Chingo De Dinero

All of that sub-prime mess going on is a joke.  The banks were loaning money to people who couldn’t pay the loan.  I treat the previous statement as a fact, if these people could pay it back, the would not get sub-prime loans, they would get regular loans and avoid the higher rates.

Why would banks do this?  Two reasons, the default projections they were using were not good predictors of the future, they underestimated the true number of people that would default.  The second, is the downside risk….when you stop paying your loan, the bank forecloses on you.  So they sell your home, keep what you own them, and return the rest to you.  The only way to lose is if the value of the home is less that what is owed.  If you have a strong housing market, with prices rising rapidly, this does not happen often.  But, if prices start to drop, this can easily happen, thus why housing prices are so important to the sub-prime issue.  So going back to my first asset pricing model, the banks used a discount rate that was too low, it did not factor in the true size of default risk.  If the banks would have charged more for the loans, and set aside a higher reserve, we would not be seeing the headlines we are seeing right now.

Back to my first statements, I think the banks got a little too optimistic, not that they are stupid, just a little too excited.  Now…they are paying for it, which they should.  Letting them suffer will result in them changing their models, and correcting the market.  That should be the end of it…the government does not need to come in and be a hero.  The banks agreed to lend money, and people agreed to borrow.  The people did not pay back, the banks lost money, so the banks will stop lending money to this sect of people.  All problems solved, the market working at its best.

As a side note, I like sub-prime loans, I actually have two for some condos I own.   One weird thing, the interest rate is less on my sub-prime, where I was viewed as risky and put very little down, than the prime ones, where I put more money down and was viewed as safer.  I guess mess like that is why the banks are having these record write-offs.

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.