Discovering Why Trading is Halted on One of Your Stocks
Fair and orderly trading is an admirable goal of any system of exchange. As part of this ideal, exchanges, the SEC, and brokers can temporarily halt trading in stocks. The impact of news, or tripped circuit breakers designed to decelerate snowballing reactions (both human and programmed reactions), are the most common reasons to halt trading. There have also been events when a computer glitch, either feeding into an exchange or into the exchange’s systems, has triggered a pause or a halt. A total of 77 stocks were reportedly halted after the opening on the NYSE (January 24). They were all labeled “LULD,” this code is used to indicate it was a volatility trading pause. But officials at the NYSE say they’re still looking into it.
Reasons to Halt Trading
Companies listed on a U.S. stock exchange are responsible for notifying the listing exchange about any announcements or corporate developments that might affect trading in its stock. These often include:
Changes related to the financial health of the company
Changes in key management individuals
Major corporate transactions like restructurings or mergers
Significant positive or negative information about its products
Legal or regulatory developments that affect the company’s ability to conduct business
A circuit breaker has been reached due to volatility
Stock Halt Codes
Each day the exchanges list stocks as they are paused or halted and include a code to indicate the reason. The codes help market participants understand for how long it may be halted and for what general reason. It’s a good idea to be familiar with the codes shown below.
LUDP or LULD: Volatility trading pause (high volatility risk for investors).
T1: News pending (halted to give investors of all varieties ample time to evaluate).
H10: This is not enacted by the exchange but instead by the SEC (could be any number of regulatory reasons).
Image: Two of the many stocks halted on January 24, 2023 (NYSE Website)
The reason for the recent multiple stock pauses was available immediately on the NYSE website. Many of the stocks showed they were opening down substantially; the exchange says they are looking into this further.
There are also times when a circuit breaker stops trading across the market exchange. This is not the reason for the multiple pauses experienced in January, but also worth mentioning. There are three levels of halt based on size of the markets (S&P 500) move.
Level 1: 15-minute halt due to a 7% decrease from the S&P 500’s previous close
Level 2: 15-minute halt due to a 13% decrease from the S&P 500’s previous close
Level 3: Day-long halt due to a 20% decrease from the S&P 500’s previous close
Take Away
When the market opens and it is not business as usual, a lot of frustration can be saved by knowing market rules and finding resources to get a fast answer. While other traders wait for their favorite news service to report on it, going directly to the NYSE website to, in this case, get a listing of affected stocks and why, can put you ahead of those that are waiting for CNBC or another news outlet. Nasdaq also will post paused or halted stocks and use the same codes as above to indicate why.
Is it Better to Shadow Trade Insiders Rather than Congress Members or Fund Managers?
As tricky as the overall market has been, a new crop of investors that had been primarily index investors have spent the past 11 months gravitating more toward creating their own diversified mix of above-average probability stocks. One proven way to put the odds more on your side as a self-directed investor is to watch trends in insider buying. It was Peter Lynch of Magellan Fund fame who said, “Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.” To be sure, management only has so much control over performance, but they are likely to have greater clarity than anyone else evaluating their company.
Why Shadow Insiders?
Following insiders into stocks you otherwise are positive about is a form of shadow investing. Shadowing successful investors is a growing trend. There are websites dedicated to highlighting the transactions of investors like Paul Pelosi, Warren Buffett, Michael Burry, Cathie Wood, and others. But shadowing directors or key executives of publicly traded companies provides investors with much more current information – SEC Form 4 is used to disclose a transaction in company stock within two days of the purchase or sale. Compare the two-day reporting to institutional funds managing over $100 million that report 45 or more days after quarter-end on quarter-end holdings using SEC Form 13F. Or Congress-persons that can wait 45 days after a transaction to report it. Moreover, the insider is generally restricted to trading windows, so their holding time tends to be longer term. So their commitment level may be much higher than say a hedge fund manager like Michael Burry that may have purchased a security just before his 13F statement date, and then sold it a week later.
And the performance is above average. University of Michigan finance professor Nejat Seyhun, the author of “Investment Intelligence from Insider Trading” wrote stock prices rise more after insiders’ net purchases than after net sales. On the whole, insiders do earn profits from their legal trading activities, and their returns are greater than those of the overall market.
Current Example
I thought to write about following legal insider buying of stocks on your watch list after a link to a research note posted on Channelchek appeared in my inbox. It was on a company I follow and it highlighted legal insider trading by an executive. The report, available here, reported that the CEO of an expanding company in the cannabis sector name Schwazze (Medicine Man Technologies), was adding substantially to his ownership of the company he runs. The note by Noble Capital Markets Sr. Research Analyst, Joe Gomes, said:
“In a series of Form 4 filings, between November 14th and November 23rd Schwazze CEO Justin Dye purchased 1,325,852 SHWZ shares at a cost of $2.36 million, or a per share average of $1.78. According to the most recent Form 4 filed on November 25th, Mr. Dye directly currently owns 1,368,062 SHWZ common shares and indirectly owns 9,287,500 SHWZ common shares through Dye Capital & Company.”
How Do You Screen and Watch for Insider Buying Activity?
There are websites such as SECForm4.com and InsiderMonkey.com that aggregate SEC Form 4 filings and post them in a searchable, fully filterable online environment so you may search for characteristics you may prefer in your stock selections. While using insider activity, whether it be raw from the SEC or served up on online screening tools, here are four things to keep in mind to help hone your skills.
Some insiders are better than others. As a rule, directors tend to know less about a company’s outlook than top executives. Key executives are the CEO and CFO. The people day-to-day running the company are better able to assess risk of an investment in their company.
More insiders are better than a few. If one insider is buying in unusual amounts, it is a green flag to dig deeper. If several have begun adding to their holdings, it can be seen as a stronger signal.
People at small companies may have more insight. At smaller companies, a higher percentage of insiders are privy to company plans, changes in strategy, and financials. At big corporations, information is more dispersed, and typically only the core management team has the big picture.
Stay the course. Insiders tend to act far in advance of expected news. This is in part because of trading windows and also to avoid the appearance of illegal insider trading. A study by academics at Pennsylvania State and Michigan State contends that insider activity precedes specific company news by as long as two years before the eventual disclosure of the news.
Take Away
Insider tracking takes some work, but the resources to monitor a list of stocks you are interested in do exist to make it easier. Investors that would prefer to build their own diversified portfolio rather than own an index fund may find that watching insider buys helps point the way toward stocks more likely to beat a particular index. Another Peter Lynch quote says, “Know what you own, and why you own it.” Following insider buying allows you to have a methodology where you do know exactly why you are in a position. And although I have no hard data, I’d guess over the past five years it has paid better to follow insiders’ reported trades rather than social media influencers’ suggestions for a trade.
Roadshows Help Investors Truly Understand a Company’s Prospects
Around the office, we debate whether Roadshow should be one word or two. We’ll never all agree, but we do all know that an investor that strives to be diligent in understanding companies in which they may invest, would likely benefit from attending an available management roadshow.
If you aren’t familiar, a roadshow is usually a series of meetings in various locations where the management of a company with either outstanding securities or undergoing an initial public offering (IPO), makes themselves available to investors in a presentation format. Each meeting’s presentation will typically include its business model, current performance, and future potential, along with competitive advantage. When an event like this is available with a company an investor would consider, there may be no better supplement to the investor’s other research than to sit with management and be able to hear from the person at the helm what their expectations are, and the biggest risk to those expectations.
Roadshows are typically organized by a financial firm that has a relationship with the company. In an IPO, this may be the firm bringing them public; for a debt issue, it may be the underwriter. For issuers already public with current outstanding securities, the introducing firm may have a relationship with the company where they are looking to bring more awareness to the opportunity.
Roadshow Events
Potential investors ask to be invited to attend a roadshow, then gather and listen to the management presentations and participate in the question/answer period. This could occur in a private room at restaurant, over cocktails, in a company office, or basically any other forum where a clear picture of the company can be conveyed and the attendees can get the information they need to understand the opportunity.
As the purpose is to get in front of and increase investor awareness, these presentations are most often held in cities that help allow maximum motivated investor participation. Technology has ushered in an increase in roadshows that are now held virtually. This allows for a broader audience in faraway locations. Smaller investors that have never been to a roadshow should not be shy in asking for a determination if they meet the expected investor level, to attend. Often times companies actually prefer to be broadly traded by many small investors than to have a few large shareholders.
Channelchek’s Involvement
The ongoing mission of Channelchek is to provide actionable ideas and quality equity research to investors in small and microcap companies. Along with Noble Capital Markets, we hold ongoing Meet the Management investor meetings with companies with interesting stories and prospects. These roadshows are often in person and at times online. To see if a company you may be interested in will be meeting in your town, click here for the current list of Channelchek/Noble Capital Markets roadshows.
Image: Statue of Liberty Torch, Circa 1882 – Ron Cogswell (Flickr)
Current Technology May Be Leading the Next Shift in Stock Market Investing
Investor exposure to the stock market has grown and evolved through different iterations over the years. There is no reason to believe that it isn’t evolving still. The main drivers of change have been the cost of ownership, technology, and convenience, which are related to the other two drivers. There seems to be a new transformation that has been happening over the past few years. And with each change, there will be those that benefit and those that fall short. So it’s important for an investor to be aware of changes that may be taking place around them.
Recent History
Your grandfather probably didn’t own stocks. If he did, he bought shares in companies his broker researched, and he then speculated they would out-earn alternative uses of his capital – this was expensive. Mutual funds later grew in popularity as computer power expanded, and an increased number of investors flocked to these managed funds – the price of entry was less than buying individual stocks. Charles Schwab and other discount brokers sprang up – they offered lower commissions than traditional brokers. Mutual funds were able to further reduce fees charged by offering easier to manage indexed funds or funds linked to a market index like the Dow 30 or S&P 500. Indexed exchange-traded funds (ETF) took the indexed fund idea one step further – they have a much lower cost of entry than either mutual funds or even discount brokerage accounts. An added benefit to indexed ETFs is they can be traded at intraday prices and provide tax benefits.
Just as Schwab ushered in an era of low-commission trades, Robinhood busted the doors open to no-commission trades, and most large online brokers followed. This change allows for almost imperceptible costs in most stock market transactions. It also changed the concept of a round-lot, or transacting in increments of 100 shares. In fact, the most popular brokers all offer fractional share ownership now.
Are Index ETFs Becoming Dinosaurs?
Funds made sense for those seeking diversification of holdings, it used to take a large sum of money to do that; investors with a $10,000 account or more can easily achieve acceptable diversification with odd-lots and fractional shares ability.
Today investors can create their own index-like “fund,” or as they called it in your grandparent’s day, “portfolio management.”
One big advantage to creating your own portfolio, even if you rely heavily on stocks from a specific index to choose from, is that you can adapt it more toward your sector or company expectations. Indexed funds are stuck with their index holdings, they have no ability to change. One may increase or decrease risk by leaving out stocks or even whole industry groups. Also, it can be managed with greater tax efficiency than an index fund tailored to your situation.
There is also the DIY thrill that one gets from creating anything themselves rather than to just buying one off the shelf. There have been a number of renowned investors like Peter Lynch and Michael Burry warning that indexed funds no longer provide expected diversification and that many of the stocks are valued higher because so many dollars are on “auto-invest” into indexes that the bad has been pushed up with the good.
An example of what added demand does to the valuation of a company when being added to an index can be seen over the last month when it became clear that Twitter would be leaving an empty slot that would be filled by Arch Capital (ACGL). The added demand for ACGL pushed up the value by an estimated 25%. Was it undervalued before (when stand-alone), or is it over-valued now? Some stocks that are getting more attention because they are in an index could, as Michael Burry warned, be in bubble territory.
The more you do to ensure your portfolio weightings mimic an index, the closer your performance is likely to be to that index. You may want to limit your holdings to names that are actually in the index and shift the weightings for return enhancement. Another concern often cited with indexes is the way that they weight holdings; you may choose to weight your portfolio using the market capitalization of each company to own the same percentage of the company’s value or use another method like pure cost measures or cost per P/E.
Picking Stocks
While studies suggest that market diversification can be achieved by owning as few as five stocks and doesn’t improve much after 30 holdings, the more you own, providing they aren’t overweighted in a sector, it stands to reason the more diversification protection you can achieve.
As a DIY, self-directed investor, it makes sense not to chase after whatever YouTube influencer, loud-mouthed-TV analyst, or Stocktwit tells you. This is your baby, and the results, good or bad, are yours. Do what you can to make informed decisions, even if some turn out unexpected. The benefit of this is you can lean away from stocks that are still in indexes that don’t have good future prospects and lean into more companies that do.
I’m hearing from more of my self-directed investor friends and investment advisors that more people are looking to own companies that have non-financial objectives they, as an investor, support. And for some of them, there is no standard ESG framework that they support. They have decided, because they do care, to do more portfolio management with individual stocks than before. This is so they can individually look under the hood at employee policies, or environmental stature, etc. While ESG funds exist, the investor or client of the investment advisor would prefer not to own anything they oppose if they can avoid it. What better way than being able to say no to $XYZ company because they do this, this, and this that is against my own fabric?
Channelchek is a great resource for any percentage of your personally managed fund that includes stocks in the small-cap or microcap categories. These stocks could add a bit more potential for return but could also change your risk characteristics. Sign-up to get research from FINRA-licensed analysts.
Take Away
Stock investing has evolved and become more inclusive. But the future may be more like the past, with individuals creating portfolios of stocks for themselves. You don’t have to be rich anymore to buy stocks, and you don’t have to own a fund to get affordable diversification on nearly any size account. There’s a trend toward building one’s own personalized, diversified, low-transaction portfolio. Channelchek is helping investors find possible fits with its free research platform.
The FOMC Votes to Raise Rates for Sixth Time (2022)
The Federal Open Market Committee (FOMC) voted to raise overnight interest rates from a target of 3.00%-3.25% to the new level of 3.75% – 4.00% at the conclusion of its November 2022 meeting. The monetary policy shift in bank lending rates was as expected by economists and the markets. The recent focus has been more on what the next move in December might look like. There were no clues given in the statement following the meeting. Many, including some members of Congress that recently wrote a letter to Chair Powell, have urged the Fed to be more dovish, while others suggest the central bank is still behind and hasn’t moved aggressively enough. A third contingent believes there may be more work to be done, but there should first be a pause to see what the impact has been of five aggressive moves.
The statement accompanying the policy shift also included a discussion on U.S. economic growth continuing to remain positive. There was little changed. Language from that statement can be found below:
Fed Release November 2, 2022
Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.
Russia’s war against Ukraine is causing tremendous human and economic hardship. The war and related events are creating additional upward pressure on inflation and are weighing on global economic activity. The Committee is highly attentive to inflation risks.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 3-3/4 to 4 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve’s Balance Sheet that were issued in May. The Committee is strongly committed to returning inflation to its 2 percent objective.
In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.
Take-Away
Higher interest rates can weigh on stocks as companies that rely on borrowing may find their cost of capital has increased. The risk of inflation also weighs on the markets. Additionally, investors find that alternative investments that pay a known yield may, at some point, be preferred to equities. For these reasons, higher interest rates are of concern to the stock market investor. However, an unhealthy, highly inflationary economy also comes at a cost to the economy, businesses, and households.
The next FOMC meeting is also a two-day meeting that takes place December 14-15. If the updates to GDP, the pace of employment, and overall economic activity is little changed, the Federal Reserve is expected to move again, perhaps not in as big of a step.
The Many Factors that Come Into a Fed Rate Decision are Mind Boggling
What do the FOMC members look at as they’re changing interest rates and whipping up new policy stances?
The Federal Open Market Committee, or FOMC, meets eight times a year. There are 12 members; seven are board members of the Federal Reserve System, and five are Reserve Bank presidents, including the president of the Federal Reserve Bank of New York, who serves as president of the committee. The group, as a whole, is arguably among the most powerful entities in the world. What is it that this group, that impacts all of us, focus on? And what specifically will they weigh into their decision at the current meeting?
Labor markets and prices are top on the Fed’s list and specifically part of their mandate. Also feeding into the mandate are contributing factors like housing, growth trends, and risks to monetary policy.
Prices (Inflation Rates)
Inflation remains elevated. In September, the Consumer Price Index (CPI) picked up to 0.4%. Energy prices declined in each month of the third quarter, dropping a cumulative 11.3% since June. The Fed will have to discern if this is sustainable or a function of oil reserve releases that will need replacing. Food prices continued high, although at a slower 0.8% increase during September.
Core CPI inflation (which strips out energy and food) started the third quarter at a somewhat slow pace—increasing just 0.3% in July. The trend went against the Fed as it rose by 0.6% in both August and September. Price growth for services was the largest contributor to an increase in core CPI in the third quarter.
One of the two mandates of the Federal Reserve is to keep inflation at bay. Chairman Powell has said they are targeting a 2% annual inflation level. While nothing that has been reported in price increases since the last meeting has approached that low of a target, the Fed also has to consider their tightening moves do not work to lower demand (especially in food and energy) rapidly.
The Federal Reserve’s preferred measure of inflation is the PCE price index; this is the measure they use with their 2% target. The PCE price index typically shows lower price growth than CPI because it uses a different methodology in its calculation, but the drivers of both measures remain similar. Over the year ending September, the headline PCE price index rose 6.2 percent, while the core PCE price index was up 5.1 percent.
Jobs (Employment and Wages)
Labor markets are still tight. The economy has added an additional 3.8 million jobs this year through September. This includes 1.1 million during the most recent quarter. During the third quarter, the U.S. economy exceeded pre-pandemic employment levels. The unemployment rate hasn’t budged much, and as of September, the rate held at a comfortable 3.5 percent rate.
The broadest measure of unemployment—the U-6 rate is a measure of labor underutilization that includes underemployment and discouraged workers, in addition to the unemployed. The U-6 rate has also remained behaved all year. It stood at 6.7 percent in September, the lowest rate in the history of the series (starting in January 1994).
When the Fed pushes on a lever for one of its mandates, in this case it is tightening to reign in inflation, it has to watch the impact on its other mandate, in this case, the job market. So far, there is nothing that has occurred on the employment side that should tell the Fed they have gone too far too fast.
.In fact, the labor numbers may suggest they should discuss whether they have moved nearly fast enough. Competition for employees continued as the economy added an additional 3.8 million through September 2022 (1.1 million during the third quarter). Notably, during the third quarter, the economy surpassed pre-pandemic employment levels as of August 2022.
Image: FOMC participants meet in Washington, D.C., for a two-day meeting on September 20-21, 2022, Federal Reserve (Flickr).
Housing Markets
Housing demand decreased in the third quarter as affordability (lending rates + prices), with economic uncertainty weighed on homebuyers. During September, 90% of all home sales were of existing homes. This pace declined 1.5 percent over the month (down 23.8 percent on a twelve-month basis). New single-family home sales dropped a large 10.9% in September; this was the seventh monthly decline.
Homes available for sale have now risen from all-time lows; this includes new and existing.
Over the past few years, home prices have increased dramatically; this was fueled by Fed policy. Prices still remain above longer-term trendlines. The Case-Shiller national house price index measures sales prices of existing homes; this was up 13% over the year ending August 2022. For reference, for the 12 months ended August 2021, prices rose 20%. The prior year they had only increased 5.8%.
Housing plays a huge role in economic health. The Fed is well aware of all the housing-related inputs to the 2008 financial crisis and the part easy money plays in market crashes. Orchestrating an orderly slowdown to the boom in housing is certainly critical to the Fed’s success.
Other Risks to Economy
Eight times a year, information related to each of the 12 Federal Reserve districts is gathered and bound in a publication known as theBeige Book. This summary of economic activity throughout the U.S. is provided approximately two weeks before each FOMC meeting, so members have a chance to evaluate economic activity over the diverse businesses the U.S. engages in.
U.S. Inflation can arise from conditions outside of the control of the U.S. For example Russia’s invasion of Ukraine has added upward pressure to inflation this year. This impact may have to be determined and netted out of calculations and policy as the Fed can’t fight this inflation pressure with monetary policy. An example would be the Fed can’t alter global food shortages brought on by war.
Dollar strength or weakness comes from many things. One of the most impactful is the difference in interest rates net of inflation between countries and their native currency. If the Fed raises rates when a competing currency has not, there is a chance there will be more demand for the alternative currency, which would weaken the dollar. Further complicating this for the Federal Resreve is a lower dollar is inflationary as it causes import prices to rise, a stronger dollar can reduce domestic economic activity as exports fall. The U.S. dollar has been rising and is now at its strongest in 20 years.
Commodity Prices were elevated in the first half of this year, mostly by energy. Although there was some relief from gas prices over the summer, energy is expected to rise into the colder months. They may rise further as the U.S. Strategic Petroleum Reserves are used less to control prices, this may be curtailed. The White House’s two goals of sharply reducing Russian revenue and avoiding further disruptions to global energy supplies while at the same time reducing oil use and production within the U.S. are a tanglement the Fed needs to consider. These can be very impactful to costs and economic activity, yet The Fed has no direct levers to impact these economic inputs.
World economies play a part in our own economic pace. If the Fed were to tighen aggressively while the global business is slowing, the impact of the tightening might be more pronounced than if the world economies are booming. Demand for goods and services impacts prices; the U.S. doesn’t live in a vacuum, and demand for our production and our demand for foreign production all must weigh on the Feds outlook for global economic health.
According to the IMF’s latest World Economic Outlook, global growth is expected to slow to 3.2 percent in 2022 and just 2.7 percent in 2023. At the same time, central banks around the world are tightening monetary policy to fight high global rates of inflation. In addition, there has been financial instability in some major world economies. These rising risks to the global growth outlook may feed back into the U.S. outlook by weakening international demand for U.S. goods and service exports. On the positive economic side, China is considering easing its Zero-COVID policy, which could eventually ease the supply chain impact to inflation.
Take Away
The original question was, “What do the FOMC members look at as they’re changing interest rates and whipping up new policy stances?” The answer is they have to look at everything. The recent mix of “everything” shows growth and employment in the U.S. have sustained at an even keel. Will previous rate hikes to calm inflation eventually take their toll? This is probably the big question the FOMC will be evaluating. Other domestic issues, including housing and the financial markets, are certainly to be weighed as well – a market crash of any magnitude could quickly slow economic activity.
The Fed has little control over what goes on overseas but must be aware of and hedge its policy to allow for.
All told, the Federal Reserve has a very difficult job. The report of the new monetary policy stance should hit the wire at 2 pm ET today (November 2).
A certain EV Company may try to charge up its stock with a buyback.
Are stock buybacks good for companies, good for investors, and better than dividends? Last week, TESLA (TSLA) investors became excited about a tweet from founder Elon Musk that could suggest the company may bow to large shareholders and do a stock buyback. The implications for a company buying back shares and stockholders are many. Below you’ll find details on what the most typical considerations are and what it means from an investor’s standpoint.
What Is a Stock Buyback?
A stock buyback is when a public company uses cash in reserves or borrowed funds to buy shares of its own stock on the open market. A company may do this to consolidate ownership, preserve a higher stock price, boost financial ratios, work to reduce the cost of capital, or to return higher asset values to shareholders.
Investors find out when a public companies that has decided to do a stock buyback announces that the board of directors has passed a “repurchase authorization.” The amount authorized provides how much will be allocated or raised to buy back shares, or in some circumstances, the number of shares or percentage of shares outstanding it aims to purchase.
During the stock buyback, the company goes to the open market as any investor would and purchases shares of its stock in competition with other market participants. The added demand and later reduced shares available (float), puts upward pressure on the stock price. Stockholders then find their shares trade at a higher price than they would have. Shareholders are not obligated to sell their stock to the company, and a stock buyback doesn’t target any specific group of holders—retail and institutional all participate.
Public companies that have decided to do a stock buyback typically announce that the board of directors has passed a “repurchase authorization,” which details how much money will be allocated to buy back shares—or the number of shares or percentage of shares outstanding it aims to buy back.
Why Do a Stock Buyback?
The primary reason a company will buy back shares is to create value for its shareholders. Remember, fewer shares should cause those still being transacted in the open market to be trading at a higher price.
Boards of public companies’ primary responsibility are to look out for shareholders’ interests. At the top of this list is maximizing shareholder value. With this in mind, companies are always finding ways to generate the highest possible returns for their investors. This, at its most fundamental level, includes increasing the value of its stock and rewarding its investors. Buybacks and dividends work to maximize value for shareholders.
Declaring a dividend is the most direct method to return cash to shareholders; there are advantages to stock buybacks:
Tax efficiency – Dividend payments are taxed as income, whereas rising share values aren’t taxed at all. Any holders who sell their shares back to the company may recognize capital gains taxes, but shareholders who do not sell to reap the reward of a higher share value and no additional taxes until they decide when to cash in.
Directly boost share prices – The main goal of any share repurchase program is to deliver a higher share price. The board may feel that the company’s shares are undervalued, making it a good time to buy them. Meanwhile, investors may perceive a buyback as an expression of confidence by the management. After all, why would a company want to buy back stock it anticipates would decline in value?
More flexibility than dividends – Any company that initiates a new dividend or increases an existing dividend will need to continue making payments over the long term. That’s because they risk lower share values and unhappy investors if they reduce or eliminate the dividend going forward. Meanwhile, since share buybacks are one-offs, they are much more flexible tools for management.
Offset dilution – Growing companies may find themselves in a race to attract talent. If they issue stock options to retain employees, the options that are exercised over time increase the company’s total number of outstanding shares—and dilute existing shareholders. Buybacks are one way to offset this effect.
How is Value Impacted?
Key metrics investors and stock analysts use to value a public are impacted by a buyback. For example, cash is removed from a company’s balance sheet, and the number of shares trading is reduced.
Once a company has bought back its own shares, they are either canceled which reduces the number of shares available to trade (not just on the open market), or held by the company as treasury shares. These are not counted as outstanding shares, which has implications for many important measures of a company’s financial fundamentals.
Metrics important to investors, like earnings per share (EPS) are calculated by dividing a company’s profit by the number of outstanding shares. Mathematically, by reducing the number of outstanding shares, a higher EPS results as the quotient.
Price-to-earnings ratios (P/E ratio) are also mathematically improved as a higher price to the same earnings is desirable to shareholders. It helps investors measure a company’s relative valuation by comparing its stock price to its EPS.
Who Else Has Done a Buyback in 2022?
If Tesla does indeed get approval from its board of directors to buy back shares, it won’t be the only large company that has in 2022. Apple (AAPL) bought back 3.5% of its shares in May ($90 billion), Exxon (XOM) bought back 2.9% of its shares in February ($10 billion), Broadcom (AVGO) bought 4.3% of its shares in May, Cisco Systems (CSCO) bought 6.4% of its shares in February (6.4%), and Norfolk Southern purchased 14.6% of its shares ($10 billion) in March.
In some cases, a buyback may not be the best way for companies to build value for shareholders:
It may not be the best use of cash. Long-range growth and building future profits come from investing in company growth, not company stock. Stockholders may prefer, depending on available opportunities for the company and other variables, that the company take a longer-term view. Stock buybacks create quick price gains but may not be the best long-term use of cash. Also, cash for a potential unforeseen challenge to the company could be comforting to some investors, depending on the situation.
When interest rates are low, companies increase their debt-financed share buybacks. In the years just prior to the pandemic, up to half of all buybacks were financed using the low-interest rates at the time. Below-average interest rates incentivized companies to borrow money to spend on share buybacks to boost stock prices. Depending on the scenario, this debt on the balance sheet may long-term weigh on shareholders.
Take Away
Profitable public companies may add value for investors through a stock buyback, also known as share buyback or share repurchase program.
If you are invested in Tesla or another company that may announce a share repurchase program, is this something to be happy about? As a rule, if a public company is profitable, has the cash to spare and its shares are relatively undervalued, then a buyback could be a positive, especially short term.
However, if the company is repurchasing shares of stock while it stymies future growth potential, it could cost long-term investors.
The Connection Between Producer Price (PPI) and Consumer Price (CPI) Inflation
Does a higher PPI mean a higher CPI? A newly released report shows U.S. suppliers raised prices by 0.4% in September from August, when the Producer Price Index report had shown a 0.2% drop. The inflation measure that has impacted the stock market most severely this year is the Consumer Price Index. The two Bureau of Labor Statistics (BLS) releases are related but not directly correlated and are often used to measure different things by economists and those in industry.
The PPI rose 8.5% in September from a year before, down from its 8.7% annual increase in August and 11.3% in June. – BLS
How CPI and PPI are Different
The PPI for personal consumption includes all marketable production sold by U.S.-domiciled businesses for personal consumption. The majority of the products sold by domestic producers come from non-governmental sectors. However, government produces some marketable output that is under the PPI umbrella. In contrast to the PPI’s components, CPI includes goods and services provided by businesses or governments when direct costs to the consumer are levied.
The most heavily weighted item in CPI is rent. It’s weighted at 24% of the index. What the BLS calls owners’ equivalent rent is the implied rent occupants would have to pay if they were renting their homes. This is how the Bureau of Labor Statistics captures the cost of housing for owner-occupied and rented housing. This heavily weighted component is not in PPI – obviously, owners’ equivalent rent is not a domestically produced output.
The PPI for personal consumption and the CPI also differ in their treatment of imports. The CPI includes, within its basket, goods and services purchased by domestic consumers and therefore includes imports. The PPI, in contrast, does not include imports because imports are, by definition, not produced by domestic firms.
How PPI Impacts CPI
The PPI trends often work their way into consumer price movements, but not at a one-to-one basis or even a standard delayed interval. The demand component of consumer’s impact, what the consumers are willing to consume at certain price levels, is at play with what is charged for goods at the retail level. So even if the cost to manufacture goods has risen, passing the cost on is not always possible without hurting sales. At some level of price increases, demand decreases. This is different for each type of product. For instance, food, medical care, and housing may not be impacted as much as recreation, clothing, and other items which are easier to put off or do without.
Companies are trying to manage higher costs without alienating consumers who are weary of price increases. So far in the 2022 U.S. economy, consumer spending has remained strong despite the rate of CPI, but economists worry that we’re approaching a tipping point.
The Fed has raised the benchmark federal funds rate at its last three meetings by 0.75 percentage points, it now sits in the range of 3% and 3.25%. Officials have indicated they are prepared to raise rates over the course of their final two gatherings this year to around 4.25%.
Today, with consumer inflation running at a four-decade high and savings measurements trending lower, consumers are expected to begin to change buying habits. This overall is bad for business and the economy, which is why the Federal Reserve is expected to continue its fight against price increases, despite their lack of popularity with the financial markets.
“Monetary policy will be restrictive for some time to ensure that inflation moves back” Fed Vice Chair Lael Brainard (October 10).
Prices have begun to fall for some goods and services, including commodities, freight shipping, and housing. Those declines have led some Fed watchers to warn that the central bank risks tightening financial conditions too much.
Take Away
Increases in producer prices are passed to consumers when they can be. However, there is only so much a consumer is willing to pay for a purchase they can put off or substitute for something cheaper. This has ramifications for investors.
Companies where demand will wain when prices rise, may find earnings weaken; these could include producers of discretionary goods. Stocks that are shares of consumer staple companies may not feel the brunt of consumer pushback; those that produce more cost-effective brands, including white label providers, may outshine their brand name competitors if consumers increase their substituting for lower priced alternatives. Health care is one area where demand changes little as prices change at the producer or consumer level.
Investors have many options to gain exposure to gold. They may purchase gold bullion, gold coins, gold exchange-traded funds (ETF) and mutual funds, gold mining companies, or gold futures and options. Publicly traded equities of gold producers and royalty companies may offer an attractive way to invest given the disproportionate percentage impact higher commodity prices may have on a company’s bottom line and valuation for a given percentage increase in the commodity itself. While most investors are likely familiar with mining companies and how they operate, royalty companies may be less familiar.
What is a Gold Royalty?
A gold royalty is a contract that gives the owner the right to a percentage of gold production or revenue. Since royalties typically cover the life of a mine, gold royalty companies benefit from the exploration upside that may extend the life of a mine and thus increase the amount of gold or revenue they receive from the mining company at no additional cost.
There are several ways to generate royalties. First, royalty businesses may help finance a development project in exchange for a royalty. Second, a royalty business may purchase existing royalties from third parties, and 3) a royalty company may take a property that they already own, sell it to a mining company, and retain a royalty on the property.
There are several types of royalties. The two most common are NSR and NPI royalties. A net smelter returns (NSR) royalty is an agreement where the mining company agrees to pay the royalty owner a percentage of the revenue, less refining and smelting costs. A net profit interest (NPI) royalty entitles the royalty owner to a percentage of the profit from a mine.
A stream is a purchase agreement that provides the owner of the stream, in exchange for an upfront payment, the right to purchase all or a portion of one or more metals produced from a mine at a negotiated price for the life of the agreement. The negotiated price is generally at a significant discount to the spot price.
Advantages of Owning Equity Shares of a Gold Royalty Company
Compared with investing in gold production companies, royalty businesses generally benefit from low overhead costs, geographically diversified asset portfolios, and exposure to multiple operators. Additionally, they avoid costly exploration expense which is borne by operators while sharing the benefit and upside of exploration investment in properties where they retain a royalty interest. Like mining companies, royalty businesses offer greater leverage to changes in gold prices than investing in bullion. Lastly, royalty businesses generally seek to build portfolios of producing royalties that support dividend payments to shareholders. It is important to keep in mind that revenues increase with rising gold prices, increasing production on its royalty properties, and a growing royalty portfolio, while costs remain relatively fixed and stable. This scenario positions royalty companies to thrive in good markets and weather more challenging sets of circumstances.
As a royalty company grows, it offers the potential for multiple expansion, dividend payments, and the ability to execute larger transactions which could accelerate its growth. Junior royalty companies generally perform well in their early years since they can grow rapidly based on an increasing capacity to transact larger deals. Additionally, junior royalty companies may become attractive acquisition candidates for a larger royalty company seeking to enlarge its royalty portfolio.
Investor Considerations:
It is important for investors to keep several factors in mind when conducting due diligence on prospective royalty company investments. These include: 1) management, 2) asset portfolio, 3) asset quality, 4) jurisdiction, and 5) valuation.
Management
Should you bet on the horse or the jockey? It is important to evaluate management’s history and track record of creating value for shareholders. Does the management team reflect a balance of technical, financial, legal, and capital markets expertise? Is the board of directors comprised mostly of independent directors who provide a diversity of relevant experience and perspectives? Do they articulate clear objectives, and is their business model sound? Most importantly, do they focus on areas they know and employ a disciplined growth strategy, or are they seeking growth at any price?
Asset Portfolio
How is the company’s asset portfolio balanced between royalties that are producing cash flow streams versus royalties that are expected to produce cash flow within five years and/or longer?
Asset Quality
Because royalty companies have little control over the decisions of the mining companies that control the properties on which the royalty interest is held, it is important for investors to evaluate the operators associated with the properties in the royalty portfolio. Are they well-capitalized major mining companies or small start-ups? Additionally, it is helpful to evaluate mineral resource estimates associated with properties in the portfolio and the operators’ plans for development.
Jurisdiction
While geographic diversity is a selling point for most royalty companies, it is often helpful to consult the Fraser Institute’s Annual Survey of Mining Companies to check if royalty interests are in favorable mining jurisdictions versus high-risk areas.
Valuation
Royalty companies are often valued based on price to net asset value. Net asset value is the net present value (NPV) or discounted cash flow (DCF) of all future cash flow of a mining asset, less any debt plus cash. Price to net asset value is the company’s market capitalization divided by the net present value of all mining assets minus net debt. For those that pay a dividend, investors may also compare dividend growth rates and yield. Larger companies generally trade at higher valuation multiples which generally increase with scale due to lower perceived risk due to greater asset diversification and a proven track record of growth. As royalty companies grow, they may be able to establish and grow dividends to shareholders, offer greater liquidity due to listings on major exchanges, and benefit from broader research. Some may also benefit from their inclusion in stock indices. For those that pay a dividend, it is important to know whether the dividend is paid from operating cash flow or whether the company is borrowing to pay the dividend.
Take Away
Investors have many options to gain exposure to gold. Royalty companies may be worth considering as a vehicle for exposure to gold. However, it is important for investors to understand their risk tolerance and return objective. The universe of royalty and streaming companies represents a broad range of market capitalizations, and many differences exist among their asset portfolios. Channelchek offers a starting point for investors to conduct due diligence and dig deeper.
