Monday, April 30, 2018

Being a shareholder what do you really own?

Here is a graph showing the declining number of publicly traded companies in the U.S. courtesy Bill Bonner and Partners.  Yes, those guys that always predict the end of the U.S. because of excessive debt.
This is a very useful chart because it can teach us some key understandings about stock market investing. Those who read my previous post with a graph of Canada’s prime rate since 1960 may notice some similarity in patterns. With interest rates at zero or even negative, private equity can take out a big loan for ‘free’ then use that money to buy out a public company, say (according to Bill Bonner) recently demised Toys"R"Us. Next the controlling interests use the company’s earnings to repay the debt; now they own a great company for ‘free’ and bought without virtually any risk. Less constructive, said controlling interests hollow out the company by making it take out more and more debt while paying themselves dividends with the proceeds and drive the acquired company into bankruptcy - that was Toys"R"Us. Scrupulous but very profitable.
Why do so many companies buy back shares?  Same reason, buying back reduces the number of shares. The remaining owners share more profits with less shareholders and the profits per share go up without any real increased Net Income. Even better, if management doesn’t increase the dividends, the company gets a lot larger cash-hoard for future acquisitions.
Think about it. A company’s capital comprises two components:  shareholder equity and debt.  If debt is nearly free at close to 0% tax deductible interest and shareholder equity is expensive because it pays a 3% or so AFTER TAX dividend, then shareholder supplied capital is very unattractive compared to debt.
Management and those who control the company buy out the other shareholders by borrowing money for free and own more and more of the company. You the shareholder benefit because you get more earnings and dividends per share. However, once the entire company's share based capital has been bought back, the business controlling interests own the company financed by debt only. No wonder the number of outstanding shares and the number of publicly traded companies are decreasing dramatically. Scarcity makes those outstanding publicly traded shares even more valuable.

Now with interest rates on the rise, these trends may reverse; shareholder capital becomes cheaper. So really, higher interest rates do not necessarily lower stock prices but when those same controlling interests want more money, they will sell shares because borrowed money is no longer cheap and share capital becomes more attractive.
And you thought that as a shareholder you owned these companies. No, you only own a portion of the profits (after they have been skimmed by the controlling interests, typically management and the board of directors). Never forget that when you sit at a poker table and you wonder who the one is who is being cleaned out – it is probably you!   As shareholder you have nothing to say just like the lenders.  When you want to truly control your net worth you must own your own business (which may be in the business of making money by lending to or owning shares of public companies), real estate and other physical assets .

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