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Politics : Ask Michael Burke -- Ignore unavailable to you. Want to Upgrade?

To: Les H who wrote (71941)	12/15/1999 3:14:00 PM
From: Les H	Read Replies (1) \| Respond to of 132070

The Economic Costs of Trading are Exceeding Profits Today's Value Investor Textbooks say you should buy shares of a company in order to share in the entity's earnings. If you own 200 shares of Merck and the company delivers $3.50 per share in earnings, you have a claim on $700 of the company's earnings (200 times $3.50). Of course, you can't walk into Merck's corporate headquarters and demand $700. If you're smart, you'll let Merck reinvest the money it earned on your behalf and turn $700 into, potentially, $7,000 some day. Over time, the stock price will track the growth in earnings and may deliver a 10-fold increase for you, too. But what happens when the money you pay for your share of the earnings exceeds the actual earnings? Apparently, that is been happening. I've found an astonishing pattern wherein investors are flipping stocks so rapidly these days that they are paying more in commissions and dealer spreads to acquire their favorite stocks than these companies generate as profits. Consider this: The average share of Apple Computer will trade hands more than seven times this year, if current volume trends continue. That means 1.37 billion shares of Apple will flip, though the company only has 175 million shares outstanding. I estimate that shareholders and institutions will pay upwards of $450 million in commissions and dealer spreads flipping their Apple shares in 1999. The company's projected net income for the year is only $385 million. The average share of Dell Computer is on track to flip four times in 1999 and total volume should easily exceed 10 billion shares. I estimate the transaction costs of this huge turnover will be $3.3 billion, almost twice Dell's expected 1999 profits. Investors will probably cough up almost $1 billion in commissions to trade shares of Tellabs this year, which seems a hefty price to pay for Tellabs' expected profits of $500 million. The king of the value destroyers has been PeopleSoft, the developer of database software. The average share of PeopleSoft will flip almost seven times this year, meaning investors are holding the stock about 51 days. They will pay more than $500 million in frictional costs this year to acquire a stake in a company generating $21 million in profits on their behalf. This turnover, as much as it is coveted and encouraged by companies, actually creates no economic value for investors, but simply provides a vast feeding trough for the brokerage industry. The numbers are even more telling for Internet stocks, where investors are cumulatively paying hundreds of millions of dollars in commissions to acquire a piece of an unprofitable company. The only hope they have of recouping their transaction costs is if people keep piling on after them and bid the stock up. There is never any assurance of that happening, however, especially when holding periods run only a few months. In all, investors will likely pay $77 billion this year in commissions and dealer spreads buying S&P 500 companies that will collectively generate between $200 billion and $300 billion in net income for them. No doubt, looking at turnover this way might prompt some academic debate. After all, if an investor holds any of the stocks mentioned above for a period of years, the profits earned by the company will far exceed the cost of admission. But the fact is that investors aren't holding these stocks very long. If current trends hold, more than 300 of the S&P 500 stocks will turn over, on average, at least once this year. Investors aren't holding most stocks long enough to enjoy one year of profits. What if this trend occurred year after year? The actual economic benefit to society of owning stocks would be negative. More money would be siphoned out of the system in trading costs than companies would inject back in through profits. The cost of owning a claim on $1 of earnings would be far more than $1. The only value actually created would be the paper gains that can be whisked away by a poor market. To say that the recklessness of individuals is fully to blame would be wrong. Mutual funds and other institutions, who probably account for 60 percent to 75 percent of daily market volume, are prime culprits. Their short-term oriented, "finger-on-the-trigger" trading habits are causing a huge leakage that would serve investors better if stocks were held longer and the money remained in shareholder's pockets. Companies are to blame too for encouraging this turnover. Executives tease the financial industry by providing earnings guidance that encourage funds to make quarterly bets on the direction of the stock. Likewise, they enthusiastically split their stock, which throws more shares into the trading den and adds to turnover and transactions costs. To date, CEOs don't seem at all worried about stock turnover, though, frankly, they should. A preacher shouldn't judge his success by weekly turnover in the pews, but by longevity of the congregation. Valuation is a function of corporate success, not turnover. Keep your earnings rising at 15 percent annual rates, and the stock will continue to rise over time, whether 1,000 shares trade every day or 10 million.