Wednesday, June 18, 2014

Corporate Tax Rates

The U.S corporate tax code is a hot button issue, with some arguing for higher tax rates and others arguing for lower tax rates. No matter which side you fall, one thing is certain: Companies have left the U.S. for countries with lower tax rates. For example, Medtronic recently announced plans to purchase Covidien and move the company's operations to Ireland. While the official top marginal tax rate in the U.S. is 35 percent, a recent study by S&P indicates that the effective corporate tax rate for the U.S. in 2012 was 32.3 percent. By way of comparison, the effective tax rate in Switzerland is 22.4 percent, in the U.K. it is 26.4 percent, and in Spain it is 26.5 percent.

There is another interesting statistic in the article that we want to make sure that you didn't overlook. Overseas revenues now account for about 48 percent of all revenue earned by S&P 500 companies.

Tuesday, June 17, 2014

Biology And Volatility

Behavioral finance is a relatively new area of study and how biology affects behaviors is a hot topic. In a recent article, John Coates discusses how biology affects risk taking behavior. As you know, most people prefer less risk over more risk and, in finance, risk is all about uncertainty. As Coates notes, a study shows that an increase in cortisol levels reduces the amount of risk an individual is willing to undertake. So, traders who have increased cortisol levels should be less likely to engage in risky trades. In the past 20 years, the Federal Reserve has become more transparent and is now giving guidance on the likely future direction of the fed funds rate. Coates argues that since this change in policy began, the stock market has become more volatile, possibly because of the lower uncertainty around Federal Reserve policy. In other words, uncertainty about the fed funds rates could actually decrease the amount of risk traders are willing to take in their investments.

Monday, June 16, 2014

Leverage And Investing

Much of the material that you will learn in this textbook is applicable to your own investment strategy as well. A recent article on CNBC highlights a couple of these lessons. As you will read, the article discusses the problems faced by a couple in their attempt to become landlords. We would like to point out two sentences near the end of the article. First, "Without leverage, the most you can lose is your initial investment. With leverage, you can lose substantially more than your initial investment." As we have discussed, leverage is a double edged sword that can increase returns when times are good and decrease returns when times are bad. As an equity investor in a company, you are protected from losing more than your initial investment in the company. However, when you use leverage for personal investments such as purchasing a rental home with a mortgage or borrowing for a stock investment, you can lose more than your initial investment and your entire wealth can be at risk.

The second statement we would like to point out is "Owning more of a good thing is not always better. Concentrating is gambling; diversifying is investing." Hopefully you are well aware of the benefits of diversification by now. A concentrated portfolio can make you wealthy if you hit it lucky, however, it can also break you if things go poorly. For investing in the future, we believe the same as the author of this article: For most people, a diversified portfolio is a much better strategy to achieving personal investment goals.

IFRS Dead?

The conversion of U.S. corporate accounting from GAAP to International Financial Reporting Standards (IFRS) has been in process for several years. However, in a recent speech, former SEC chair Christopher Cox stated he had come to "bury IFRS, not praise them." Cox argued that the lack of progress in adoption of IFRS standards over the past six years has weakened enthusiasm for conversion to IFRS in the U.S. During Cox's last year as SEC chair, the process for converting U.S. financial standards to IFRS by 2014 was outlined. However, subsequent SEC chairs have not followed through on the conversion. IASB chair Hans Hoogervorst disagreed with Cox, arguing that the recent adoption of lease accounting changes is an indication that IASB and FASB standards are becoming more similar.

China Now Largest Corporate Debt Issuer

China's corporate sector has become riskier in recent years, with declining corporate cash flows. Even with the increased risk, China is now the largest issuer of corporate debt, with $14.2 trillion outstanding at the end of last year. By comparison, U.S. companies had $13.1 trillion in debt outstanding. S&P estimates that one-fourth to one-third of Chinese corporate debt is loaned by shadow banks, financial intermediaries that provide services similar to traditional banks, but not tied to banking regulations. One risk of shadow banking is that lending in this segment can contract much more quickly than in the regulated banking segment. By 2018, it is estimated that Chinese corporate debt will increase to $20 trillion.

Friday, June 6, 2014

Negative Savings Rates

Saving money does not pay in Europe. The European Central Bank (ECB) recently lowered borrowing and savings rates. In fact, the ECB lowered the rate paid on regional bank deposits to a negative .1 percent! By lowering interest rates, the ECB is hoping to stimulate spending and inflation, which is about .5 percent in euroland. So, how do you calculate the real interest rate with a negative nominal return? In this case, the real rate is approximately negative .6 percent.

Arithmetic Versus Geometric Returns

As the quote often attributed to Mark Twain goes "It is difficult to make predictions, especially about the future." Nowhere is this statement more relevant than making predictions about the stock market. In a recent discussion of future stock market returns, a 12 percent market return going forward was proposed. What is more dangerous is that an 8 percent withdrawal rate for a retirement portfolio was suggested.

You already know that the roughly 12 percent arithmetic average since 1926 overstates the average return for a longer period because a weighted arithmetic/geometric average using Blume's formula is more appropriate for longer horizons. We should also point out the danger of withdrawing funds. Suppose you started withdrawing 8 percent of your initial portfolio value in 2008, when the market lost about 37 percent. At the end of the year, you only have about 55 percent of your original portfolio left, so you have much less money left to go up with a good market return. Research indicates that a withdrawal of 3 to 5 percent of the initial portfolio value is much more likely to support your retirement withdrawals, even with a 12 percent arithmetic average market.

We would also like to ask you a trivia question: When did the S&P 500 begin? Although you may think 1926 since that is the beginning of the data used in the textbook, Ibbotson and Associates create a proxy for the S&P 500 back to that date. Actually, the S&P 500 was launched on March 4, 1957.

Wednesday, June 4, 2014

CEO Pay Season

Proxy filings for many major U.S. corporations occur in the spring, which means the top earning CEO list comes out. Larry Ellison, CEO of Oracle, again heads the list, earning $78.4 million during 2013. However, Salesforce CEO Mark Benioff may have been paid more by some measures. Benioff's 2013 pay of $31.3 million puts him as the 8th highest paid CEO, but Benioff's compensation was a staggering 57 percent of Salesforce's cash flow and over 12 percent of sales. And Facebook paid out 11 percent of sales and 20 percent of cash flow. By any measure, these pay packages seem to be an extraordinarily high percentage of sales and cash flow.