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So today a company I own First Cash Financial Services (FCFS) announced an additional share buyback of 1,000,000 shares.  The shares were down 10%, I thought they should go the other way.  In all honesty, I do not know why the stock was down, but I highly doubt it was due to the buyback.

Stock buybacks are usually a very bullish thing, it is a signal by Management that they think the stock is a good investment.  If they really felt strongly about this they should be buying for themselves too, right?  But, anyhow, what share buybacks do is reduce the number of shares outstanding, thus increase each shareholders % ownership.  The downside is that the company has less cash, since you own the company, you have less cash.  It is always positive that a company is generating enough cash to be able to purchase shares, but is this better than having a dividend, or expanding the business.  This is not easy to determine.  But, there are some benefits, if the company pays a dividend, you will be taxed at the ordinary income rate.  When you have share buybacks, the gain from share appreciation, which is taxed at the capital gain level.  For the expansion of business, you have to be very careful not to expand just because you have money, because you could cannibalize your business.  Again, this is not easy to determine, it requires a ton of info,  and is stochastic.  Moral of the story, is the actual buybacks do not make any difference, since the company has the funds to buy back shares, it is positive, and it shows managements opinion that shares are a good value.  But, do not put too much value in share buyback, it is just a modification to the capital structure.

Stock splits are not important!!!!

Stock splits are a simple mathematical action.  You divide the price by two and multiply the number of shares by two.  Of course, if you own a stock, it doubles, the stock splits, and now you have twice as many shares at the same price…that is very good.  But, it is no better than having the same number of shares that are twice as valuable than when you originally purchased.  It should have no affect on what the company is worth, or how the price will move in the future.

When valuing stocks, it is important to use various ratios…PE, PEG, Price to Sales, etc.  These seem very basic, and are, but there is one problem with them….The problem is what is used for price.  The typical value for price is the market cap….the total number of shares * share price.  The problem with this is that it does not factor in capital structure.  My point is that if you were to buy a company, not only do you have to purchase all outstanding stock, you must also pay the debt.  On the other site, if you the company had a net cash position, you would get that cash.  So how do you factor this in….Enterprise Value.  All enterprise value is, is market cap plus debt, minus cash.  So if the company is cash heavy, the price is smaller, making the PE, PEG, and other measures more favorable.  On the other hand, if the company is in a lot of debt, the valuing ratios will be less favorable.

So, the moral of the story, whenever you do your valuing ratios, do not use market cap, use enterprise value, it gives a better reading.

This is the absolute most basic rule that everyone should know before buying any stock, or other asset.  It is very simple, and asset’s current value should be equal to the present value of all future cash flows.  So now, lets make an example to bring it to life.

If the asset is a peice of paper from the government to give $110 in one year. The interest rate is 10%.  The price today, for this piece of paper is $100.

See, how easy it is…but, this stuff gets real complicated real quick.  First, it is not always one payment, maybe it is equal payments, then a lump sum, or some one month, another chunk of money in six months, then another payment after 9 months.  But when these are fixed, like above, it still is pretty easy.  In the case of stocks, it can get pretty complicated, you have to do your homework to try to guesstimate the future cash flows.  This is 90% science, but still 10% art, in my opinion.  The other piece, the interest rate to use is also hard.  So hard, people actually won a Nobel Prize for trying to figure this out (CAPM).  The basic idea is you take the risk free rate, amount the US Government pays, and ad some risk premium.

In the previous paragraph I tried to give a little credit to the people who price many of these assets, but there is no need to know the ins-and-outs, it is more important to know, an assets current value is the present value of all future cash flows.