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Carlo and I went to high school together about 30 years ago. We remained friends after we left school even though we went our separate ways. Our common thread is that we are both entrepreneurs running our own businesses. After years of not seeing each other, last night we spent a couple of hours together discussing the economy and investing.
Carlo's complaint last night, which is characteristic of many investors today, was that he worked hard all his life, watching what he spent and saved. "But I'm being punished for it," he lamented. Why? Carlo looks at other investors who had less than him, but who borrowed heavily after the credit crisis of 2008 to either buy stocks or buy real estate. And they've done remarkably well.
"I worked hard, saved, and bought bonds. Meanwhile, I lost money because the return I've gotten over the years hasn't kept up with real inflation. What the government tells me is the inflation rate is a lie. I'm upside down!"
Carlo went on and on: "I know people with no education, people who have never ran a business, people who never saved, but they made millions since 2008 because they bought properties, interest rates went down, and real estate prices went up."
The government, by lowering interest rates so aggressively since the credit crisis and keeping them low, "punished savers but boosted speculators," he noted.
Yes, Carlo would have been better off to close his business in 2008 or 2009, take all his money, borrow as much as he could and either have bought stocks or real estate. He would be further ahead by millions of dollars today.
Investing is about risk and reward. The higher the risk you are willing to take, the greater the return. But it can go against you, too. If you borrow heavily to get into an investment and it turns against you, you can easily get wiped out.
By this point in this story, my readers are probably asking, "What should Carlo do now?" That's because I assume many of my readers are in Carlo's situation, too.
If I were Carlo, the first thing I would recognize is that the greatest investor fortunes of our lifetime have been made by getting into investments when they are the most depressed and holding on until they come back.
Today, investors can go out and buy a share of Amazon.com, Inc. (AMZN/NASDAQ) at $300.00 a share. The company lost money in the most recent quarter. It trades at 100-times expected earnings for 2014 and doesn't pay a dividend. There is huge demand for Amazon.com shares, which explains why the price has hit a new record high.
Also, today, investors can go out and buy the shares of Goldcorp Inc. (NYSE/GG) at $28.00 a share. Goldcorp is down 50% from its 2011 high, the stock trades at 14-times earnings, and it pays a dividend equal to a yield of 2.13%. The company produces about 600,000 ounces of gold a quarter at a cost of between $1,000 and $1,200 an ounce. Demand is falling for Goldcorp shares as gold prices have fallen and the company has taken some write-offs to recognize the lower price of gold. By the way, the shares of gold companies relative to earnings are selling at the lowest level in decades.
Sure, there is risk if gold prices fall below $1,000 an ounce. But there is also a huge reward if gold prices go to $2,000 an ounce.
Hence, the risk/reward play is always there for an investor like Carlo to act upon. He just needs to eventually take action on one of those plays when the opportunity is presented.
Michael's Personal Notes:
The second-quarter earnings reporting season is underway, and mainstream stock advisors have high hopes. But what we are seeing is "more of the same" of what we saw in last quarter's S&P 500 company corporate earnings: revenues are lower; corporate earnings are mediocre, and share buyback programs are boosting per-share income.
Take E. I. du Pont de Nemours and Company (NYSE/DD), a constituent of both the S&P 500 and the Dow Jones Industrial Average, as an example. The chemical giant reported corporate earnings of $1.03 billion, or $1.11 per share, for the second quarter. These earnings were 12% lower than the same period one year ago.
Caterpillar Inc. (NYSE/CAT), the mining and construction company that is also a component of both the Dow Jones Industrial Average and the S&P 500, reported a decline of 43.5% in its second-quarter corporate earnings compared to the same period one year earlier; Caterpillar slashed its outlook for the entire 2013 year. The company's profit fell to $960 million in the second quarter from $1.7 billion a year earlier. On a per-share basis, the company's corporate earnings declined from $2.54 to $1.45. (Source: Reuters, July 24, 2013.)
This April, Caterpillar announced its first share buyback in more than four years. The company has or will purchase $1.0 billion worth of its own shares at market prices. (Source: Associated Press, April 25, 2013.) And, of course, this will boost per-share earnings.
Halliburton Company (NYSE/HAL) is one company that reported corporate earnings slightly above estimates at $0.73 per share compared to $0.72 expected. But the company's profit actually went down for the second quarter to $679 million compared to $737 million from a year ago -- a decline of almost eight percent.
So how did Halliburton beat the Street with its per-share profit? In the second quarter, Halliburton purchased $1.0 billion worth of its own shares; hence it reduced the number of shares in circulation, pushing up per-share earnings even though actual profits were lower. Halliburton recently announced it raised its share buyback authorization to $5.0 billion.
Pfizer Inc. (NYSE/PFE), the major drug maker included in the S&P 500, has announced another share repurchase program valued at $10.0 billion -- the fourth increase in its share buyback program in two and a half years, bringing its total share buybacks to $39.0 billion.
This is not what you call real corporate earnings growth, dear reader. S&P 500 companies are barely meeting already-lowered analyst corporate earnings expectations in the second quarter. Hence, these companies are resorting to stock buybacks to prop up per-share profits.
Companies cannot continue the practice of buying their own shares to increase per-share corporate earnings for the simple reason that sooner or later, they will run out of cash to make the stock buybacks. You really have to look at this from the outside in, as they say. If big public companies can't achieve real profit growth, and they resort to share buyback programs to boost per-share profits as a result, how far away can the end really be for the stock market rally?
Originally posted at Profit Confidential
© Michael Lombardi, MBA