IBM buys back stock - if EPS goes up - should the price?

IBM is in the news because they are planning to buy back a lot of stock $15bn or so. The stock went up on the news. But why? Well buybacks, especially big ones can signal that the firm has a lot of cash or is going to get a lot more cash - thus will be making loads in the future. Buy backs are also good news for firms with cash sitting around. That money is better off in the hands of shareholders rather than being used for some dubious project.

But the reason why the stock price shouldn't go up is due to an increase in earnings. EPS will rise after a buyback purely because shares outstanding (the denominator in the EPS) went down. But net income (the numerator) is unchanged. I suspect that there are a lot of analysts who fix upon a valuation multiple - say 20X earnings, and apply that multiple to any EPS number that comes along. Thus by their reckoning, IBM's price should go up because the EPS went up. This is completely wrong, and frankly pretty stupid.

Link here

People just don't get compound interest.

Compound interest is a wonderful thing, but I always suspect that people just don't get how powerful it really is. One prediction of this is that individuals think that credit card debt is easy to pay off, and that there is not that much benefit from starting to save early.

This paper shows that households do in fact behave in this way, and they offer a theory for why.

But perhaps the simplest illustration of the effect of compounding is the following. Consider $10,000 invested for 10, 20, 30, and 40 years at 10%.

10 years: $25,930
20 years: $67,270
30 years: $174,490
40 years: $452,590

The question then is: If someone gives you $10,000 what should you do with it?

Northern Rock and Continental Illinois

Evan Davis of the beeb draws parallels between the Northern Rock bank and Continental Illinois. If your not familiar with the latter - it was the last big bank run in the US.

Link here

Pay day loans

From Newmark's door and interesting piece on pay day loans. These loans are widely viewed as being some sort of evil money grabbing scheme that exploits the poor. The study finds that pay day loan providers really don't make abnormally high returns. The reality is that the pay day loan business is expensive to operate.

A policy implication then, is that by imposing rate limits, the supply of pay day loans will decline.

A better index to describe subprime woes

Evan Davis of the Beeb has a nice blog about finance related stuff. This article talks about an index that measures the performance of the subprime market. The picture is pretty grim. The line basically drops off the bottom of the chart.

link here Evanomics

Recession worries

Unfortunately, if you start talking about it enough it might happen. US consumer confidence has plummeted. We may be entering the inevitable recession.

Link: BBC

More interest in Yahoo.

First it was Rupert Murdoch's newscorp expressing interest in Yahoo and now it is AOL. Frankly, anything must be better than Murdoch getting a hold of it. But its hard to see how AOL can benefit that much in what would become a marriage of two tired internet brands.

Link BBC website

Northern Rock is nationalized

In a surprise move, the British government has nationalized the Northern Rock Building Society (link to FT article). A building society is like a savings and loan, but it is basically a bank now. Northern Rock had grown aggressively through a practice of making loans and funding them in the commercial paper market. With the subprime collapse they got hit on both sides of the balance sheet.

There had been some talk of a buyout by Virgin. But according to the Government, the numbers didn't add up. Apparently the shareholders didn't agree with this. Their shares were trading for 90p (about $2) and will now be worthless.

This is the first nationalization of a bank for 25 years or so. But the Northern Rock was the first British bank in 100 years to suffer a bank run.

Value weighted returns or dollar weighted returns

We normally compute stock returns using a value weighted index, made up of the stocks in the market weighted by their market caps. But fund managers use a different approach (sort of) - they weight their returns by the amount of money that they had invested in the market. So the months when they were more heavily in the market are more important than the returns from the months when they were not as heavily in the market.

So what - well a study has applied this method to the overall stock market and looked at time dollar weighting the returns based on how much money was invested at a particular time. The results are not encouraging. Market participants are bad at timing the market...For example, the performance of the S&P 500 would fall by 1.4% from 10% a year to 8.6% on a market timing basis.

Article here (source Hal Varian's website and the NY Times)

Words of wisdom on technology

Hal Varian - says “technology changes — economic laws do not.”

Yours truly has said more than once - "it doesn't matter whether you are making computer chips or potato chips - finance is finance"

Its nice to see that I am not alone in this...

Hal Varian is a pretty famous academic economist who consults for Google now. He is also well know to most Business PhD students as his microecon text book is standard reading.

Link from the Freakonomics Blog on the NY Times

Fed rate cuts meet resistance

Despite aggressive rate cutting by the Fed, borrowing costs are going up for home buyers and corporations. Credit spreads have widened as continuing concerns about borrower's credit worthiness continue to worry lenders.

Article here

Source: Bloomberg.

Speeding and stock trading

There's a correlation between speeding and trading too often! Both are examples of over confident behavior. Both are pretty stupid - you can loose your life or your wealth.

New York Times piece

The research is forthcoming in the Journal of Finance.

Link from Finance Professor

Freezing loan rates = bad idea

Freezing prices in a free market is never a good idea. Here Richard Thaler argues why Hilary Clinton's idea to freeze interest rates on subprime loans is just bad economics. I'm inclined to agree with him.

For those who are not familiar with Thaler - he is a renowned behavioral economist from U. Chicago.

Thanks to Newmark's door for this link

MSFT to go to YHOO shareholders

Get out the popcorn and pull up a chair. MSFT is rolling up its sleeves - its gonna be a slugfest.

Yup MSFT looks like they are going to mount a proxy fight - basically try to remove the directors of YHOO.

More credit woes

The Economist has an good piece on how weakening balance sheets of banks is hurting their ability to extend credit.

Yahoo to reject MSFT

It took them a week to figure out a plan, but Yahoo is going to reject MSFT's offer.
Yahoo to reject MSFT

Realistically, this is the appropriate thing for them to do. When you know that your bidder has very deep pockets you owe it to your shareholders to try and get the best price possible. I doubt though, that MSFT will sweeten the deal much. Its still a good deal for YHOO shareholders.


Jerry Yang is clearly playing hard to get and trying to get an extra few bucks out of MSFT. Given that he owns over 40 million shares of YHOO, pushing the price up to $40 per share will net him a gain of over $20 since MSFT originally bid. His holdings will have increased by $800 million!

Bankruptcy Scores

FinanceProfessor talks about bankruptcy prediction and Altman's Z score.

link here

What is interesting is that it is Altman himself making the prediction. Great stuff.

FinanceProfessor also lists a couple of nice sites that show you how to implement Altman's method in excel.