Yet Another Reason the Stock Market Is Overvalued

In my online stock valuation class I teach, The Analysis and Valuation of Stocks, I have my students grab the annual report of a company of their choosing and use it for analytical purposes in the class.  Over the now 12 years I've offered this class, I've seen trends in the different companies they've chosen.

Garmin, remember them?
Palm?  Those were fun times!
Blackberry?  Ah, the early 00's.

However, of even more interest was the financial trends that were spotted when we'd get into the nitty gritty of it.  Most recently two trends that are related

1.  "Cash Flow from Operations" continually exceeding "Cash Flow from Investing"

and

2.  A almost nearly always guaranteed repurchase of shares.

Before you fall asleep let me explain these things to you and why they are very relevant to everybody today.

First, "Cash Flow from Operations" (CFO) and "Cash Flow from Investing" (CFI) are two "boring" financial statistics that all companies have.  Most people focus on "net profit" or the bottom line, but savvier analysts know to look at CFO and CFI.

The reason is (without going into a long and boring detailed explaination of non-cash accounting) CFO is the amount of actual cash the company is generating while CFI is the amount the company spends on maintaining and expanding it's operations.  Ergo the "cash from OPERATIONS" goes to pay for the "cash expended on INVESTING."

These two numbers I believe tell you more about a company than any other financial numbers.  First, it tells you if the company is profitable and not just on paper, but actual cash (CFO).  Second it tells you if the company is expanding or contracting (CFI should be a negative number showing the company IS expanding and investing).  And third, it tells you if it can finance its expansions and operations with the money it generates internally.  Ergo, if CFO generated exceeds the amount spent on CFI this is a GREAT thing because the company neither has to borrow money or issue new shares to expand.  It is SO PROFITABLE it can do it in house.

There is a problem, however.

As I noticed most of my student's companies were generating a lot more CFO than they were expending on CFI.  Yes, profits have recovered from the depths of the Great Recession, but this economy wasn't booming.  And most of the profits I knew came from cost cutting, not investing in new plants and equipment, expanding operations, and thus employment.  Ergo, what the financial statements of these companies were telling me was the reason for such excess CFO over CFI was not because of healthy CFO, but rather low expenditures on investments and CFI.  This is why corporations can have these "record profits," but employment growth and private investment is not forth coming.

Second, now enter in stock repurchases.

Say you're a CEO of a corporation that is generating a lot of cash flow, but not expanding or investing a lot.  Well, you're left with the enviable position of having a lot of extra cash on hand.  But if you're not going to invest that cash, you have to do something with it.  So what do you do?

Stock repurchases.

Repurchasing a company's stock is NOT investing and does NOT show up in the CFI.  Additionally a company repurchasing its shares does NOT create any ACTUAL investment.  No factories are built, no facilities constructed, no people employed.

It does however boost the price of your stock because it "undilutes" the amount of shares outstanding.  This not only boosts the stock price and makes your shareholders (who indirectly vote you into your executive position) happy, but also makes your stock options much more valuable.

Ergo, the trend you see of companies with excess CFO who like to repurchase their shares.

It is here I would like to show you the S&P 500's "statement of cash flows," but unfortunately you have to pay for such research.  Instead I'll merely pull some key, large companies we're all familiar with and highlight this phenomenon on their cash flow statements.

Though your eyes may be glazing over, if you look at the highlighted (red) sections you'll see these companies (Colgate, Exxon, and Apple) making tons of money (CFO), but not fully reinvesting it (CFI).  The remaining cash is (primarily) used to repurchase shares (and sometimes pay dividends) or buy other stock's shares (highlighted in blue).

These corporate actions not only speak volumes as to what the "holy trinity" of corporations, investors and employers (all 3 in 1) think about investing in the US, but also have serious ramifications for US stock valuations.

First, they're saying, "Are you nuts?  Invest here?  Sorry, we're going to spend what we have to to ensure our current investments don't rot, make what meager investments we see that are truly profitable, but sorry, economic growth and the investment climate is just not worth it.  We're just going to repurchase shares because THAT'S OUR BEST USE OF OUR MONEY."

Second, in doing so they further inflation a stock market bubble that is already inflated with trillions of 401k, IRA, 403b, and other pension/retirement fund money.  This has driven the S&P 500 well beyond it's historical PE of 15 to a now dizzying 26 implying a 73% overvaluation that only idiot Americans would cheer for and IRA Zombies invest in.

Ultimately, though, there is a hidden lesson corporations and investors are indirectly telling the American public (and western civilization citizens in general).  And that lesson is one of:

"Fuck you."

I don't know how long it will take "corporation hating" Americans to realize that those same corporations who they love to loathe and blame their laziness and lack of work ethic problems on are also the primary source of:

1.  Jobs
2.  Careers
3.  Economic innovation and growth
and
4.  Retirement wealth

in this country.  And the fact they have made it so inhospitable financially, politically and socially to be a corporation here that corporations would rather

1.  Spend money repurchasing their shares
2.  Spend money buying other companies' shares
3.  Open factories overseas
4.  Bribe/lobby politicians
5.  Pull a Medtronic or Burger King

than hire and invest in the US should be a wake up call to all the Obama-supporting college graduates working as barristas for $9/hour. i.e.- even the dumbest of leftists should have the mental capacity to understand these basic lessons of economics and human incentive.

Sadly, however, western minds have been so damaged and polluted with self-pitying victimization and laziness they'd rather sit and mope, feeling sorry for themselves, blaming those "white-male-ly" corporations, and thusly condemning themselves to a life of poverty and mediocrity, than spend the energy it would take to get a basic education in accounting and economics.  But, hey, at least they "weren't part of the system man!" and stuck it to those "corporations, man!"

Regardless, for all those Americans who hate corporations and are too busy to be bothered with cash flow statement accounting, enjoy listening to "Rage Against the Machine" when you're 50 and maybe, MAYBE, making that last payment on your student loans.