Lumbard & Kellner, LLC

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Lumbard Investment Counseling is a traditional investment advisory firm. located in Hollis, NH.

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Magic


September 9, 2010

We can’t emphasize enough the magic that occurs when a company buys back shares at a ridiculously-low price. If a company sells at ten times earnings—that is, the stock sells for $10 and the earnings are $1—those earnings are 10% of the price of the stock.  The company can pay a 10% dividend, or use all those earnings to buy back 10% of the company’s shares.  If it starts the year with a million shares, it will end the year with just 900,000.

900,000 is a lot smaller than 1,000,000. Even if the company has ZERO growth next year, it’s still going to divide its profits among a much smaller number of shares.  If you do the math you discover that the earnings jump from $1 per share to $1.11 per share.  Management has turned zero growth into growth of eleven percent!!

This is really happening, all across blue-chip-stock land. IBM, Raytheon, and Microsoft have been buying shares.   Lockheed, which sells at just about ten times earnings, just bumped up its earnings forecast by 20 cents because it’s been buying shares at lower-than-expected prices.

In 1999 Microsoft earned 70 cents per share, and paid no dividend whatsoever.  The stock reached $59.56.  Eleven years later the stock is down to $24—no, there weren’t any splits—and earnings per share are up to $2.40. Microsoft is raking in huge amounts of cash that can be used to pay the 2.3% dividend, and buy back huge numbers of cheap shares.  The result will be a near-guaranteed boost to the growth of those earnings per share.

Eventually investors are going to notice that scores of companies are turbocharging their earnings growth in this surefire way that doesn’t depend on the economy, industry growth, or brilliant new products.   Was Microsoft a good stock to buy in 1999, when everybody loved it and the economy was strong?   No. It was a truly awful investment. Is it a good stock to buy now, when nobody gives a damn and the economy is weak? Follow the lead of the world’s biggest and best corporations.  Sell their bonds, and buy their stocks.

                                                  

Please see the Autumn 2010 issue of Insight.

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