Share buyback binge is going strong, investors beware!

Is there anything wrong with this? Yes, it means that companies are spending more money on “financial engineering” than on capital spending. It certainly does indicate that companies are at a loss on how to improve their top line, which is what will ultimately improve the bottom line. It leads to frequent complaints by analysts about the “quality” of earnings.

It’s a very important point. Apple is part of an elite group I call “buyback monsters,” companies that have been aggressively buying back stock for years. Apple’s shares outstanding topped out in 2013 at roughly 6.6 billion shares. Since then it has been down every year and now stands at 5.2 billion.

That is a reduction of 21 percent in shares outstanding since 2013. What’s that mean? It means all other things being equal, the company’s earnings per share are 21 percent higher than they would have been had it not done the buybacks.

But that’s only since 2013 … there are companies that have been doing this much longer. IBM shares outstanding topped out at 2.3 billion way back in 1995, it’s been going down almost every year since then, and now stands at 939 million shares. Think about that. That’s a 60 percent reduction in shares outstanding in a little more than 20 years.

Same with Exxon Mobil, after the Mobil acquisition in 1999, shares outstanding topped out at just shy of 7 billion in 2000 and have been going almost steadily downhill since. There’s now 4.2 billion shares outstanding, a reduction of 40 percent since 2000.

Here are just a few more buyback monsters:

  • Northrup Grumman: 50 percent since 2003
  • Gap: 55 percent since 2005
  • Bed Bath & Beyond: 50 percent since 2005
  • McDonald’s: 36 percent since 2000
  • Microsoft: 30 percent since 2004
  • Intel: 30 percent since 2001
  • Cisco: 32 percent since 2001

Why are there buybacks at all? They were originally used to support the issuance of stock options. The options increased the share count outstanding, so to keep the countdown the company bought back shares. But as the opportunity for significant top-line growth waned, buybacks to reduce share counts became a separate strategy to prop up earnings growth.

What is my beef with buybacks? Part of management’s compensation packages include stock options. Buying back company shares ensures that their stock options don’t expire worthless.  It not only fools investors that the earnings are growing but it rewards poor management.

Take IBM for example, despite being one of the most aggressive buyback monsters on the Street, you can’t say IBM’s stock price has soared in the last decade. In 2014, the company eased off a bit on its buybacks, and the stock headed south. It headed south because IBM was beset by fundamental growth issues: Its revenues from its old line businesses were shrinking and there was not revenue from emerging  businesses (like Watson and artificial intelligence) replacing it.

The lesson: No amount of financial engineering like buying back shares can replace management’s inability to grow the business.

 

 

Is Basic Income the answer to a new AI world?

I am so glad that I am a retired senior. I don’t have to worry about a robot taking my job. Since I have lots of time on my hands to think, I wonder what a new AI world would look like. For example; will my 2 year old granddaughter even need to get a driver’s licence? Will the Uber or cab that she orders even come with a driver?

Now I have always been a big fan of science fiction movies. There is a scene in the movie “Logan” where Wolverine has to dodge driver-less trucks to cross the highway to help some people. Installing AI in 16 wheeler trucks could replace the need for a lot of truckers.

Fast food restaurants have been the training ground for teenagers and young adults.  I used to tell my kids that they better get a good education or you will end up using the phrase “would you like fries with that” while working at MacDonald’s. However, even MacDonald’s are installing new self-serve kiosks. Now you can even order your Starbucks coffee using your phone. Where will young people get work experience?

Everywhere I look, jobs are slowing disappearing, the new AI technology seems to have very few limits.

“For example, Australian company Fastbrick Robotics has developed a robot, the Hadrian X, that can lay 1,000 standard bricks in one hour – a task that would take two human bricklayers the better part of a day or longer to complete.”

Japan has the highest percentage of people over the age of 60 and their population is shrinking. As a nation, there is a shortage of workers and they have embraced the use of robots in the work place. This trend could be coming to North America sooner than you think.

As a baby boomer, I worry about the future cost of health care. The world population is aging and health care costs are raising. I hope that science fiction turns into reality and my caregiver looks something like this.

   or this 

Why universal basic income may be necessary

A 2013 study by Oxford University’s Carl Frey and Michael Osborne estimates that 47 percent of U.S. jobs will potentially be replaced by robots and automated technology in the next 10 to 20 years. Those individuals working in transportation, logistics, office management and production are likely to be the first to lose their jobs to robots, according to the report.

For many, basic income sounds like a free ride or welfare. Economist believe that masses of people will not just sit at home but will make a contribution by continuing to work. The basic income would allow recipients to explore other options not available to them if they are struggling just to survive,  such as retraining or to find new job opportunities.

In theory, new opportunities would spring up to replace jobs done by machines. However, there are some practical problems, like where will government get the money if less people are working to pay for a basic income program? The North American education system would require a major overhaul to put more job training skills into the curriculum.

Some additional information to consider

The government of Ontario just announced a three year basic income pilot project to help low income earners in three cities. A single person can apply to receive $16,889 a year and couples will receive $24,027. Recipients who are employed will keep what they made from their jobs but their basic income would be reduced by half their earnings. For example, a single person earning $10,000 per year from a part-time job would receive $11,989 in basic income ($16,989 less 50 per cent of their earned income), for a total income of $21,989.

Is basic income just a pipe dream or a future reality?

 

 

 

 

 

Baby Buffett loses 4 Billion on Valeant shares

Hedge fund manager Bill Ackman first came to my attention when he invested in Canadian Pacific railroad. As an activist investor, Ackman started a lengthy proxy battle with the board of directors to remove Fred Green as CEO and appoint Hunter Harrison in his place. Not only was Ackman successful but it was very profitable for his hedge fund since the value of CP shares more than doubled under Harrison’s leadership.

In early 2015, Bill Ackman invested in Valeant, another Canadian company. His hedge fund purchase shares around $196 and recently sold all of them at $11 a share. He accelerated his losses by buying call options and selling put options.

Hindsight is of course 20-20, are there any investment lessons that we can use?

 Lesson: Intelligent people are capable of doing very dumb things.

Bill Ackman is clearly a smart man otherwise his Pershing Square hedge fund wouldn’t manage pension fund money. But if you asked the average investment professional /your grandmother whether it is a good idea to stick over a quarter of your assets into a highly levered pharma roll up the answer would tend to be a firm “no”.

Lesson: Position sizing is very, very important.

Always be aware of your risk of ruin, no matter how much you are convinced the odds are in your favor. Regardless of how amazingly smart and brilliant you are and how many hundreds of hours of research you have done, it is perfectly possible that you will lose money on any given investment. Pershing Square had too large a position to simply sell its stake and walk away when things started to go wrong.

Lesson: Highly incentivized management teams can still blow themselves up, and take you down with them.

Part of the original appeal of Valeant to the hedge funds that backed it was how the CEO’s stock options had been structured to make him highly incentivized to get the share price as high as possible. Having management teams with “skin in the game” is clearly important but this does not mean they will not do something very stupid.

Lesson: Auctions are not usually very good places to find bargains.

Ackman admits that he now believes Valeant “substantially overpaid” for Salix, its last big acquisition before things fell apart. A big problem with a role up strategy is paying high prices for third rate assets that no one else in the world is willing to buy.

Lesson: Beware of political risk.

Valeant used aggressive drug pricing to help pay for their acquisitions which got the attention of American lawmakers. Bill Ackman had to testify at a hearing held by the U.S. Senate aging committee which was reviewing escalating drug prices. It also became a big issue during the U.S. 2016 presidential election.

Lesson: Take a loss, don’t let your Ego get in your way.

There is no doubt that billionaires tend to have large egos. Being labeled “Baby Buffett” on the cover of Forbes is quite the ego booster. But there is an old saying, “the bigger they are, the harder they fall”. Ackman’s buying call options and selling put options on a losing position is a clear sign that his ego wouldn’t accept taking a loss on Valeant shares.

Postscript: The share price of CSX railroad jumped up 35% on rumors that Hunter Harrison would be the new CEO. Harrison got the job but can he deliver another turnaround? It may be too early to tell. However, I bought some shares of CSX for my investment club. 

 

Canadian Marijuana bill gives a new meaning to Happy Easter

On Thursday, Liberal Prime Minister Justin Trudeau introduced a bill that would legalize marijuana for recreational purposes. It would be the first developed country in the world to fully legalize pot since the international war on drugs began in the 1970s. The government hopes to clear the parliamentary and procedural hurdles to make pot legal by July 1, 2018.

The bill would allow people to own up to 30 grams of dried or fresh cannabis and sets the minimum at 18 years of age, though provinces and territories can set a higher legal age. Consumers can grow up to four plants at home or buy from a licensed retailer. The federal government will handle licensing producers while provincial governments will manage distribution and retail sales.

Speculators have dived into Canadian marijuana stocks raising concerns of a green bubble. Only two marijuana producers are showing any profits. Most companies are spending money to increase their production facilities in anticipation of increase recreational use. None of the players know the exact size of the recreational market, with sales estimates ranging from nearly $5 billion to roughly $10 billion.

The Canadian marijuana index which contains 12 stocks already has a market cap of over 5 billion.

Marijuana Index Ticker Market Cap
Canopy Growth Corporation WEED 1.61b
Aurora Cannabis Inc. ACB 903.73m
Aphria Inc. APH 898.84m
Cronos Group Inc. MJN 411.54m
Supreme Pharmaceuticals Inc SL 293.17m
OrganiGram Holdings Inc OGI 285.50m
CanniMed Therapeutics Inc. CMED 274.54m
Emblem Corp EMC 205.47m
Hydropothecary Corporation THCX 174.94m
Emerald Health Therapeutics I EMH 126.65m
THC Biomed Intl Ltd THC 77.32m
Naturally Splendid Enterprises NSP 20.90m

Beware that insiders have been selling according to Bloomberg!

“Since March 1, five directors, officers and board members with Canopy Growth Corp. sold 3.2 million shares worth at least $7.5 million, including Chief Executive Officer Bruce Linton, who sold $3.7 million worth of his holdings, according to data compiled by Bloomberg. Between March 1 and April 10, eight executives and the chief cultivator for Aurora Cannabis Inc. sold a total of 4.9 million shares worth $11.8 million, data show.”

A found two companies listed on U.S. exchanges that are in the medicinal marijuana field that look interesting.

 

AbbVie (ABBV) is ahead of the field in medicinal marijuana because its cannabis-based drug Marinol has already been approved by the Food and Drug Administration and is currently being marketed. Marinol relieves nausea and vomiting in patients undergoing chemotherapy. It is also used for AIDS patients who have lost their appetites.

GW Pharmaceuticals (GWPH) could be a growth play in the medicinal marijuana field. With a market cap of $2.16 billion, the company has researched marijuana-based medicines since 1990 and has a promising drug called Epidiolex. The drug has not been approved by the Food and Drug Administration, but it is showing effectiveness in treating epileptic seizures. It is cannabis-based and could gain wide acceptance quickly if approved.

On a personal note, my 84 year old mother suffers from high levels of anxiety. Her doctor prescribed a number of different anxiety drugs but she couldn’t tolerate the side effects. Out of desperation, I convinced her reluctant doctor to refer her to a cannabis clinic for assessment. She has been approved and is currently ingesting small quantities of cannabis oil. It is still too early to tell but I have noticed some improvement.

Happy Easter

Disclaimer: I do not own any of the above mentioned stocks. This post is for educational purposes.

Active or passive investing? Why I now use both approaches

There is perhaps no controversy in the investing world more contentious than active versus passive equity investment management. Members of both camps constantly argue that their way is unequivocally the best, despite real-world results that support one side’s argument one year and the other’s the next.

Blackrock, the world’s largest money manager, is overhauling its actively managed equities business. They are cutting jobs, dropping fees and relying more on computers to pick stocks. This is a clear indication how difficult it has become for humans to beat the market.

“BlackRock  CEO Larry Fink has sometimes expressed disappointment in the performance of the company’s actively managed stock funds, and he has pivoted increasingly to focusing on the company’s data-driven “Scientific” equity teams.”

Most investors seem to be in either the active or passive camp, few use both methods. For years, I have been in the active camp because I use options to make money during up and down markets. However, providers of exchange traded funds (ETF’s) have evolved beyond just offering low cost sector and index funds.

The growing popularity of ETFs have increased competition among providers to attract investors to purchase their products. I have notice an increase in the number of products that include covered call and also some put right options.

                               A Partial list of Covered Call ETFs

Advisor Shares STAR Global Buy-Write ETF (VEGA)
CBOE S&P 500 Buy Write Index ETN (BWV)
Credit Suisse Gold Shares Covered Call ETN (GLDI)
Credit Suisse Silver Shares Covered Call ETN (SLVO)
First Trust High Income ETF (FTHI)
First Trust Low Beta Income ETF (FTLB)
Horizons S&P 500 Covered Calls ETF (HSPX)
Recon Capital NASDAQ 100 Covered Call ETF (QYLD)
S&P 500 BuyWrite Portfolio ETF (PBP)
BMO Covered Call Canadian Banks ETF (ZWB-TSX)listed on the Canadian TSX stock exchange
BMO Covered Call Dow Jones Industrial Average Hedged to CAD ETF (ZWA-TSX)listed on the Canadian TSX stock exchange
BMO Covered Call Utilities ETF (ZWU-TSX)listed on the Canadian TSX stock exchange
BMO US High Dividend Covered Call ETF (ZWH-TSX)listed on the Canadian TSX stock exchange
First Asset Can-60 Covered Call ETF (LXF-TSX)listed on the Canadian TSX stock exchange
First Asset Can-Energy Covered Call ETF (OXF-TSX)listed on the Canadian TSX stock exchange
First Asset Can-Financials Covered Call ETF (FXF-TSX)listed on the Canadian TSX stock exchange
First Asset Can-Materials Covered Call ETF (MXF-TSX)listed on the Canadian TSX stock exchange
First Asset Tech Giants Covered Call ETF (CAD Hedged) (TXF-TSX)listed on the Canadian TSX stock exchange

A key advantage of ETFs with covered call option writing is investors have some downward protection during these uncertain times. Plus you don’t have to be approved by your financial institution to trade options. Keep in mind that the management expensive ratios are going to be higher than index funds and these ETFs are also fairly new so it may be difficult to evaluate their past returns.

 

Disclaimer: These are not recommendations, do you own research before investing.

 

 

 

 

Still doing tax returns for my adult children & their spouses

Every year I ask myself, should I continue to offer to do tax returns for my adult children and their spouses? All of them have university degrees and are smart enough to file their own tax returns. My daughter was willing to do it one year using tax preparation software with only a little help from me.

Part of my problem is Canadians are not even aware of how much tax they pay. Plus we keep voting for governments that buy votes using our tax dollars. The average Canadian family will pay 42.9% of their income in taxes imposed by all three levels of government in 2016. (Federal, provincial and local) Tax freedom day was June 7, 2016 if Canadians paid their total tax bill up front. Our U.S. neighbours tax freedom day was April 24th and they will only pay 31% of their income in taxes.

There are a number of reasons why I continue to offer to do tax returns for the whole family. Having worked as a financial advisor, tax planning is a key element when putting a financial plan together. My tax knowledge and skill comes from working many years with accountants and tax lawyers ensuring that my whole family pays the least amount of tax.

Plus, the Canadian tax system is very complicated and is constantly changing with every federal and provincial budget. For example: many tax credits that were given by the Conservative government have been taken away completely by a new Liberal government.

For the 2015 tax year, the Liberals cancelled income splitting for families, a maximum tax credit of $2,000 for transferring up to $50,000 of income to a spouse with a lower income if they had a child under 18 years of age.

Some changes for 2017 include the elimination of the following credits:

  1. Education and textbooks credit
  2. Children’s fitness credit
  3. Children’s arts credit
  4. Public transit tax credit

Now, most retired Canadian seniors who don’t have a pension from their former employer are not even aware of a $2,000 pension credit. It requires opening a RRIF account, transferring $2,000 from their RRSP and then taking it out. They don’t have to wait until they reach the age of 71 in order to open a RRIF account. Plus, RRIF income can be split with your spouse if both of you are 65 years of age which could potentially add up to $4,000 of income tax free per year.

The Federal Liberal government will introduce a new budget on March 22 and there are rumors of more tax increases. Three things that Canadians should worry about;

  1. Higher capital gains inclusion rate from 50% to 75%
  2. Reducing the dividend tax credit
  3. Taxing your principal residency 

I will end this post with two well known proverbs. ” In this world nothing can be said to be certain, except death and taxes.” & “A penny saved is a penny earned.”