IBM and Buybacks

Awhile ago, I mentioned IBM as a company that has done well for its investors, even though it has pursued a very active stock buyback program. I'd like to take a second look at this poster boy for the strategy.

An item in a recent Barron's magazine points out that IBM's earnings per share have risen sharply since 2007, but largely due to its very aggressive program of stock buybacks.   Outstanding shares have been reduced by 25% in this period, meaning that its earnings are spread over fewer shares, thus raising earnings per share. This is the flavor of the month in the world of stocks.

The company recently announced ANOTHER stock buyback, this time $15 billion, bringing the total since 2007 to $75 billion.  That's a huge figure.  People talk all the time about Apple's cash hoard, but IBM has offloaded over half as much of Apple's total hoard in the last six years!

On the face of it, IBM's ten year story is compelling.  In 2003, the stock was roughly $91 per share, in 2007 $105, and now $176, a rise of nearly 100%.  The stock has outperformed the S&P 500 index by about 50%.  Much of the outperformance coincides with the huge stock buybacks initiated in 2007.  Interestingly, though, gravity seems to be kicking in.  A fast rise following the latest buyback announcement has fizzled, and the S&P gap is shrinking rapidly.  By the way, if you look back over longer periods (25 years or more), IBM looks anemic, underperforming the S&P 500 vastly since 1988. Does that matter?  Well, if you're over fifty and have owned IBM for awhile, it probably does.

In 2006, the company earned $9.7 billion, which rose to $16.6 billion in 2012, a rise of 70%.  (For a ten-year comparison, the company earned $7.58 billion in 2003, with a rise in earnings of more than 100%).  That's impressive, especially since sales have risen far less rapidly (from $91 to $104.5 billion since 2006.  These guys know how to make money, and they've been able to increase net earnings sharply even as revenue growth has slowed greatly.  Still, that slow growth is sobering.  Can the upcoming decade offer a similar bottom line of high profit on meager sales?  Color me skeptical. 

Let's do two run-throughs.  First, let's assume an investor who has sold shares to take advantage of the buybacks.  Assuming an initial position of $105,000 in 1997 (1000 shares at $105 per share), this individual would have sold off 250 shares (25% of the entire position) at an average price of $140, netting $35,000.  The remaing 750 shares would be worth $132,000, or a total of $167,000.  This would be a 59% gain over seven years, with taxes due on the shares sold.

The buy and hold investor would still own 1000 shares, presently worth $176,000, a bit better than the seller, even before taxes! That's interesting, isn't it, Carl Icahn fans?  Grabbing the cash isn't necessarily the better option, at least short term.  Long term, well, we'll see.

Now, has this wash of cash into buybacks really been shareholder friendly?  Let's imagine a scenario where IBM had not bought back shares.  There would still be 1.5 billion shares outstanding.  The PE ratio would now be 10.9  instead of 15.  Unless you believe getting rid of cash actually improves a company's ability to earn money, you would assume earnings would, at the very least, have held steady.  Therefore, I would expect the market to value these earnings at the same 10.9 PE as now.

But, IBM would still have the $60 billion in hand, at a minimum, to add to its present $12 billion!  That constitutes nearly 1/3 of its present market capitalization of $197 billion. The additional $60 billion would amount to an additional $40 per share. At a minimum, therefore,  I calculate that the stock price would be $229 a share, or 30% higher than it is now.  

And as to net income, would it really still be flat?  Could IBM have done nothing with that extra $60 billion, other than toss it overboard like chum?  Surely they could have used it to earn a modest amount more, perhaps 10% over these last six years?  After all, I've already agreed that these guys know how to make money.  The extra $1.6 billion in earnings would (at a P/E ratio of 10.9) add another $11.6  to the stock price, so $237.6.  So I think it's entirely reasonable to assume that IBM, as a company, would now be worth nearly 35% more if it had eschewed the buybacks. 

Now we get to the crux of the issue.  Earnings that would "normally" generate a PE of 10.9 are sitting out there today with a PE of 16.  Since today's IBM is clearly weaker financially (by over $60 billion) than the hypothetical one, why would this be?  Obviously shareholders are expecting future buybacks, as IBM has obediently just promised.  What would happen if the company reneged on the promise, or simply failed to repeat a future renewal?  Bad things!  Buybacks inject steroids into stock prices; withdrawal symptoms would (will) be severe.

Now is this potential stumble any different than that following the suspension or reduction of a regular dividend? Stock prices plummet in both cases.  So what's the difference?  Well, look where the money goes. Dividends go to all shareholders.  If they are regular and predictable and rising, shareholders benefit greatly.  They build retirement portfolios on these "safe" earnings.  Buyback money goes to the sellers of stock, who must generally pay taxes on the gains.  Non-sellers might see a temporary rise in stock prices, but are vulnerable to the end game.  Substantial buybacks (like IBM's) clearly weaken a company, often just prior to market turbulence and a frantic need for cash.  And by the way, the most publicly acknowledged flaw of stock buybacks is terrible timing.  CEOs initiate them when they have money in hand, which usually coincides with high stock prices, and terminate them in downturns, when their stock is actually cheap.  This is classic buy-high/sell-low behavior. 

But, you say, IBM's game has been going on for seven years, with nice results.  Even Warren Buffett jumped in in 2011.  Why worry?  Well, what should be worrisome for IBM shareholders is that recent flattening of income.  The growth rate of earnings has been declining for five years, even as earnings per share have jumped.  Retiring shares has masked this troubling trend.  Hmm, could that actually be the point of the exercise?  Specifically, think about who gains by manipulating the stock price.  Who gets immediate rewards in stock options exercised as soon as humanly possible, and floats serenely into the sunset on golden parachutes when the storm ultimately strikes?

Update: Nearly a year later.  The same trends I discussed above continue.  IBM's revenue for 2013 declined 4.55% to $99.75 billion from 2012.  This year, the earnings drop continues, at a 4% pace.  In the first two quarters of 2014, the company bought back nearly $12 billion worth of shares.  The stock price?  Absolutely flat, year to date!  While the market is reaching all-time highs, IBM is limping along below levels reached in 2011.  All that money poured into buybacks, and the stock has gone nowhere!  Since the company's plan is to "only" buy back another $3 billion this year, what is likely to happen when the binge stops?  Of course, these wizards could simply declare another giant buyback program (how about $20 billion this time?).  The point is: no amount of trickery can evade the inevitable reckoning.  IBM is shrinking, and eventually the market will punish it for the lack of real growth.  Throwing away its lifeblood (cash) will only make the painful adjustment to reality worse.  Folks, if a company has nothing better to do with its precious cash than stock buybacks, you should RUN away!  Where?  Well, that's a difficult question, but I'll try to explore some ideas in my next post.

Update (October 21, 2014):  A couple of weeks hence, and 2014 third quarter results are in.  It's not pretty.  Operating earnings for the quarter fell 10%, resulting in a nasty drop in the stock price to $169.  So, in a year when the stock market rose steadily, IBM has dropped seven points, despite pouring $15 billion into buybacks!  The New York Times has an article that is music to my ears: The Truth Hidden by IBM's Stock Buybacks.   It points out that the company's revenue has been flat for TEN years, it has spent $108 BILLION on buybacks, $30 billion on dividends, $59 billion on capital expenditures and $32 billion on acquisitions. That $1.50 out the door for every $1 invested in the business. The article suggests that IBM has "been spending its money on the wrong things; shareholders, rather than building its own business".  I would correct that a bit: ex-shareholders have been the real winners.  The only sure way to take advantage of a buyback is to sell, after all.  The article also mentions a "dirty secret": buybacks "can have an impact on executive compensation by goosing certain metrics that boards use to measure a company's performance."  Good for the executives, bad for the shareholders, bad for the company.  The bottom line here is that the value of an investment is ultimately determined by the company's earnings stream.  No amount of financial voodoo will change that fact.  IBM's extravagant cash spew has clearly weakened the company's ability to grow earnings (through investment and acquisitions), and there will probably be hell to pay.  Warren, you might end up owning a larger share of the company due to buybacks (his rationale for climbing on board, while blithely rooting for a long-term flat stock price!), but it's a far weaker company.  Do you seriously think IBM would have NO use for that wasted $108 billion in today's dog-eat-dog world?

Update: February 1, 2015.  The saga continues.  IBM is now down to $152, a point last seen in early 2011.  This is because the company's revenue is below what it was in 2004!  Guess what, they STILL intend to buy back $6 billion of stock right away, with more to come in April.  The company has, however, abandoned its earnings goal of $20/share. Even with gigantic repurchases (lowering the number of shares participating in the earnings figure), the core business is so weak that the fantasy figure looks out of reach.  Don't worry though, Ginni Rommetty just got a $3.6 million bonus, with more to come if she meets the company's next set of goals.  So, she'll throw $6 to $15 billion more at the stock, to make sure she nabs that bonus.  It's good for her, at least, especially once she gathers in her golden parachute when the natives finally come howling for her scalp. I'm not alone in my dyspepsia, the company is now the fourth most-shorted issue in the NYSE. 

Update: October 23, 2015.  Two years after I said it, here's a paragraph from a scathing SeekingAlpha article entitled "Too Many Stock Buybacks have Hurt IBM":

"IBM has been generating huge amounts of cash over the past ten years, ranging from $8 to $16 billion, and all that cash is almost nowhere to be found. Where is all that cash? Most of it has been given to those who have sold their shares to the company. Practically, the company, as things stand right now, has been rewarding the sellers of the shares at the expense of loyal shareholders who have been holding their ownership stakes. Of course, people do not usually see it like this, but when the stock price goes down, things turn out this way. When the share price goes up, it turns out better for loyal shareholders."

I couldn't have put it better myself ... WAIT, I did, back in November of 2012:  "

"So why does Carl (Icahn) want the company (a theoretical company in this example)  to initiate a buyback?  Simply put, it's a great way to make a fast buck.  Announcing the buyback, and then initiating it, puts upward pressure on the stock.  Suddenly, extra cash is chasing the shares available for sale.  Demand outruns supply (temporarily), and the price jumps.  So, Carl sells into a rising market, pockets the quick gain, and departs.  He could care less about "stockholder value!"  He's a scorpion, stinging companies is what he does.  Lesson for non-scorpions?  Stock buybacks only benefit the folks who sell!  Those who stay are left with a company whose cash has been frittered away to others.  I think it's a form of financial rape."

Yeah, a bit overwrought (buybacks COULD make sense if the stock is frantically cheap), but anyone listening in 2012 might have taken a pass on IBM with its high of $210 and low of $193 in 2012.  A good choice, as the company has just announced further miserable results, with the stock now having fainted to $141.  Sadly, though, no one is listening ... yet.

Update January 29, 2016.  After YET another bum quarter, IBM's stock price is down to $124.  People are finally listening (not to me, of course, but to the Johnnie-come-latelies who have finally recognized that something is not right in Rometty-land.  This time they're blaming currency conversion ailments.  Otherwise, earnings would have declined by only 2%.  Yeah, it's always sumpin' with Ginni.  By the way, they just gave her a special EXTRA bonus of $5 million (for a job well done?).

The argument for IBM (articulated fatuously by Warren Buffett himself) is that the stock price doesn't matter.  He even rejoices (he says) when the stock price drops.  He, and others, say they're in the game for the dividends.  On the face of it, the argument is compelling.  IBM's dividend has risen from $.18 quarterly in 2004 to $1.30 today, a compounded growth rate of nearly 20% over eleven years.  Why that's Buffett-worthy.  No wonder Warren jumped on board.  He's found a magic formula for getting even richer, right?  Well ... let's go to the blackboard.

Say you had bought 1000 shares of IBM at the 2004 year-end price of $94. Over eleven years, you would have received $34.70 per share in steadily rising dividends.  Add that to today's share price of $124 and you would have netted $64,700 on an investment of $94,000, which happens to be 4.8% compounded, with taxes due on dividends along the way.  WAIT, WAIT!  What happened to that lovely 20% yearly growth rate?  Shouldn't you now have $698,000?  Isn't that what the dividend growth rate promises?  

Buddy, you've been jobbed.  IBM's relentless stock buy-backs have dropped the share count from 1.6 billion to just under 1 billion over this span.  The company's revenue is being spread out over fewer shares.  And something alarming has happened along the way.  The amount IBM steers to dividends has risen precipitously (making for those delicious yields), but dividends represent an ever-larger percentage of company earnings.  In 2004, dividends were just under 16% of company net income.  Now, it's 38%.  


The scenario above assumes you'd bought at at the beginning of the shell game.  What if you'd bought mid-way, when the stock was over $200 a share?  Would you still be rooting for a decline, Buffett-style?

Ginni (and her former boss) have been robbing Peter to pay Paul.  The proof of the pie is in shareholder equity.  That, folks, is what the owners of the company actually own, total assets minus total liabilities, or approximate breakup value, if you like.  At the end of 2004, the figure was $31.69 billion (already down from a peak of $43 billion in 1990).  Shareholder equity has deflated with a loud hiss ever since, to a nadir of $11.87 billion in 2014, and a still feeble $14.26 billion at the end of 2015.  That's a fat 55% loss of value, far exceeding the 38% decrease in shares outstanding over these eleven years! What happened to that equity?  Look no further than stock buy-backs (over $100 BILLION - money handed over to the stock's sellers) and lavish dividend increases.   It's a miracle this whale still floats!

Still, shareholders have in fact received steadily rising dividends.  So, why should these widows and orphans worry?  Even the near-sighted should be able to spot what's wrong with Rometty's reverse ponzi scheme.  It's unsustainable. Raising dividends by 425% over eleven years, while net income wobbles downward is no way to run a railroad.  What do you think will happen to the stock once the buybacks end or, horror of horrors, the company actually is forced to cut the dividend?  Hint: gravity!  

Of course, Rometty's  promising gigantic new revenue streams ... eventually.  "Forget the disastrous decay in the core business; the cloud will launch IBM to the stars!  And by the way, would you like to buy a nice bridge to Brooklyn?"  


March 2017.  After a huge run-up in the stock market following Donald Trump's electoral victory, IBM appears to be sitting pretty.  The price is $173.  Compared to the dismal $120 seen last year, that's a good run.  But ... $173 is actually just about where IBM was FIVE years ago!  It topped $200 several times since then, and has fallen back from those peaks.  

Now I'd call a flat five years no victory at all.  But there's still a drum-beat of positive hype regarding the company's aggressive buybacks.  A recent SeekingAlpha column just ran through the Buffett line: that flat or dropping stock prices along with steady stock buybacks are just great for the long-term dividend investor.  He points out that Buffett now owns 6.8% of the company, as opposed to 5.5% when this particular period began.  This is due to the drop in shares outstanding.  So, that's a 23% increase in Berkshire's share of IBM's equity.  That equity is actuall2016y down a bit over the same span ($18.98 billion then, $18.4 billion now), resulting in a compounded rate of return just under 5%.  Even adding dividends received into the calculation does little to improve this very modest result.  This is the best the Sage of Omaha can do?    

Furthermore,  this point in time looks particularly favorable to Warren.  It skips past that ugly year-ago low, and presumes a fairly low starting point (2012). Pick a few other starting points, and the picture dims fast. The article mentions that net buybacks over the years have been over $100 billion (perhaps somewhat less once adjusted for sneaky new issuances).  That's over FIVE TIMES the company's net present worth! Please, do you seriously think IBM is worth more now that it would have been if it had simply kept the money?  If so, Warren would own 5.5% of a company worth far more than today's shrunken total.    

You want to know the strongest argument against IBM's stock buyback program?  The company itself!  Between 2010 and 2014, it poured $70 billion into buybacks!.  In 2015 that fell to $4.7 billion.  The latest figure? $3 billion.  So, if buybacks are so magical, then why stop them?  Why throw tons of money at the market when the stock is hovering at or over $200 / share, and then nearly stop once it has plummeted?  Ginni can slather on all the lipstick she wants; the object of beautification is still a pig (to be precise: I mean the company, not Ginni).  She has a proven track record of buying high; is she her successor about to sell low?

July 2017.  Stock has swooned again, down to 145, a price last seen in 2015 and again in 2009.  So ... depending on entry point, a flat 8 years!  And Warren has finally pulled the plug.  Why didn't he listen to me sooner?  And still the company buys back shares.  

December 2018.  Another year past, and the stock is now down to $115.  Admittedly, it's been a brutal couple of months, with a full year's upside wiped out, and more.  Still, IBM stand out as a truly punk investment.  It's still getting touted as a magnificent dividend play, but really?  

A Social Security Screed

Yeah, I know this blog is supposed to be about bonds.  But I only have one blog (to date), and I need to vent somewhere.

I just got a huffily aggressive letter from AARP.  On the envelope is the following reproach:  "You have not responded to our previous letters."  Right there, I'm peeved.  Am I somehow obligated to respond to every damn thing AARP sends me (endless offers for overpriced car and life insurance among other things)?  That's a bad start.

Then a cover letter indicating that it's urgent for me to protest to President Obama and Congress about unfair cuts to my social security benefits.  Hmm, and what are these unfair cuts?  Well, actually not cuts at all.  Actually, a proposal to reduce the amount by which future benefits will be raised (via the so-called Chained CPI).  In what world is a smaller raise a "cut"?   Why the deceptive language?

The letter then skips merrily into the realm of untruth.  The "average senior", I am informed, subsists on a mere $20,000 a year.  Gee, that's a bit of a surprise to me, and the figure is, in fact, just not true.  The average retiree drew in $29,000 a year in 2008!  So by now, this average person is clearly receiving substantially more, so at least 50% more than the AARP terror figure.  And, of course, consider that a majority of seniors are married, and therefore often pulling in two sources of retirement income.  In fact, the median (not average) income of a retired household is more like $36,000.

What's the difference?  Well, it's a lot easier to live on $36,000 than $20,000.  It's the difference between dignity and desperation, decent food and cat food.  I am not foolish enough to insist that the higher figure is great.  It's not.  Life on $36,000, depending on where you live, can be tight indeed.  And the poor oldster trying to live on $20,000 or less, is in desperate straits.

But why is the AARP trying to pretend that desperation is "average"?  It's cynical and dishonest, preying on the uneasiness we all have about an uncertain future.  I think this effort represents one of the worst things about our system: entrenched interests protecting their slice of the government pie, regardless of need, fairness or common sense.  Middle class entitlements of all sorts defy logic.  Why collect money (mostly from middle and upper earners) only to dole it right back to those very folks?  Subsidizing the needy is morally compelling; subsidizing the majority is dumb.

Here a breakdown of the Social Security problem.  Most people, particularly retirees, believe Social Security is a grand savings plan: you pay in while working, and collect in retirement.  So, you are getting back what you put in when your check arrives every month.  This is a comforting fiction, but it's simply untrue.

To quote the National Academy of Social Insurance:

By law, the funds are invested in special-issue Treasury securities that earn interest. In effect, the funds are loaned to the Treasury, which borrows the money just as it borrows money when it sells Treasury securities to the public. In other words, the surplus money collected by Social Security helps pay for the rest of the government. In return for the funds it loans to the government, the trust funds receive Treasury securities bearing a market rate of interest. The average interest rate on the portfolio held by the Social Security trust fund was about 4.1 percent in 2012.

Note: there is no saving plan, no separate account into which your monthly social security contributions flow.  Instead, these payments, both from you and your employer, are go directly into the government general fund (via the purchase of treasury securities), from which pretty much all bills are paid,  The result is an IOU to the Social Security Trust.  If you think that's terrible, well it's been terrible from ... the very beginning.  Social Security has ALWAYS been a pay as you go scheme.  Present retirees are paid, in effect, from the present stream of money going into the government, whether from income taxes or Social Security taxes.  My major objection to the scheme is not that it is deceptive (which it is), but that it's an open-ended commitment.  Today's promise must be honored in the future.  There is no provision for matching income and expenditures.  Old folks today are relying on their children and grandchildren to cough up the dough, regardless of whether that is affordable or not.

And, folks, the affordability of Social Security is very much in question.  It's a combination of demographics and dubious populism.  Demograpics matter because the cohort of retirees is mushrooming, while the working folks who must pay the bill is static, perhaps even shrinking.  Thus, while many workers supported each retiree in the thirties, we might face a situation where as few as two working folks will be supporting each retiree.  How much can these guys handle before something gives?

Populism matters because politicians of all stripes (yes, even Republicans, even conservatives) have succumbed spinelessly to the "plight" of the elderly, raising benefits relentlessly, even as the baby boomer wave rolls relentlessly forward.  So, Social Security is indexed to inflation, but at a rate that almost certainly exceeds real inflation.  And benefits have been expanded to the disabled, a category that has mushroomed far faster than the population.  Why do you suppose that is?  Well, for one things, it's a whole lot easier to achieve that designation that ever before.  Just take a look to see how many lawyers are eager to help you get on board.  And benefits are regularly given to children, not just those of dead retirees, but minor children of living pensioners!  I kid you not.  When I retired in 2008, my benefits were exactly doubled because both of my children were below the age of 18.  This ride will not end until my son heads off to college in another five years.

Above all, this tidal wave of largesse is distributed irrespectively of need.  In fact, it's worse than that.  The system is specifically designed to reward those with the least need.  Take a look at Social Security charts, and you'll see that payments rise steadily with income, particularly peak income.  So, if you have a few fat years just prior to retirement (I did), then you pull in maximum benefits.  Be unfortunate enough to have punk earnings, then you'll come in at the very bottom.  But folks, the whole point of Social Security is .... SECURITY.  It only makes real sense as part of the safety net. 

Here's a radical idea: suppose Social Security were need-based.  It would be payment designed to ensure a safe and dignified retirement, declining for those with higher incomes, disappearing with those whose need is spurious.  Since the number of people with such pressing needs is small relative to the entire population of retirees, the funding pressure from Social Security would ease greatly.

Now, what about the rest of us?  Well, how about a REAL savings plan?  Many of us already have (or had) one, an IRA or a 401K.  Since Social Security is a tax, and therefore presently mandatory, why not steer the excess into a form of forced (but real) savings, a government IRA perhaps?  Individuals could be afforded the same level of investment control they now have over their IRAs and 401Ks.  They would just have to wait for the money, as they probably should anyway.  The flow of funds into these saving accounts would be enormous.  One important side benefit would be the stimulative effect such investment might have on the economy.  It could be huge.

Would this fly?  The major problem is that government would no longer be allowed to spend retirement income flows on non-retirement matters.  That would be painful, particularly the transition.  The new approach would surely need to be phased in over a period of years.  It would, however, be logical, prudent and fair.

The political issues would be thorny:  worst would be the outrage seniors (egged on by the AARP) would feel at "losing" their benefits.  It would probably be necessary (although silly) to separate out "savings" Social Security from the payments directed to needy elders.  If  payments came from different buckets, regular retirees might feel less hostile to seeing part of their monthly working contributions diverted elsewhere.  So, ultimately, needs-based Social Security might come from the general ledger (as now), and savings Social Security (based on a lower tax rate than at present) going into a separate, shielded trust, a real one, not a sham.

Out on a Limb!

A couple of entries ago, I went on a rant about my favorite stock bugaboo: the share buyback.  Today I came across a particularly fatuous discussion of this very topic in Barron's Weekday Trader column of September 16, 2013.  Entitled "Seagate: The Shareholder's Friend", the article describes a very aggressive share buyback program that is designed to reduce the company's outstanding shares by 30%, to 250 million shares.  An earlier program has already reduced the share count by 26% to 371 million from 500 million over the last three years.  Seagate's president is quoted as saying "We don't believe in holding excess cash on our books."

Notably, the article proceeds to draw a comparison with Seagate's main rival in the disk drive business, Western Digital.  It says that Seagate's share price is up 30% this year, while Western Digital's is up 50%.  The difference is that Western Digital has been investing its "excess cash" in flash memory acquisitions, a strategy Seagate dismisses as premature.  The company president is confident that he'll be able to buy mature technology later on.

Now, I am no expert in this business, but  I do know that flash drives are vastly quicker than disk drives.  For example, the very sexy Ultrabook I'm using to compose this blog boots up in seventeen seconds, due to its advanced flash memory.   I also know that flash is upending memory technology across the board.  The very biggest players (EMC and IBM) are investing huge sums in this area.  So, what I see here is a classic face off between a company committed to financial engineering and one committed to reinvesting in the business.  

While both companies have risen sharply over the last three years, that rise is from very low levels following a long period of distress: too much capacity and falling volumes. Seagate bottomed at $3.80, Western Digital at $11.45.  Neither, therefore, has been a particularly great investment over a 15 year span.  Still, economic recovery coupled with careful capacity management has caused both stocks to soar in the last couple of years.

With its "shareholder friendliness" and 26% buyback, why has Seagate's recovery lagged its rival's?  Well, folks, follow the money!  As opposed to dividends, which clearly end up in the shareholders' pockets, and are therefore, clearly shareholder friendly, the funds allocated to buybacks have ended up in the pockets of ... the sellers!  People who no longer own Seagate (or who own fewer shares) have received the dough.  For the rest, it's gone!  If that makes you feel like a sucker for loyally staying the course, well ...

Cash comparisons between the companies are eye-opening.  Seagate's 2012 ending cash position was nearly identical with the start of the year; Western Digital was up by $1.1 billion.  Seagate spent $1.4 billion on stock buybacks, while WD spent  $.66 billion.  Seagate also spent $518 million on dividends, compared to WD's $181 million.  Making the comparison extreme is the fact that Western Digital is 1.55 times the size of Seagate. So, which do you think is the grasshopper, and which the ant?

Why is Seagate up at all?  Don't forget about the law of supply and demand.  A constant flow of buyback dollars has an effect on the share price. It rises temporarily when there are more buyers than sellers.   What I find compelling is that Western Digital is up quite a bit more, with far less tinkering.  Clearly, I think, its more sophisticated investors find the pursuit of technology a superior path to shareholder rewards.

So, which company is right?  Well, again, I'm no expert.  What I do know is that Seagate now has much less cash on hand to buy flash drive technology, or do anything else, for that matter.  And once it's retired another 30% of the shares, it will have even less money when the time comes to buy a "mature" flash drive company at sharply higher prices.  Hmm, what sounds like the better way to reward shareholders: invest in technology that is clearly the future of the business, or get rid of excess cash while waiting for a better entry point?

What is the likely outcome?  Well, if history repeats (or rhymes), Seagate will eventually face a huge financing nut relating to its tardy effort to acquire flash technology.  One way to free up cash will be to cut the dividend.  Then it will then borrow a ton of money, at much higher rates than today's, or perhaps raise funds in a massive issuance of "new" stock. None of these things will be good for the stock price.

At present, Seagate's per share price is about $40, Western Digital's 65.  I see this as a perfect test case for my abhorrence of buybacks.  I hereby go on the record with a prediction:  five years from now, Western Digital will have significantly outperformed Seagate (not by a few percentage points, but by factors: two, three, four times). Will I actually make the bet (perhaps by shorting Seagate, or establishing option spreads in Western Digital's favor?  Probably not.  I'm a Bondsman, after all.

Update:  Over a year later.  The trends I discussed above continue.  Seagate's revenue has fallen 4.7% in 2014, while net income has declined even faster, 14.58%.  Yet the stock is up 40% for the year (to $56).  Why would that be?  Well, while the market is rising as a whole, such a sharp rise against a backdrop of dreary financial results can only be understood in the context of stock buybacks.  As for Western Digital, its revenue fell much less (1.44%), while its net income has exploded 65%.  And Western Digital's price is up even more than Seagate, even though its buyback program is dwarfed by Seagate's.  What do you think will happen to Seagate's price when the company stops blowing its cash on buybacks?  Western Digital, using far less cash for buybacks and dividends, is investing in the core business.  Down the line, I continue to predict that it will outperform Seagate by large margins.

Update: January 2015.  Well, I did take a flyer in Western Digital, purchasing out of the money calls and selling at the money calls.  The stock flew up, and I ultimately cashed out for a $5,000 profit.  No big deal, but a nice confirmation of my read on WDC.  As to Seagate, it just announced that it's halting stock buy-backs, now indicating that they only make sense below a stock price of $60.  Guess what?  The stock immediately dropped 7%.  Why? Because folks were counting on further buybacks!  Guess what's going to happen going forward?  Gravity, folks!

Update: May 2016.  Well ... Both stocks have hit hard times.  Today Seagate is trading at $18.64, Western Digital at $35.74.  Both have been rocked by a slump in sales of personal computers, and both are down roughly 70% from year ago highs.  Now, however, Western trades nearly double Seagate.  So, even in tough times, its price relative to Seagate has improved sharply.  And, despite sharp controversy relating to Western's purchase of flash drive maker Sandisk, the company has solidified its technology going forward.  So, it has spent its money on the company's future.  And Seagate? It announced ANOTHER $2.5 billion buyback a year ago.  The result?  The stock has PLUNGED, and now has a preposterous dividend of 13% (200% of net income, while Western's dividend yield is a far more sustainable 5%).  All that money, tossed overboard in the name of enhancing shareholder value!  Once Seagate cuts its dividend, the stock will face more downward pressure.  The company will still have its core  technology issue and the prospect of further income erosion.  So, I'm fairly sure the gap between the two companies will widen further ... much further.  Does that make Western a good buy?  Hell if I know.  This article is, after all, about the follies of stock buybacks.  I think that point is strongly substantiated by this ongoing thread.  An arbitrage strategy, shorting Seagate and going long Western might be attractive, but that's no longer my game.

Reality vs Hype

In the world of investing, you are subject to an endless flow of hype.  At every level, from the most granular (a specific stock, annuity, fund, ETF, REIT, option straddle, etc.) to the broadest (are we on the brink of collapse, or historic opportunity?), experts will bombard you with recommendations to DO SOMETHING NEW!  Overwhelmingly, they want you to stop whatever you're doing now, and follow them down a yellow brick road of endless opportunity. They will always make their advice seem irresistable, with pie charts, tables, Powerpoint slides and inspirational videos sweeping you into ... well, usually questionable actions. 

The most useful advice I can give you is to remember that the interests of people who come to you unasked are vastly different from yours.  Every time you follow such an expert's advice, he or she makes money.  Do you?  Distressingly, most people have no answer to this question.  They swing one way for awhile, then head off in another direction, but ultimately don't know what's working and what isn't.

To do better, long term, you MUST keep track of your own personal results.  It is utterly amazing to me that many people have no real idea of how they are doing with their investments.  They might look a year-end statements from a brokerage or mutual fund, but usually don't track things more closely. 

If you haven't set set up a means of monitoring your investments, both short and long term, then you should start now.  If the technology is intimidating, then hire someone to do it.  Mind you, hire them to track your investments, not direct them.  You should still do the latter, particularly if you're interested in being a Bodacious Bond investor.  If you're at all tech savvy, or willing to become so, then there are many tools to help you.  Things like Quicken will hold your hand throughout the (frankly painful) setup process.  I personally make do, and very well, with a spreadsheet,  I use Open Office, which is free, but most folks have a version of Microsoft Excel lying around too.

What you need to do is get a comprehensive listing of what you own, when you got it, what it cost when you got it, and what it's worth now.  Money in and money out is exceptionally important.  If you're saving regularly (a very very good thing), then you might be building substantial net worth, but still be failing as an investor.  Your tracking system should enable you to distinguish between the performance of money already invested, and new money coming in.

Where am I headed with this?  Simply put, once you have a detailed tracking system in place, then you are positioned to take charge of future choices.  When you bite on a new ETF promising to goose returns by buying commodities, you can see how it actually does, as compared to the glowing, back-tested projections in the brochure.  Whenever you do something new, I would strongly recommend including a note as to why you did it.  Look at that note regularly, and see how your reasoning has worked out over time.  I guarantee this will be a sobering experience, particularly so in the world of stock investing.  Even if you own a portfolio richly studded with Microsoft, Google, Facebook, IBM, EMC, etc., you will probably be bewildered by how much less well you have done than all the charts would suggest.

If you are like me, or the huge majority of individual investors, your tracking tool will help you see the vast gap between hype and reality.  One key thing you might learn is that hype can come from within just as easily as without.  In the grip of enthusiasm (or depression) we are all prone to doing goofy things.  Your tracking tool will be relentlessly objective, even if you are not.  Most likely, you will, reluctantly or not, come to the realization that a plan is necessary.  If you're attracted to bonds (since you've come thing far in my blog, I'm sure you are), then the Bodacious Bond portfolio might be perfect for you.  And note one thing:  I won't make a dime off of you!  This blog is a labor of love after all.