International Business Machienes (IBM) Strong Investment

IBM is a one of the largest technology companies in the world. The company is facing substantial headwinds right now in the form of lower revenues, but it is mainly a short-term concern that investors should take advantage of and buy on the dip.

Shareholder Friendly

IBM spends billions every year buying back its own shares, and has one of the largest share-repurchase programs in the entire market. This builds shareholder value over time, as there are less shares outstanding to evenly distribute gains among, so that each share earns more of a percentage of the total company’s earnings. The company began repurchasing their own shares in 1995 and has since then halved their total shares outstanding by reducing an average of 50 million shares from its total shares outstanding yearly (adjusted for splits). This massive repurchase program has continued through thick and thin, pausing only slightly during the 2000 tech bubble for one year. The company did not pause their buying spree in 2008, however, and therefore succeeded in buying back their company’s stock when it was cheap, allowing for a set amount of money to be able to buy back more shares than if the share price were to be more expensive. The company has also increased their dividends for 18 years straight, and it currently sits at an acceptable 2.4%. Also, the company’s payout ratio is considerably low, at a modest 24% of its annual net income. This is important, since low payout ratio companies with medium to high dividends tend to outperform in the long-term, as demonstrated by many studies in that area. Investors should keep in mind, however, that IBM’s management prefers to create shareholder value through share repurchases, not dividends. Therefore, the majority of created growth in IBM is intangible, since it is being driven with share repurchases. Only the EPS numbers and company announcements will reflect how much of an impact the repurchases have had on the company’s stock.

Strong Moat (Competitive Advantage)

IBM has survived and thrived for many years through its competitive advantages. IBM’s main customers are large corporations that require its products for operations and are quite reluctant to change their usage of IBM’s systems. A good example of this is in China, where the Chinese government, fearful that U.S. technology corporations are spying on them for the government, is urging companies to change their operating systems from IBMs. The companies response was that there was little to no alternative to IBM’s systems, which are the only ones with the processing power to carry out their data. They also stated that it would take too much restructuring and change that is completely unnecessary. In America and other countries this effect exists as well, and with IBM being the most recognized brand in its industry, companies will tend to stick to it as it gives companies satisfactory results.

Current Condition of IBM’s Stock

Investors absolutely detest IBM’s stock right now. The company was the worst Dow performer in 2013, and was also the only company that was negative at the end of the best year for stocks in more than a decade. This was due to revenue concerns by investors, since revenues have been flattening out and falling in the past few years. This was completely unexpected, as IBM is such a large corporation that should be able to generate steady cash flows and increase revenues over the long-term. Investors in the company, however, need not worry about these issues, as the company is currently going through an immense restructuring program that will leave it as a primarily software company, instead of its old position as a technology hardware company. This is a great idea from management, as there is much room for growth in areas such as the cloud right now, and IBM is trying to poise itself to profit from that growth. The company’s management is also very productive and knows what it wants to do. This is shown by the company’s 5-year “road maps” that take the form of EPS (Earnings Per Share) projections into the future. Management sets very high expectations for the company and works to met those expectations in the future. The company well surpassed their last 5-year road map, and are well on their way to a $20 EPS in 2015 (the company had $16.26 in EPS numbers in 2013).

Investors should recognize that IBM is extremely undervalued at this time, and right now represents a great time to buy into an undervalued and strong tech giant.

 

The TJX Companies (TJX) Another Good Buy For a Recession

TJX is a parent company that owns many off-price discount retailers. Marshalls, TJMaxx, and Home Goods are it three U.S. names, and it also owns multiple foreign discount retailer names.

Business Model (Discount Retailer)

TJX focuses on selling fashion and home fashion names for discounted prices, offering consumers the ability to purchase comparable merchandise for cheaper costs than leading retailers. This business strategy is strongest when other companies are the weakest: recessions. While still focusing on fashion shopping, consumers may find themselves stranded for money during recessions, and TJX allows them to buy what they want for cheaper prices. TJX’s stock price easily outperformed the overall market indices during the 2008 Great Recession as well as the recession in 2000. Discount retailers have gained considerable admiration from investors and customers alike in the past few years, depicted by the company’s rapid upwards share price movement as well as uptrends in revenues and net income easily surpassing the market averages. This will help TJX considerably in the next recession, as it is now much more recognized than it was before, which will contribute to more customers turning to the company when hard times hit.

Shareholder Friendly (Buybacks and Dividends)

The company is also remarkably shareholder friendly through stock buybacks and consistently increasing dividends. The company has increased their dividends for over 15 years and show no signs of slowing or cutting their dividend. In fact, the low payout ratio of just 20% shows that the company has much room to grow their dividend and continue their streak. Also, the company has been aggressively buying back their own stock for over 15 years as well, and have almost halved their shares outstanding since that time point. The company consistently builds long-term shareholder value through dividends and stock repurchases, and will likely continue this trend in the future, as there are no foreseeable headwinds for the company, and it cash flow and revenues remain strong as ever.

Current Share Price Conditions (Lower Consumer Spending)

The current share price of TJX is not doing considerably well. After having a large run-up since 2008, shares have been very lackluster in the past few quarters as lower consumer spending has hurt both earnings and future prospects for the company. Of course, all of this is completely irrelevant to the company’s long-term ability to grow, and investors should view these minor short-term problems as a buying opportunity into a strong company that trades at a 16% discount to its peak prices a few months ago. Consumer spending for certain will pick up in the future, and investors need not to worry that the current short-term headwinds will hurt TJX in the long-term.

TJX is one of the most shareholder friendly companies I have ever seen that also offers great growth potential and protection against recessions. All investors should consider the company as a holding in their portfolio.

Western Union (WU) Undervalued

Western Union is a money-movement company that has been beaten to a pulp in the past few years. The main contribution to such negative investor sentiment is the rise of new competitors to Western Unions business, mainly companies that facilitate the money-movement system through online and technological ways instead of  Western Union’s methods which typically involve physically going to a Western Union counter and picking up or sending the money yourself.

Wrong Mindset for Bears (Western Union’s Business Not at Risk)

Bears on the Western Union train continuously state that new companies such as Paypal are significantly more efficient at transferring money than Western Union. This fact is very true, but the problem is that the two companies don’t target the same customer base. Western Union’s main customers are consumers that don’t have phones or tablets of laptops, so they are forced to use Western Union’s “old-fashioned” ways of doing things. So to say, it’s entirely plausible that both Paypal and Western Union are successful as companies, as they do not operate in the same part of their industry, since their consumer bases are different. Bears would then argue that technology that can access the internet and use systems such as Paypal are continuously gaining popularity, and as world economies prosper, as will their citizens, thus giving them money to buy these technological advances. This is not exactly true in the foreseeable future. It would take years, if not decades, for the countries of the world to all develop and prosper as much as countries like America and the European Union, and while the gradual shift to online forms of money-movement may hurt Western Union’s earnings, no proof of that happening exists in the past few years.

Financial Structure (Earnings and Cash Flow Remain Strong)

For the past decade, Western Union’s revenues have grown consistently higher, as have their EPS (Earnings Per Share) numbers. This gives no proof whatsoever that the bearish case is playing out in any meaningful way. How could a company be losing customers and still gaining in revenues and earnings? The company has also been averaging a little more than $1 billion a year in cash flow, allowing it considerable room to expand its dividend and share buyback programs. They also still control the vast majority of market share in their industry, as the next largest competitors have 4 times less revenues than Western Union.

Shareholder Friendly (Dividends and Buybacks)

Western Union’s dividend streak has been somewhat choppy, but they have managed to increase their dividend considerably for the last decade, giving the the current yield of 3% annually, a very nice amount for the average investor. The payout ratio for the company is also only 35%, which gives them even further room to expand their dividend. The company is also an avid share repurchaser, having reduced its total shares outstanding over 26% since 2007. They have shown no signs of slowing their repurchasing program, and management has already authorized another $500 million in repurchases in 2014.

Low Valuations (P/E Ratio, High Short Interest, Low Share Price)

Western Union’s share price has remained in the same relative are for the past 6 years, ever since the Great Recession. This is due to the sell-offs that the rise of competitors have caused for the company. Now, however, these sell-offs have worked for the bullish case, since the company now trades at a measly P/E ratio of 10, well below the current S&P P/E ratio, as well as the industry average for Western Union. Also, the company has a very high amount of short interest; about 12% of its float is in shorts. Although this may sound like bad thing, it too works in Western Union’s favor, as there are many people betting against the company, so much of the downside it can see is already priced into the stock. Likewise, the sell-offs that Western Union has experienced only mean that there are more people waiting on the sidelines, and, if they see something good come out of Western Union, such as evidence that the rising of competitors does not adversely affect Western Union’s business, then there is a higher base of investors that would buy into the company, since it is so oversold. Although this manner of thinking may sound relatively flawed, especially if current trends continue, when applied to a strong business (or the stock market in general), it proves very fruitful. For example, in destructive recessions like 2008, everyone was selling. But the sheer amount of selling in the market forced prices to go up, since there was so much money out of the market that money had nowhere to go but back into it, driving prices back up. And vice versa for excessive bull markets such as 2000.

Western Union is an extremely recognized and respected business that commands a major market share; bears are misinterpreting the new rise of competitors to its industry, and heavy selling the the short term can only lead to heavy buying later on.

 

Some Notes on Dividends That Investors Should Never Forget

Dividend Subtracted From Share Price

For any investor in a company that seeks dividend income from that company, some things should be known. The first is that any money paid out in dividends will be taken directly from capital gains of the stock. This means that if a company gives you a 5% dividend annually one time, on the ex-dividend date (the date the dividend is recorded in a company’s books) the company’s stock price will fall 5%, since they are essentially giving away 5% of their money to their shareholders and it is no longer their money.

Payout Ratio

Another thing to be understood by dividend investors is what the payout ratio of the company is and how it affects the dividend. The payout ratio of a company is the percentage of cash flow that goes to paying the company’s dividend. This number is important, since a high dividend isn’t necessarily good if it eats up all of the company’s cash flow and the company is spending all their money on the dividend. A low payout ratio for a company is therefore a good thing, as the company has a lot of room to increase their dividend without necessarily having to earn any more money from their base operations. Any payout ratio above 50% for a company is probably too high, although certain industries like consumer goods and food don’t really have anything else to spend their cash on, so the majority would go to shareholders.

Reinvest or Not?

It is common to ask oneself whether or not to reinvest dividends for the companies one owns. Reinvesting dividends does seem like a good idea, after all, after 10-20 years of a good stock market run with an average yielding (2-3%) dividend, reinvesting would secure double the market gains than if one put all the money into a giant cash pile. Then one thinks of the giant cash pile you would’ve accumulated throughout those years and wonder: if I had taken the hundreds or thousands of dollars I got in dividends every year and invested them into different companies, more undervalued and better poised for growth than the dividend paying company I had, would I have wound up with more money in the end? Perhaps. And many investors prefer to think that they can reinvest the dividends back into the equity or fixed income markets better than just throwing it all back into the same company, for there will always times when that company turns overvalued and would be a very bad buy, however there are a number of things investors need to be aware of before they reinvest the dividends themselves. First, dividends are taxed at a higher rate (in the U.S) than capital gains. This means that if you take your dividends as cash and reinvest them, you would have to pay the higher tax on the dividend than if you reinvested it into the same company where they would turn into capital gains. Also, trade fees are needed to spend the dividend on other investments, and DRIPs (Dividend Reinvestment Program) don ‘t charge trade fees for repurchasing the same company. This way, you are forced to earn substantially more if you choose to reinvest your dividends just to earn the same amount as if you reinvested into the same company.

Further Notes on Reinvesting

DRIPs work as a form of DCA (Dollar Cost Averaging), where you put the same amount of money into your stock(s) every set time period (e.g. every month you buy $100 of company ABC, buying more share when it is low and underpriced and less when it is up and overpriced). This method of investing proves very fruitful in the long run, as you are accumulating good companies all the time, but are buying more on dips and less on tops. Also, dividend reinvestment should be all but required for your strict long-term companies. I view my long-terms (the vast majority of my portfolio) as the best investments in the entire stock market, and I would be more than willing to pay large premiums to buy them, as I think they are good companies no matter slight overvaluation. I reinvest dividends for all of these companies, since I am willing to buy them all of the time, and DRIPs allow me to slowly grow my positions in these companies.

American International Group (AIG) Trading at a Large Discount to Book Value

AIG is an insurance company that has operations all around the world and in the United States. The company was hit extremely hard in 2008 due to its insurance against CDO (collateralized debt obligation) defaults. This in turn caused the company to get hit hard in the housing bubble, when  it had to pay back almost all of its customers. The stock dropped 95% in a matter of months and the company had to get bailed out by the government. Investors even now are avoiding the company just because of these catastrophic losses. This is an oppurtunity for you and me.

Undervaluation (Low P/B ratio)

The company’s current P/B (Price to Book) ratio is a measly 0.72, meaning that the company’s total assets minus liabilities is currently higher than the market cap, meaning that you’re buying the company for less money than everything it owns minus everything it owes, meaning that you’re essentially paying 72 cents for every dollar worth of the company. Now, this sounds like a real bargain deal: automatically earning 50% on all of your money invested? Is that even possible? Essentially, that is what this low P/B ratio would mean, however, there is always the possibility, however small, that the company will get hit again like in 2008 and drop another 95%, or stay at this low P/B for years, if not decades to come. More likely, the company will slowly grow back to a P/B ratio of about 1, perhaps faster than the market, perhaps not, but AIG definitely remains severely undervalued for the insurance giant it is, and share prices should be much higher than they currently are.

Growth Driver (Share Buybacks)

Essentially share buyback programs are just made to increase the amount of money each investor earns for every dollar the company earns, since there are then less shares to divide up the profits to. Many great investors, including Warren Buffett, advocate for share buyback programs in companies, but only when shares are cheap. There is no better waste of a company’s money than initiating share buyback programs when shares are at their peaks. unfortunately, when shares are at their peaks is typically when the company is doing the best and generating the most profits, so naturally they decide to make a share buyback program with the extra money at the worst possible time. Then, when the recession rolls over and the share prices drop 50%, companies find that they don’t have the money anymore to fund a share buyback program, and, while they could’ve bought back double the shares in the recession, they chose to do the buyback program when their shares were dramatically overpriced. Fortunately for investors, AIG’s stock is fundamentally cheap on valuations, and their management, recognizing this, is doing the smart thing and initiating large share buyback programs to reduce the share count now, before prices go up. They have already approved a $2 billion share repurchase program on June 5th, 2014, which will reduce their total shares outstanding by 4-5% this year alone.

In conclusion, AIG is a great company trading at a very depressed price to book value, which will definitely increase in share price in the months and years to come. The company is taking large lengths to reinstate their dominance in the insurance industry after the collapse in 2008, and management is buying back stock at a very opportune moment, creating long-term shareholder value in a great company.

Chubb (CB) Good Buy for a Market Correction

Low Volatility (Bond Investments)

Chubb is a property and casualty insurance company that has very low long-term volatility. The main contributive factor to its low volatility is the where the company invests their float (premiums paid to insurers by customers). The vast majority of the company’s investments are in high-quality bonds, which have a very low correlation to stock market prices. This conservatism causes Chubb to do significantly better than the overall market in times of stock market drops, since its investments aren’t in stocks, which would go down with the market, but are in bonds, which drop very little to no amount in value when the stock market plunges.

The Current Company Situation (Low Valuations and Shareholder Friendly)

Chubb’s current valuation metrics (P/E ratio, P/B ratio, PEG, etc.) are all very low and none of them present any reason to believe the company is overvalued. In fact, the low P/E ratio of only 10 gives the company a very undervalued feel, although it is fair to note that other insurance companies (Travelers, AIG, etc.) also trade at very low P/E ratios of 10 or lower. Also, the company’s management is very shareholder friendly: in addition to increasing the company’s dividend for an astounding 32 years in a row, they have also managed to almost halve their shares outstanding through share repurchases since 8 years ago. All in all, Chubb is a great investment if investors are looking for a good company that won’t totally die in a market correction.

Pinnacle Foods (PF) High Growth Potential With Multiple Risk Factors

Pinnacle Foods is a small food company that you’ve probably never even heard of. This is because they own a number of different brands that all fall under their company name. Bird’s Eye, Duncan Hines, and Vlasic are just some of the numerous brands that Pinnacle Foods owns. Never even heard of those brands? Doubtful. Pinnacle Foods estimated in their annual report that their brands are currently in over 85% of American households. That’s a very large number.

Business Strategy

Pinnacle Foods’ management has stated that their business strategy is to both grow their Leadership Brands, namely Bird’s Eye and Duncan Hines, and to ‘reinvigorate iconic brands’. This is the company’s slogan and what they thrive on. Basically Pinnacle Foods buys brands from other companies that used to be very popular but have now fallen slightly from grace. They buy the brands at cheaper prices since they are less loved and generate less income, they turnaround the brands and grow them again to their old status. A recent example of this is the acquisition of Wishbone from Unilever. Wishbone makes different varieties of salad dressing and the company has not been doing as good recently as it had in the past. Pinnacle Foods just bought the company last year from Unilever, and it is now time to see whether or not the acquisition will prove fruitful in the future. The company also takes many measures to try and grow their Leadership Brands, the highest-margin and highest growth-potential category of their brands. Pinnacle Foods’ CEO is Bob Gamgort, the former CEO of Mar’s Incorporated. He has had over 25 years of experience in the food industry through Mars, and took over Pinnacle Foods in 2009. I believe he is well suited for the job and is an experienced and strong leader.

Risk Factors

The company market cap is only currently $3.6 billion, and although that sounds low for a company of such magnitude, it is actually relatively high based on Pinnacle Foods’ annual net income, since the P/E ratio of the company is 34, more than double the S&P 500’s. Another risk factor of the company is the above-average amount of debt that they have, nearly $2.5 billion. Management has assured shareholders that their first priority is reducing the debt load, but with a payout ratio of 84%, they seem to be focusing more on dividends than anything else. Net income hasn’t been growing at all for the past few years, and any dividend growth potential in the years ahead could only be achieved by an increase in net income, as the payout ratio is so high.

How to Do Better Than the Vast Majority of Investors (Emotional Tolerance)

When to Sell (And When Not To)

Long-term investors need to recognize one thing about themselves: that they are investing for the long-term. That means that no matter how many recessions there are, how much their investments go down, or how many bad earnings their companies give out, they shouldn’t sell. Sell a company only if there is something fundamentally wrong with the company that was bought, or because the reason you bought the company no longer exists. But never sell a company because it is down. If all the underlying fundamentals of the company that was bought are still healthy, then the smart move would not be to sell and lock in the losses, but to buy more and profit from future gains. Likewise, if a company goes up but its underlying fundamental are deteriorating, then it would be prudent to sell the stock, even if it is in the middle of an uptrend. Investors need to look at all of their investments with a calm head of thoughts. Too much money was lost selling at the bottom of bear markets through fear of losing more money, or buying at the top of bull markets in fear of missing out on future gains.

What to Do

Investors need to develop the emotional tolerance to see a recession, but also see great opportunities to buy good companies at cheap prices. Investors shouldn’t sell in a bear market just because their investments are down, they should buy more. Investors also shouldn’t buy in overheated bull markets, as there is a great chance a bear market is following, which would provide an even better entry point for the company they were considering buying. Emotional tolerance is what is needed in order to perform these actions without hesitation or fear. Think back to the financial crisis of 2008, or the internet bubble of 2000. What did you do back then when everything was down 50%+? Did you sell and lock in all of you losses, never to return to the market again? Did you calmly wait for everything to blow over and refuse to look at your investments until they were up again? Or did you buy more and more as the market went down more and more, seeing opportunities where everyone else saw a money-eating machine? Don’t sell because things are down, or buy because they’re going up. Buy when you find a fundamentally good company that you think will do well in the future, and sell when those fundamentals deteriorate.

Coca-Cola (KO) Strong Investment

The largest and most recognized beverage company in the world, Coca-Cola has put its mark on the world in a variety of ways. Coca-Cola’s name is everywhere: the World Cup, TV commercials, baseball games, and even on vending machines that sell Pepsi, its main competitor.

Marketing Strategy (Advertisements)

Coca-Cola’s marketing strategy is to associate anything that brings happiness and joy to people’s with its own brand. Just saw your team score in the World Cup? Coca-Cola conveniently pops up right afterwards just to remind you of their proud sponsorship of the event. Through this tactic Coca-Cola has become the largest beverage company in the world, and people from everywhere recognize Coca-Cola’s name and logo. Did you know Coca-Cola is the second most recognized word in the entire world (Right after “okay”)? The company spends billions in advertisements all around the world, spreading its name to everyone and making you think of it whenever you think of any event that made or makes you happy.

Loyal Consumer Base (Secret Recipe)

Immediately when someone becomes thirsty for a soda Coca-Cola springs to mind, and with such a loyal consumer base Coca-Cola’s customers will never leave its side. This can also be attributed to Coca-Cola’s “secret recipe”, a heavily guarded secret to how exactly to make Coca-Cola’s concentrate. This “secret recipe” has consumers addicted to its product. This was proven early in Coca-Cola’s history when rival Pepsi first came out. Coca-Cola immediately began to rapidly lose customers to the rival business, and management finally came to the decision to change the recipe for Coke which had remained the same ever since the company started. The reaction was immediate. Consumers were outraged. Coca-Cola was under attack from almost every direction as new reporters called it “the worst marketing blunder of the century” and consumers called and wrote to the company in deep anger. Coca-Cola was forced to revert the recipe back to the original in just a matter of months. Ironically, from then on Coca-Cola thrived while Pepsi could only watch and wonder at the power of its business.Many people back then insisted the management had changed the recipe on purpose, knowing that that would happen, but management consistently denied it and people were forced to believe that the “worst marketing blunder in history” turned out to be one of the best marketing ventures ever after just a few months. Also, Warren Buffett, a long-time and proud holder of Coca-Cola’s stock, has also said Coca-Cola has no “taste-memory”, so people will never get tired of drinking it and will keep coming back for more.

Long-Term Expansion for the Credit Industry

The credit industry is one of the best industries poised for growth in the future. Global consumer shifts into techonology-based forms of transactions leave credit card companies in the best position to profit. The four dominators of this industry (pictured above) have already seen incredibly fast and aggressive growth of their share prices.

Prospects for Growth (Developing Markets)

While mature markets like the United States and much of the European Union have already adopted credit cards as their primary forms of transactions, developing markets around the world still hold many prospects of expansion for credit companies. This ensures that large credit card companies already have a reliable consumer base for consistent earnings (developed markets), and also gives the companies lots of room for expansion (developing markets).

Business Structures (Credit and Banking)

Of the four companies in the above picture, Visa and MasterCard operate solely in the credit industry, and derive a vast majority of their profits from that industry. American Express and Discover are credit card companies, but also have banking segments of their companies that they earn money from. This added bit of diversification may prove to be useful in the future as they have something to fall back on if the credit industry takes a hit, but could also hinder their long-term growth prospects as the credit industry definitely has more growth potential ahead of it than the mature and consolidated banking industry. In the end it comes down to how well management steers the company, regardless of the industries they operate in. Also not mentioned in this blog is Capital One, a somewhat prominent credit company, although not possessing nearly as much market share in the credit industry as any of the above companies. Capitol One’s banking exposure is much larger than American Express or Discover, though, and is a likely candidate if you would prefer more a company with more banking operations than the four prominent credit companies.