance. ADM may look like a good performer on a 4 year scale, however, once you expand your horizon to more than 10 years, a very different - and much less appealing - picture emerges. For this reason I try to bring you 15 to 20 years of data at stockPup.com. Since the goal of an investor should be finding companies that can consistently - and over long periods - generate high returns, ADM is not for us.

Monday, June 7, 2010

Shareholders' perspective: Microsoft (MSFT)

In this video we take a look at Microsoft (MSFT) from the perspective of a long-term shareholder, and examine changes in Microsoft shareholders' equity over time.

Wednesday, June 2, 2010

First chart - Lowe's equity and dividends

For the past couple of years I have been working on collecting and cleaning the historical fundamental financial data of major public companies. The database that I put together goes back 20 years, and covers data such as  earnings, dividends, assets and liabilities, common and preferred equity, etc - things you need to understand the long-term performance of any kind of a business.

While I am still working on releasing this data and analytics through stockPup.com, I thought I'd share the very first graph I created with my own data. Here is a look at the changes in shareholder equity, and the accumulation of dividends, for one of my favorite companies - Lowe's (LOW).

Lowe's is known as a "dividend aristocrat," due to the consistency of their increasing dividends. Indeed, you can see on the chart that in the past 10 years Lowe's has paid out about $1.50 in dividends per split-adjusted share. What is more impressive is that over the past 10 years the equity per share has increased from about $3 per share to over $13 per share.

An equity increase of 4.3 times in 10 years is equivalent to 15% compound annual increase. Adding in the dividends we get to 17% per year. For a company the size of Lowe's (they are number 42 in Fortune 500), this is a very impressive rate of growth in shareholder wealth.

Of course, equity growth is only one - although arguably the most important one - of the many dimensions of analyzing a company. In the next few months I plan to bring you deeper insights into corporate fundamentals. So, stay tuned!

Disclosure: long on LOW

Thursday, May 27, 2010

Investing in stocks - explained in 3 minutes

To kick off the stockPup blog about investing, I put together a 3 minute video explaining the fundamentals of investing.


Big thanks to Mark Hurst of Gel and Sal Khan of the Khan Academy for popularizing this format and encouraging me to make a video!