So stocks are priced these days as if American growth will never happen again, while government bonds are being priced as if significant inflation will never happen again.
We can talk all day about this, and perhaps even show how U.S. treasuries are priced as if inflation will remain lower than has been historically normal. (The 10-year bond locks your money for 10 years for just 2.6%) We can also show how a stock like Coca-Cola (KO) is priced as if it will never grow again. (Just take its current earnings and look up the formula for a perpetual annuity)
But unfortunately, the average investor has to wait and hope that the market will eventually realise this dichotomy between asset classes.
Thing is, large multinationals don’t have to wait. For example, Coke.
Coca-Cola has a market capitalisation of $132 billion dollars, thus it costs $132 billion to buy all of its shares. At the same time, Coca-Cola has an enterprise value of just about $134 billion, which equates to the value of its shares ($132 billion) plus the value of its net debt (very small, about $2 billion).
Yet Coca-Cola is one of the more defensive businesses that exists in the world. It can easily carry a some leverage, unlike a volatile pharma or tech startup, given its entrenched businesses and non-cyclical nature of its sector.
So let’s say Coca-Cola decides to take advantage of the massive hunger for bonds in the market right now, and issues $33 billion of debt. This would be a massive issue, but Coca-Cola could likely get away with a historically low interest rate given how the bond market is these days. Coke could then take the $33 billion and buy-out one quarter of its available shares in the market at the current price. Even after doing this, it would only have $35 billion of debt vs. a market capitalisation of $99 (assuming its share price doesn’t rise after the buyback, which is doubtful), and would be far from heavily leveraged for company of its nature.
If the company can then beat the (uber) sceptics and achieve some modicum of growth in the future (as in, ever), it’s stock price would likely move higher. Again, you can calculate the value of a perpetuity here to value a constant stream of earnings with zero growth.
If its stock price doesn’t go up despite higher earnings, then it can just play the same bond vs. stock market spread again , and now has more earnings to pay interest with — essentially selling itself into the highly priced market (issuing bonds) and buying itself back in the lower priced market (buying back stocks). This could work with many well established multinationals who are currently carrying low levels of debt, which includes many of the largest names. Which means debt-financed stock purchases could be ahead, either via companies debt-financing buy-backs, or via companies debt-financing acquisitions of other companies (BHP and Potash rings a bell). Food for thought.
(Credit to Kevin Ferry for triggering this post)
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