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STA Weekly Report – The Anatomy Of A Share Buyback

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This week’s market report will be in an abbreviated format as I am currently out of town. However, I will have a full newsletter for you next week.

INSIDE THIS EDITION:
The Anatomy of a Share Buyback
Tax Planning for 2018 and Beyond – Especially the Impact on Retirees and Small Business Owners
401k Plan Manager

The Anatomy Of A Share Buyback

A share buyback is when a company buys back shares of its own stock. As we have mentioned, buybacks are at a record high so understanding the anatomy of how a share buyback works can be helpful to understand what companies are doing with available cash but also to see how buybacks can affect underlying earnings per share results.

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Source: Goldman Sachs

Share repurchases (or buybacks as they are also known) can typically be done in one of three ways.

First, it is possible for the company to simply buy shares in the open market. This method entails paying the market price for shares and is typically guided by a preapproved share repurchase authorization that is approved by the board of directors. This provides a company with some level of flexibility in terms of when they buy back shares.

Second, a company can utilize something called a tender offer to repurchase a specific number of shares. This will typically be done at a premium to prevailing market prices but allows shareholders to tender shares based on terms of the tender or may be done using a dutch auction where a price range is provided giving the company the ability to determine the lowest price it may be able to buy shares at.

Last, and least common, is the direct negotiation with a large shareholder where the company can buy back a larger block of shares. Like in the tender offer method, this third method is typically carried out at a premium which allows the company to buy back shares and provides the seller with an increase in wealth.

Regardless of how the buyback is carried out, the result is typically the same. It reduces the number of shares outstanding. However, whether they increase earnings per share will depend on how the buyback is being financed. The two examples below should help explain how the cost of debt might affect the net result of a buyback on earnings per share results.

When a Buyback is financed with debt that is more expensive than earnings yield

The following table shows key data for a fictitious company that is financing a buy back using after-tax debt that is more expensive than its earnings yield. After calculating the Earnings Per Share following the buyback, the company generates $4.92 per share in earnings.

When a Buyback is finance with debt that is less expensive than earnings yield

Holding key information steady for the company above, except that the after-tax cost of debt to finance the share buyback is less than the earnings yield, that same company’s earnings per share would increase by 2.2%.

This example serves two purposes. First, it is a simple illustration of how a buyback does not necessarily result in a boost to earnings per share. In fact, how a company finances a buyback can create meaningful differences in whether a buyback is a positive for earnings per share results. Second, it serves as a strong reminder that investors should work with advisors that understand the nuances associated with macroeconomics, fundamentals, and technicals. Financial markets can be complicated and constantly changing, and because of this, not understanding the details can lead investors to incorrect conclusions sand make errant investment decisions.

Luckily, by working with an advisor that understands these market dynamics can help mitigate these risks and set an investor on the path to reach their goals and objectives.

Weekly Technical Commentary

Healthcare gets close to an upside breakout

One of the factors keeping the S&P 500 from moving higher has been a lack of leadership from some of its largest sectors excluding technology and consumer cyclicals. However, one of these sectors, healthcare, as of last Friday, appeared to be forming a bottom. Chart 1 below, shows the Healthcare Sector SPDR (XLV) needing to close above its April/May highs in order to establish a more positive trend. The gray area in Chart 1 plots a ratio of the XLV divided by the S&P 500. So far this year, the XLV has underperformed the SPX by a couple of percentage points. Since it is the third biggest sector in the SPX, an upside breakout, which may be getting close, would be a big help to the S&P 500.

Chart 1

Source: Stockcharts

Financial Sector Bounces off 200-day moving average

Due to their size and uninspiring performance this year, financials have been the biggest drag on the market so far this year. The red line in the top box in Chart 2 shows the relative strength ratio of the financials sector divided by the S&P 500. As you see, it has been falling all year. Thus far in 2018, the financial sector has been flat (versus an S&P 500 gain of 3%). In fact, the only sectors doing worse are utilities (-5%) and consumer staples (-11%). The difference however, is that utilities and consumer staples only have a combined weighting in the S&P 500 of 8%. Financials on the other hand make up 14% of the S&P 500, representing the second largest sector (behind Technology). As a result, financials’ weak 2018 performance has been a big drag to the rest of the market. Not all the news is bad though. In fact, there may be reason to be optimistic as Chart 2 shows the Financial Sector SPDR (XLF) rebounding off its 200-day moving average for the third time since the start of April. This is a positive development as the third test of support is usually the most important one. An upturn in the XLF would be supportive to the market and a move above its May peak would be even better.

Chart 2

Source: Stockcharts

Weekly Global Asset Class Performance

If you have any questions, please feel free to email me at luke@stawealth.com.

Luke

STA Investment Committee

Luke Patterson, CEO & Chief Investment Officer

Mike Smith, President

Andrei Costas, Senior Investment Analyst (Equity Strategies)

Nan Lu, Senior Investment Analyst (Fixed Income Strategies)

Tax Planning for 2018 and Beyond – Especially the impact on Retirees and Small Business Owners

Scott Bishop, Executive Vice President of Financial Planning for STA Wealth Management hosts a special edition of STA Money Hour with STA Wealth’s newest Financial Planning team member, Mike Churchill, CPA.  Before joining STA Wealth, Mike was a Tax Manager for ABIP CPAs.

On today’s show, MIke and Scott covered many important and timely tax planning topics related to the Impact of the Tax Law Changes in the 2017 Tax Cuts and Jobs Act as they relate to Retirees and to Owners of Small Business.  Many of these Retiree topics are also discussed in the Retirement Survival Guide as well.  Here are some of the strategies discussed on the show:

  • Roth Conversion Strategies
  • Charitable and Itemized Deduction Strategies
  • Qualified Charitable Distributions from IRAs and Charity as Beneficiary of an IRA
  • Potential Tax Loop Holes and Tax Traps for the Small Business Owner including:
    • Income Tax Reduction Strategies
    • Income Alchemy Strategies
    • Tax Planning for Tax Thresholds and Phase-outs
    • Planning for the New 199A Qualified Business Deduction (a 20% discussion).

Click Here to Listen to The Full Interview



Disclaimer:

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA Wealth Management, LLC. Please remember to contact STA Wealth Management, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. STA Wealth Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA Wealth Management, LLC’s current written disclosure statement discussing our advisory services and fees continues to remain available upon request.

Financial Planning and Investment Advice offered through STA Wealth Management (STA), a registered investment advisor. STA does not provide tax or legal advice and the information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters or legal issues, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

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