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Technology Stocks : Semi-Equips - Buy when BLOOD is running in the streets!
LRCX 155.15+2.1%Nov 26 3:59 PM EST
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To: Zeev Hed who wrote (9961)6/11/2001 9:46:50 PM
From: Ira Player  Read Replies (1) of 10921
 
This causes "mis allocation" of capital

It depends on how you look at it.

Let's create a fictional corporation that has an excellent credit rating (because it has no debt), has very good cash flow from a rapidly increasing sales of proprietary piece of software, but the stock is getting no respect. It is selling for a trailing PE of 10, PS of 1, while generating gross margins of 80%.

Given this scenario (if you find it, PM me please...lol) if makes very good sense to:

1. Use cash flow to buy back stock.
2. Borrow against that great credit rating to buy back stock.

If the purchased stock is truly retired (not held as treasury stock, but retired), the earnings per share could actually improve by borrowing at 8% while buying back shares that are getting 10% (PE ratio of 10) against the earnings.

It's not always a "mis allocation" of capital.

When the market realizes what the 'real' value of our hypothetical corporation is, the stock price will follow. When the PE is where it should be for this wonderful, but well hidden (from me at least) company, say around 40, it should reissue some shares and pay off the 8% debt with the newly minted 2.5% (earnings) shares.

Ira
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