Market Buzz – The Reign of the Balance Sheet Will Continue in 2012
Canadian stocks closed at their highest level in nearly four months on Friday, powered by financial and energy issues. Surprisingly, healthy U.S. employment figures offset sluggish Canadian jobs data and uncertainty over a Greek debt deal and helped the market to solid gains.
U.S. job creation in January far outstripped analyst expectations, with the unemployment rate dropping to a near three-year low of 8.3 percent. In addition, the pace of growth in the U.S. services sector unexpectedly accelerated to its highest level in nearly a year.
All told, the Toronto Stock Exchange’s S&P/TSX composite index ended up 23.80 points, or 0.2%, at 12,577.28. It was the TSX’s highest close since October 8th and capped the index’s seventh straight weekly rise.
Of course, this raises the question as to whether a pull-back is in order. To that, we answer in the affirmative. However, we do have a number of companies we are focusing on and would find weakness in select names and excellent opportunity to buy.
But what to buy? Well, for the “type” of companies we are currently looking for we look no further than to one of our most successful 2011 investment themes of 2012. One we expect to continue on into 2012 – and perhaps even accelerate. The trend is “the reign of the balance sheet.” In the first month of 2012, companies with strong balance sheets including zero or manageable debt, solid cash positions, good working capital, and good cash generation continue to power the market and garner the most attention. This attention can come from good to premium multiples or, in the case of four companies from our coverage universe in 2011, premium takeover bids. Both can lead to superior returns for investors.
From crisis and volatility comes opportunity. That became very apparent this past year as we saw four of our Focus Buy recommendations, Bridgewater Systems Corporation, Breakwater Resources Ltd., MOSAID Technologies Incorporated, and Distinction Group Inc., receive premium takeover bids. The common theme with each of the companies was strong balance sheets and strong cash flow. In fact, the first three each had over 40% of their market capitalizations in cash at one point, with strong earnings, zero debt and growth.
This type of pristine balance sheet can withstand and even profit from a downturn (via strategic expansion through purchase of distressed assets). We believe companies that hold this profile will continue to attract more attention from individual investors and as potential acquisition targets in 2012.
In fact, this was one of the main reasons we released our 2012 Cash Rich/Debt Free, Profitable Canadian Micro to Mid-Cap Report this past week.
Looniversity – Reverse Stock Split
Through the soaring bubble market of the late ‘90s, many investors became very familiar with the concept of a stock split as the run-away tech stocks hit triple digits and management endeavored to keep the per share price tag at “affordable” levels. However, if the first quarter of 2008 is any indication of what we might expect over the near term, enter the bear market’s answer, a reverse stock split.
When a company engages in a reverse stock split, it substitutes one share of stock for a predetermined amount of shares of stock. Like its cousin the stock split, it does not increase the market capitalization of the company.
To illustrate, assume ABC Corporation has 10,000,000 shares of common stock outstanding. Assume the market price is $10 per share and that ABC Corporation declares a 1 for 4 reverse split.
After the reverse split, ABC Corporation will have 1/4 as many shares outstanding, or 2,500,000 shares outstanding. The stock will have a market price of $40. If an individual investor owned 100 shares of ABC before the split at $10 per share, he will own 25 shares at $40 after the split. In either case, his stock will be worth $1,000. He is no better off before or after. Except that the company hopes that the higher stock price will make the company “appear more attractive” and thus, more investors will purchase the stock and the stock price will be bid up.
There is no assurance that a company’s stock will rise in price following a reverse split. In fact, some academic research indicates that NYSE and AMEX listed companies that reverse split their stock that did not perform well subsequent to the split. This may be due in large part to the fact that most companies that reverse split are in rather poor financial shape to begin with.
Put It To Us?
Q. Can you elaborate on the term “dead money” in reference to the stock market?
– Erick Broden; Calgary, Alberta
A. Dead money is a common term used on Wall Street to describe money that does not earn a return for an investor. From money stashed in a mattress to a non-interest yielding checking account or a security that does not yield returns, all are considered dead money. Essentially, any money or investment that does not grow or yield gains for the investor is usually referred to as “dead money.”
When an investor invests in securities, the expectation is that the security or investment will yield some profitable returns. When an investment is not expected to yield any returns, the investment is referred to as a “dead money investment.” Examples of dead money investments are shares or stocks of companies that are not expected to improve or appreciate past their current price (over a particular period in many cases).