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Researchers have noted that, in the 1990’s, companies that bought back their stock outperformed the market for up to 4 years after the announcement of the buyback program. The most significant reason for this increase is that managers buy back stock when they believe that it is significantly undervalued, and, of course, buying back the stock increases its demand and therefore its price.
However, a recent study by Standard & Poor seems to contradict this commonsensical notion. They found that 320 out of the 423 companies in the S&P Index that repurchased its shares between January 1, 2006 to June 30, 2007 would have done better by taking the money and investing it in an index fund benchmarked to the S&P 500.
The conclusion is that, while most managers don’t try to mislead investors, many buyback programs do not specify how many shares will be repurchased nor the time of their repurchase, and, often, the buybacks don’t occur—and sometimes, the stock buyback program can be bogus, announced to increase the stock price at least temporarily!
The study has found that those managers that heavily use discretionary accruals—which are revenue or expense items that managers have large discretion in deciding when they will appear in the company’s financial statements, and what their value will be—generally perform worse than companies using less discretionary accruals. Managers using discretionary accruals aggressively can only bolster the share price temporarily, because eventually such items will have to appear in the financial statements.
The finance professors who conducted the study reasoned that managers that announced bogus stock buyback programs would be more likely to use discretionary accruals. They conclude that the stocks of companies that announce a buyback program, but don’t use discretionary accruals aggressively, generally outperform the market.
Strategies- Are Buyback Stocks Still Good for Investors
This study found that many companies that buy back a significant amount of their own stock may be manipulating the company’s earnings downward right before the buyback, which is then adjusted upward after the buyback is completed, resulting in better than average performance.
(Note: the above video link may not last long.)
The most lucrative months to be in the stock market, according to the Stock Trader's Almanac 2007, is from November to April. Over the past 57 years, the Dow Jones Industrial Average gained only 174.61 points over the worst 6 months of the year, from May to October, but gained a total of 12,850 points over the best 6 months, from November to April. That's almost all of the Dow's gain. (Closing value on 5/15/2007: 13,383.84.)
If you had invested $10,000 in the stock market, but only kept your investments during the best 6 months, from November to April, over the past 57 years, you would have $588,000 today. However, if you had kept your investments in the market for only the worst 6 months of the year, from May to October, the value of your investment would only be $10,341—barely more than you had invested 57 years ago!
Reasons given for the increase in the best months are that people invest year-end bonuses and tax returns, and make 401(k) contributions.
The video did point out, however, that May was the best month, for 13 straight years, from 1985 to 1997, for the S&P 500.
One thing that I have observed is that the 1st half of May is often good, as it has been this month, but then it starts declining toward the end of the month. I also believe that one could do better by beginning the investment period in mid-October, after the stock market reaches its low point, rather than waiting until November. The stock market usually starts rising toward the end of October, especially after the 3rd Friday of the month, when October options expire, then the rise simply continues into November.
New financial products—structured products and equity-indexed annuities—are being marketed that promise an investor possible good returns, but no losses.
Structured products and equity-indexed annuities are basically contractual derivatives that an investor purchases in exchange for returns based on the terms of the contract, which is predicated upon other financial assets or derivatives. (Structured products are sometimes called structured notes, because they are much like bonds or notes—contracts that promise to pay according to the terms of the contract, and have a maturity date, when the investor will get back the principal.)
Structured products are issued by brokerages and trade on the American Stock Exchange. An example of a recently issued note—a type of note called an indexed-linked note—is the Morgan Stanley Capital Protected Notes (GBI);(Prospectus for GBI). This note derives its value from 3 indexes, equally weighted: the Dow Jones Euro Stoxx 50 Index, the Standard & Poor's 500-stock index, and Japan's Nikkei 225. The original issue date was February 28, 2007 for $10 per share, it pays a small dividend, and matures in 2011. These notes are senior unsecured obligations of Morgan Stanley.
A drawback to the notes is that it is difficult to currently ascertain the liquidity of the products.
Equity-indexed annuities are issued by insurance companies and also have a no-loss guarantee, and are based on stock indexes. However, they have severe drawbacks:
An important caveat for both of these products is that the guaranteed return, like bonds, depends on the financial status of the issuer. If the issuer becomes insolvent, then these financial instruments could become worthless.
Employee stock options are usually granted to management personnel to attract talent and to motivate them to increase the value of the company, and, therefore, its stock price. Employee stock options give the employee the right to buy company stock after a stipulated period of employment for a stipulated price that is usually equal to the price of the company's stock when the stock option is granted. The recent news about back-dated options involves specifying a date previous to the actual granting of the option, when the stock price was at its lowest, thereby making the stock option grant more valuable, but not accounting for the added expense in financial statements.
Employee stock options differ from exchange-traded call options because
there is a vesting requirement that requires the employee to work a minimum number of years for the company;
the term of the options can last 10 years or longer;
and if an employee leaves the company, he must either exercise his vested options or forfeit them.
Stock options have value, so if a company grants employees stock options, then the company is giving something that has value. If the company sold the options to the public, it would have more cash. By giving it to employees, it is giving an equivalent of cash, and, therefore, it should be expensed on the company’s income statement. However, many companies have resisted this, because it will result in lower reported earnings.
The purpose of evaluating employee stock options is to determine the impact on company earnings such grants have. Previously, many companies, particularly high-tech companies that used them extensively to attract top talent, reported the option grants in footnotes rather than as a compensation expense, which could greatly lower reported earnings. On the other hand, it is more difficult to evaluate footnotes than to compare numbers among different companies. Now that companies are required to expense option grants, they are looking at various ways to determine a value for the granted options.
Various pricing models are used, especially the Black-Scholes formula, which is commonly used to valuate exchange-traded options. The problem with using pricing models is that different companies can use different models, and, thus, it may be misleading for investors to compare the financial numbers of one company with another. A further complication is that a major component of all pricing models is the volatility of the stock, which has to be estimated.
One company, Zions, tried a marketing approach by creating options with similar terms to employee stock options, then sold them to sophisticated investors at a an auction. The options sold for half of what pricing models would have predicted. However, this market-based approach may be flawed, due to the number and sophistication of the bidders, and various other factors.
It seems unlikely that the market value of an employee stock option will be equal to its actual expense to the company, for they are not really connected. Companies, of course, prefer the market value if it lowers the compensation expense, and Zion’s experiment would seem to indicate that. Of course, if pricing models yielded a lower figure, then companies wouldn’t even be talking about using the market model, which has its own problems, such as actually issuing the securities and selling them in a bidding auction. The companies just want a lower expense number, which will result in higher reported earnings. It may be better to require companies to use a single pricing model so that investors can compare apples to apples.
These artlcles underscore 2 important disadvantages to holding stocks in a margin account, which are often lent out to short sellers, and if they are:
You cannot vote with your shares, but the borrowers of the stock can, in what is being called empty voting;
and if the stocks pay a dividend, what you actually get instead of a dividend that may qualify for the favorable tax treatment of 5% or 15%, is a payment in lieu of dividends, which is taxed as ordinary income that may be as high as 35%.
What's worse, the borrowers of the stock, often short-sellers, can vote in the worse interest of the corporation to try to deflate the stock price, and thereby profit from short selling—thus, voting against the interests of the true owners of the stock.
A possible scenario is for a hedge fund, which frequently profits from short selling, is to borrow the shares right before the record date—usually 30 days before the vote, and vote in its own interests. Delaware law, which governs most large companies because they are incorporated in the state, give voting rights to whomever happens to have the stock on the record date. Often, owners of the stock are unaware of the lending, that their right to vote has been transferred to someone else.
Sometimes, because of inadequate accounting, both actual stockholders, and the borrowers, both vote, leading to overvoting, which the New York Stock Exchange has found to be a frequent occurrence in some instances.
Private investment in public equity securities (PIPES) are unregistered securities, which can be stock or convertible debt, issued by small-cap, high growth companies that are sold in a private placement to institutional investors at a 5% - 15% discount to the issuer’s common stock. The company then tries to register the PIPES with the SEC so that they can be sold to the public by the original investors. PIPES allow a small company—which cannot get loans or more traditional financing because the company is too small, unproven, or too heavily in debt—to avoid the time and expense of a public offering, and receives immediate cash.
Although PIPES have surged recently, the SEC has significantly slowed the registration of these securities because of the risks, which include insider trading and the significant dilution of the common stock, which can lower stock prices. Often, the number of shares issued as PIPES is more than the number outstanding, so the SEC has been reluctant to register more shares than 33% of the public float—the number of shares held by the public, to prevent significant dilution and the consequent undermining of the common stock price.
The SEC is also leaning toward treating the resale of the securities as a more heavily regulated primary offering rather than as a secondary offering. The SEC may provide more information, in 2007, as to when the resale of PIPES can be considered a primary offering or a secondary offering.
AIM (Alternative Investment Market), launched in 1995, is part of the London Stock Exchange for new companies, that requires less money and less disclosure to get listed than it does on an American exchange, leading to more new companies being listed than for the New York Stock Exchange and NASDAQ combined. Half of AIM’s 1600 companies have listed since 2005, with almost 300 companies outside of the U.K. 90% of the companies have market values of less than £100 million (about $197 million).
To get listed on the London Stock Exchange, the Financial Services Agency of Britain reviews listings to prevent fraud, much as the SEC reviews listings for new companies before they can offer shares to the American public. AIM uses nomads, instead.
Nominated advisers, or nomads, who typically work for a stock brokerage, reviews the company’s documents to learn about management, financial controls, and growth potential, to decide if it should be listed on AIM. If approved, then companies must pay an annual fee of $7,595 to the exchange, and $40,000 to $100,000 to their nomad. To contrast, the annual cost of an NYSE listing ranges from $38,000 to $500,000, and NASDAQ, $21,225 to $75,000.
Once listed, the nomad provides advice on handling news and is supposed it ensure that the company is serving shareholders well. Because many nomads tout the companies under their watch, they have a vested interest in presenting the company in the best possible light, making any information they provide about the company suspect. The London Stock Exchange has 14 people monitoring nomads and any unusual price movements in any stocks. An external committee handles any discipline deemed necessary. If a nomad, who cannot sanction the company for violations, has any qualms about its company, the nomad is required to contact the London Stock Exchange.
There are a few conflicts of interest in using nomads as overseers. If a nomad resigns, for instance, trading of the company stock is halted until a new nomad is found. Another conflict of interest arises because the listed company can dismiss its nomad, whose brokerage would lose the fees paid for nomads, which could cause nomads to overlook irregularities.
In general, companies listed on AIM have not done well. The FTSE AIM Index is down slightly, compared to the 16% growth in the Russell 2000 Index, which is composed of companies similar in size, for the same period.
Pink Sheets, LLC, is planning a similar service in the United States, referring to the nomads as the Designated Adviser for Disclosure, or DAD.
Goodwill is an intangible asset, the value of which is recorded on the acquiring company's balance sheet as the difference between what it paid for the acquisition and the acquired company's fair market value, or book value.
Goodwill of a Company = Purchase Price - Book Value of Company.
Goodwill is no longer amortized, but, to comply with FASB Rule 142, Accounting for Goodwill and Intangible Assets, it must pass an annual impairment test, to determine if the goodwill is still worth what was paid for it. If not, then it has to be written down, which will diminish stockholder equity, and may trigger covenants on any debts that the acquiring company has issued, and thus, imposes a risk for current stockholders. Such is the current case with Expedia, as is illustrated by the above article.
CAPS is a free stock-rating forum just introduced to the public by the Motley Fool, that rates stock pickers from individual investors to big brokerages, research boutiques, and stock-picking mavens like James Cramer.
Participating investors predict how a particular stock will do compared to the S&P 500 over a specific interval of time. They are then rated in proportion to how correct their predictions were, and how the returns fared against the index. A participant is assigned a rating after predicting the performance of at least 7 stocks.
Individual stocks are also ranked, using a 5-star metric, by the participants. Only participants that have a rating can influence the rating of a particular stock, and the effect on the stock's rating will be proportional to the participant’s rating.
To rate the predictions of Wall Street firms and famous mavens, the Motley Fool relies on data provided by Briefing.com for analysts’ recommendations, and compares them to actual performances.
Thus, individual investors can see how well they’ve done compared to the big boys, and how well the big boys actually do.
Program trading was restricted to big investors, but several brokerages are now offering program trading software for small investors. TD Ameritrade Holding Corp. is planning on providing automated trading to its customers very soon. Fidelity Investments provides Wealth Lab Pro software where investors can program their own algorithms based on historical data and 600 market indicators, or choose from about 1,000 quantitative strategies already programmed into the software. TradeStation claims that investor interest is high and growing. Interactive Brokers provides forums where program traders can exchange ideas for new algorithms, or provide their ideas to new investors. Some brokerages are offering a less risky strategy by simply sending alerts based on preset market parameters. Most brokerages prudently allow only active investors with a substantial minimum in their accounts to program trade.
Naturally, the brokerages like program trading, because computers trade without worrying about how much money the trades are costing the investor in brokerage commissions. Other risks to the investor include the possibility that the trading algorithm will have significant flaws that may only come up in unusual market conditions, especially since it is impossible to test this kind of software under every possible scenario, but these flaws could cost the investor a significant amount of money, for which the investor will be legally liable. This is especially true for new algorithms being submitted by other investors in forums.
Alas, program trading, like technical analysis, and throwing darts at a list of securities, only works some of the time for the lucky few. Since program trading doesn't take into account company fundamentals, it is, by necessity, based on historical patterns, and if one can profit by simply repeating past strategies, then we can all be rich by simply following the most successful algorithms. But this can't work, because trading doesn't create new wealth—it only transfers wealth from 1 trader to another, so in any given trade, somebody wins, but somebody else has to lose, although it may not be immediately evident who is who.
There is one group, however, who will be consistent winners with program trading, and that's the brokerages, as they reap the increased commission income that comes with program trading.
However, virtual trading simulations are limited because there are no real emotions involved in the trades, which often moves the investor to make unwise choices. It may also build unwarranted confidence, either in one's ability or in certain strategies. While backtesting can be done to quickly test strategies, they don't reflect current market conditions, and, thus, may lead to losses in real trading. Some virtual trading companies mentioned in the article: CyberTrader, Fidelity (Wealth-Lab Pro), FX Solutions, optionsXpress, and Scottrade.
The Dogs of the Dow strategy is to buy the 10 blue chip stocks of the Dow Jones Industrial Average (DJIA) that have the highest dividend yield (=dividend/stock price), and holding them for about a year, then repeat, if desired. Often, these are stocks that have suffered price declines in the previous year, thus raising their dividend yields. The Dogs have done well this year, with total returns of 21% versus 7.9% for the DJIA. Last year, however, the Dogs lost 5% versus a gain of 1.7% for the DJIA. This strategy would probably work better if some analysis was done to determine why the Dogs have become dogs, and is their status going to change. Such an analysis would probably involve changing the time frame as well. Nonetheless, since they do pay dividends, at least the shareholder is getting paid while holding onto the stocks, and, of course, there is simplicity in following the naive strategy that may work more often than not.
STOXX Ltd., a European stock-index provider, launched 3 indexes that cover initial public offerings of stocks in Europe, that have a free-float IPO market capitalization between €100 million and €3 billion ($128 million and $3.85 billion).
The Dow Jones STOXX IPO Indexes include IPOs that have been on the market for 3, 12, and 60 months. Each company will be transferred to the longer index as it passes the time limits for the current index. The number of components of each index is necessarily variable, but will not fall below 10.
I recently read in the Wall Street Journal (June 3, 2006) about traders making money on the annual Russell Index reconstitutions, and was wondering how profitable that really is. Now that the list of additions has been published (Additions: Russell 3000® Index (Russell.com)), it is, evidently in some cases, very profitable! The following examples were picked randomly, and presented in the order that they were picked.
For instance, here's a 6 month chart of Amrep Corp. (AXR: Summary for AMREP CP NEW):
As you can see, Amrep went from about $25 in January to the latest quote of $59.75. That's about a 140% increase in about 6 months. Not bad. In fact, here's a comparison with the 3 major indexes—the DJIA, the S&P 500, and the Nasdaq—over the same time period:
Here's another: Lakes Entertainment (LACO: Summary for LAKES ENTERTNMT), which went from less than $7 at the start of the year to $11.80.
PeopleSupport, Inc, (PSPT: Summary for PEOPLESUPPORT INC) went from a little over $8 in January to a little over $14 recently, settling down to $13.75.
That's an increase of about 67% in 6 months. Not too shabby!
Here's one that lost during the time frame, I.D. Systems, Inc. (IDSY: Summary for ID SYSTEMS INC):
And here's the 6 month chart for Stratex Networks (STXN: Summary for STRATEX NTWKS INC), where the price peaked around late April and the beginning of May, and then declined almost to where it was 6 months ago:
Anadys Pharmaceuticals, Inc. (ANDS: Summary for ANADYS PHARMACEUTICA) is another that declined after peaking about late March:
As you can see, some of these stocks, peak around April, and then decline. This indicates that the active traders have bought by then, and then buying declines.
What stocks are added to the Russell indexes are based mostly on market capitalization, and the indexes are reconstituted every year. Because about $3.8 trillion worth of index mutual funds and exchange-traded funds are benchmarked against the Russell indexes, any new additions to the Russell index are bought by the fund managers to reflect the changes. Active traders anticipate this by looking for companies that are increasing in market capitalizations, and thus, are likely to be added to the index in June. One study, published in the Financial Analysts Journal, found that between 1990 and 2002, index funds tracking the Russell 2000 suffered 1.3% - 1.84% because of traders buying the stocks before the fund managers.
Of course, fund managers also try to determine what is going to be added to the index, because if they don't, they'll be buying the stocks at higher prices, which will hurt the fund performance. So, it is the combined buying by active traders and fund managers that drives up the stocks' prices before they are actually added to the index. No doubt some of the stock price declines results when the active traders sell for a profit.
Most companies have to deduct the cost of stock options in their reports this year, and this article discusses how this will lower the expected earnings of some companies, especially since many analysts haven't included options costs in their estimates.
The problem with larger corporations, and the source of many corporate scandals and much corruption, such as with Enron and WorldCom, is that the people who directly manage the corporation do not have a significant ownership in it. Even when they are compensated with stock options, or better yet, restricted stock, top-level executives can frequently profit more by fraud, which they can carry out because they have direct control of the corporation. Although the board of directors exists to represent shareholders' interests and to oversee management, this does not work as well as it should.
Below are 3 sites devoted to this issue:
"Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance", OECD April 1999.
"IRRC is the leading source of high quality, impartial information on corporate governance and social responsibility. Founded in 1972, IRRC provides proxy research and analysis, benchmarking products, as well as proxy voting services to more than 500 institutional investors, corporations, law firms, foundations, academics and other organizations. IRRC is unique in the industry as it does not advocate on any side of the issues it covers. Clients can be assured that IRRC data and analyses are objective and unbiased."
A good point to remember is that yields rise as the stock price falls, which is a good indicator that the yield will be unsustainable.
NASD BrokerCheck enables investors to get information on any NASD-registered firm or broker, which includes virtually every securities firm doing business in the United States.
Created in 1988 by the National Association of Securities Dealers (NASD), an investor can learn about the professional background, business practices, and conduct of registered firms and their brokers, and other information such as bankruptcies, consumer complaints, or disciplinary actions by the SEC or the NASD, either by going to http://nasdbrokercheck.com or by call (800) 289-9999 and requesting a report about a particular firm or broker.
Additional links on this site include
On the SIPC Protection page, you can check to see if your broker is a member of the Securities Investment Protection Corporation, which returns money to investors if the broker/dealer holding their funds becomes insolvent.
NASD BrokerCheck does not include information on Investment Advisers (IAs). Instead, go to the SEC’s Investment Adviser Public Disclosure website at http://www.adviserinfo.sec.gov for information about SEC-regulated and state-regulated IA firms. Note that only information about IA firms is provided, not IA representatives, although this will be added in the future.
NASD Manual — Here's a guide to the complete NASD Manual Online.You can also find a list of all state securities regulators at http://www.nasaa.org, the official website of the North American Securities Administrators Association. Click on the Contact Your Regulator link, and then the state of interest. You will also find links to pages within the websites of NASAA members containing information about individual state, provincial, or territorial securities laws, rules and regulations. By clicking on the name of a state, province, or territory, you will be redirected to that jurisdiction's website.
1. Evergreen Solar (NASDAQ: ESLR)
Three-year-revenue compound annual growth rate: 112.0%
3. Overstock.com (NASDAQ: OSTK)
Three-year-revenue compound annual growth rate: 134.9%
6 rules of easy investing:
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