July 14th, 2014
How Low Interest Rates Allow Companies to Fake Earnings Gains and Perpetuate the Myth of Recovery
by Michael Clark, Seeking Alpha
To look at IBM's stock chart one would never guess that IBM has endured 8 quarters in a row of declining revenues. This is a depression: 8 quarters of declining sales. Why is the stock going up? Well, IBM is borrowing money at low interest rates to buy its own shares to drive up the price of the stock - and, in the process, taking on more debt, essentially making itself weaker as a company in every way except through the stock price, that it is 'fixing' at high levels. At least for the moment. When no one is buying your stock, and revenues are declining, what can you do if not cheat a little bit?
Share buy-backs are the BIG SCAM of the season, brought to you by (you guessed it) the friendly Federal Reserve Bank.
Low interest rates have allowed IBM, and other companies losing money hand-over-fist, to buy back their own shares, reducing the number of outstanding shares to drive up EARNINGS PER SHARE. As long as investment media agrees to focus on (dumped-down) EPS expectations and not sales or income, stocks continue to shink a bright spotlight on their own honor.
There are two ways to drive up EPS:
- make money;
- take on more debt and buy back shares to trick the public. The first way is the method of successful capitalism; the second method is the way of corrupt capitalism in bed with the state to avoid the picture of failure.
Let's look at the IBM monthly stock chart:
Looks pretty good, in fact. Almost like a successful company; certainly it does not look like a company that is in trouble and has been 'losing money' for the last seven years. In fact IBM earnings have not really budged an inch since 2007.
Let's look at a recent story of IBM's earning disaster, from Paul Lily at Declining Hardware Sales and Expensive Layoffs Hurt IBM's Bottom Line:
It was another rough quarter for IBM, which reported a drop in revenue. That marks eight quarters in a row of revenue declines. For the first quarter of 2014, IBM's total revenues reached $22.5 billion, down 4 percent from the first quarter of 2013. On the plus side, IBM is still making a profit - $2.4 billion in Q1 2014, though even that figure is marred by the fact that it's down 21 percent year-over-year.
In fact, sales have dropped over the last 7 years at IBM to the 2007 level. But the stock price has doubled in that time.
I'm not a fundamental analyst. I fancy myself as a poet-philosopher, and a technical analyst of stock trends. When it comes to reading earnings reports, I'd rather read Dante.
But I realized I needed to comprehend what was going on. How could a company that was clearly failing in the marketplace - a company with seriously declining sales - watch its stock price climb. This was not what capitalism was supposed to be about, was it?
No, it wasn't. The FIX was in. The Federal Reserve, with its low interest rate policy, had fixed the game. The FIX was the repression of rates to allow companies losing ground in the global depression to pretend they were really winning by allowing/encouraging these companies to borrow money at low rates to buy back their own shares. By retiring shares through these purchases, companies changed reality to make it look like earnings were actually going up. Of course, debt is rising; it is low-interest debt, true; and company officials are collecting those infamous bonuses that are tied to stock price appreciation.
I may seem to be picking on IBM. In truth, many companies we consider great, leading US companies are engaging in this ruse of trading debt (future losses) for the illusion of presennt earnings growth. Apple at least has earnings growth, even as it has bulked up on the low-interest rate cream-pie served by the central bank. This is socialism for the rich. This is NOT what capitalism is supposed to be about. This is robbing the future of America to keep the rich rich.
IBM's outstanding shares have declined from 1.3 billion in 2010 to 1.01 billion in 2014.
There is also the issue of these buy-backs occurring at what might be (depending upon who and which metric you believe) one of the most expensive, overpriced markets in the history of Wall Street. If these shares were to experience a 30% correction, a real possibility, once the Fed stops the fix, either by stopping its non-printing creation of money or its repression of interest rates, which seems to be coming sooner rather than later, then will losses on these share repurchases trigger another corporate run on Washington for more tax-payer bailout money?
Buyback Quarterly reports a 50% increase is share buyback (year/year) in the first quarter of 2014. There were $500 billion in corporate buy-backs in 2013 - the second-most in the history of Wall Street. Interesting, 2007 had the highest buy-back amount, at higher interest rates, suggesting that the covering-up of revenue losses occurred from 2001-2007, even before the 2008 meltdown.
The Fed has enabled this addiction to cheap money (corporate and consumer) - and the Fed will probably attempt to keep it going as long as possible.
How does all of this work? I consulted a web page, WIKIHOW, to investigate this matter. They use an example of Microsoft's earnings - I apologize to Bill Gates in mixing apples and oranges, in a sense. This is the example they gave, which I'm working with: How to Calculate Earnings Per Share.
According to this page, MSFT had net income or net earnings of $13 billion for the year 2012. MSFT had 8,330,000,000 outstanding shares. If we divide the earnings by the number of shares we get Earnings Per Share (which is different than simply earnings, of course - and this difference allows a lot of manipulation, as we will show).
$17,000,000,000 divided by 8,330,000,000 equals 2.04 EPS.
Let's say the company experiences a bad quarter and has revenues decline by $1,000,000,000. It's not the end of the world - they are still selling $16,000,000,000 worth of software or machinery or services. But the EPS declines from 2.04 to 1.92. This is about a 6% decline. If the headline reads: "IBM earnings decline 6%" - investors might notice this. So, companies can trick investors (in many other ways also, true) by buying back shares. If you don't improve the earning side of the equation, you improve the shares side of the equation - while you also take on more debt as a company. In fact, these are two negatives, that seem like a positive.
Let's say the company in question declines in revenues by the agreed-upon $1,000,000,000 but buys back a billion shares. Suddenly, the company is not reporting a negative quarter, the actual loss of $1billion in sales, but they report EPS surged from $2.04 to $2.18. Investors don't even notice that sales are going down. Earning (per share) are up a whoppiing 14%.
Of course, it cost this mythical company $35,000,000,000 to by back these 1 billion shares, not a small matter - but the company just issues more debt and sells it to pension funds and mutual funds and hedge funds - and if the stock market tanks, of course, it will primarily be these funds (and retired investors) who take the loss.
And the government enables this type of cheating on Wall Street. They are all in bed together. The government passes laws to help Wall Street take money from investors - and then Wall Street rewards the governors who, when finally replaced in Washington by voters, go to Wall Street for $1million/year jobs.
This is State Capitalism, government and business soaking the public together. Where does corporate income originate? The money is not grown on trees. It comes from consumers. When the government regulates Wall Street, profits are more honest. When government realizes that they can join Wall Street to get rich quick by soaking consumers, then we have a state of crisis, cataclysm. The only way for the public to continues buying is through lower and lower interest rates, more and more debt - debt slavery in fact. When the Big Government enables Big Business (as partners in crime) to enslave the public, and rob them at will, this is a cataclysm.
QE and ZIRP are unmitigated theft from the public in favor of the elite who have lost their conscience. I understand you can make the argument that such Socialism for the Rich saves jobs, and keeps Americans from economic hardship. You can make that argument. But not without seeing the other side of the argument, that it also transfers immense wealth from taxpayers to the VERY rich. It also destroys the religion of capitalism, upon which some Americans believe America was founded.
Bailing out failing companies makes these companies weaker and more in need of help. All the arguments that were made against welfare for individuals in the 1960's by the conservatives, many correctly, can be used against Wall Street today. Weak companies need to fail, so that stronger companies with better products or systems can replace them. We are impeding Nature's replacement system with Man's imagined replacement system.
America and the World suffered greatly in the Great Depression. But we did not die. We did recover. Or, if we died, we were reborn - depending upon which vocabulary you prefer. In fact, the Economic Cycle dies every 36 years. We suffer; we deflate; we die. But we are reborn. Impeding this process (with the Fed playing God) is only going to delay everything, death, decay, gestation, rebirth.
Japan delayed everything with QE and ZIRP. Their housing bubble burst in 1989. Japan crashed. Then the brought in the QE and ZIRP, late, I'm sure at American insistence. They should have bottomed out 18 years later, had they 'taken their medicine', raised rates, and destroyed all the bad debt in the system. They did not. They lowered rates to protect the debtors, protect the speculators, and punish the Japanese people. I'm sure there intent was to protect everyone, to save everyone from pain. But people who take on too much debt, at the wrong time in the business cycle, should not be protected from reality by those who did not take on the same debt load. Let the guilty fall. That is justice.
IBM's stock should be trading at multi-year lows, not multi-year highs. But Wall Street found a way to cheat. I don't mean to pick on IBM alone. MANY companies are doing the same thing.
For those of us who believe that the 2008 meltdown was caused by debt (corporate and consumer debt) and by leveraged corporate debt especially, the fact that corporations have taken on 15% more debt since 2008 guarantees another and a even more horrible crash, one which will not be mitigated by Fed money-printing.
NOTE: For a full report on IBM's chicanery, you can read David Stockman's expose on Zero Hedge entitled "Big Blue: Stock Buyback Machine On Steroids."