Have you ever bought the stock of an excellent company only to lose money? It happens all the time. The longer you invest, the more you realize you won’t make perfect decisions. More importantly, avoiding bad stocks is the key to long-term success.
Warren Buffett’s investment advice on his top two rules for investing: “Don’t lose money. And don’t forget the first rule.”
Smart stock picks often turn out to be the ones you didn’t buy rather than the ones you did. Buffett also recommends most investors buy a low-cost S&P 500 mutual fund or ETF.
For today’s article, I thought I’d turn things on their head and discuss three smart arguments for owning dumb stocks.
To do this, I must first identify three dumb stocks to pick. Every person’s version of what a dumb stock is differs. For me, a dumb stock is any company that uses debt to repurchase its shares. (Before all you Apple (NASDAQ:AAPL) shareholders burn my house to the ground, there are circumstances where it makes sense to use debt to buy back stock.)
With that in mind, here are three smart takes on three “dumb” stocks.
|IBM||International Business Machines||$137.48|
Barron’s article explained Apple’s $5.5 billion bond issuance with varying maturities from seven to 40 years in August 2022. The bonds had interest rates ranging from 3.25% to 4.1%, with the largest portion ($1.75 billion) at 3.95% maturing in August 2052, 30 years down the road.
Now, the “Use of Proceeds” section doesn’t emphasize which capital allocation levers it will ultimately use. However, at least a big portion will go to stock repurchases.
Due to Apple’s AAA credit rating, bond expert Martin Fridson speculated that CFO Luca Maestri may have alerted CEO Tim Cook about two things: the potential closing of the window for inexpensive debt issuance amid rising interest rates.
Apple issued debt in August 2022, and interest rates increased by 200 basis points to 4.25%-4.5% that year. Rate hikes paused in June 2023, but two more 0.25% increases are expected by year-end, reaching a range of 5.50%-5.75%.
On May 8, 2023, Apple issued five bonds at rates between 4.00% and 4.85%, raising gross proceeds of $5.25 billion. Repatriated cash from overseas is taxed at 15.5% and can be paid back interest-free over eight years in installments. Lower interest rates will prompt Apple to repatriate cash and pay down debt used for share buybacks.
It’s capital allocation 101.
International Business Machines (IBM)
I’m not suggesting that International Business Machines (NYSE:IBM) is the poster child for capital allocation in corporate America. However, there have been times in its history when borrowing to buy back stock made complete sense.
In May 2007, The New York Times reported on the tech company’s $11.5 billion borrowing for a share buyback.
In 2007, IBM borrowed $11.5 billion through an international subsidiary, allowing them to use overseas cash for buybacks without incurring taxes.
Remember, this was before the 2017 tax cuts. As a result, IBM would have had to pay 35% of any cash it brought back to the U.S. to pay for the share repurchases. For example, in Sept. 2007, as part of its plan, it issued $3 billion in 2017 notes at 5.7%.
The company saved approximately $800 million by borrowing $3 billion at a low interest rate, instead of repatriating the funds and paying higher taxes.
I’m not an IBM fan, but it’s hard to fault their math.
Exxon Mobil (XOM)
Forbes published an interesting article in 2020 examining U.S. blue-chip companies’ $2.5 trillion debt binge. The article listed some of the biggest borrowers from the S&P 500. Exxon Mobil (NYSE:XOM) was one of them.
The article highlighted that between 2010 and 2019, Exxon’s net debt grew from $6.6 billion to $49.7 billion, an increase of more than 10-times. It also noted that non-financial business debt had increased by 64% since 2010.
Quantitative easing by the Federal Reserve fueled corporate debt used for share buybacks, reducing the S&P 500’s share count to a two-decade low, according to economist David Rosenberg.
At the end of 2009, Exxon had 4.72 billion shares outstanding. By the end of 2019, that number had dropped to 4.23 billion, a 12% decrease in share count. That might seem like a small reduction. However, Exxon’s $41 billion acquisition of XTO Energy in 2010 led to the issuance of 416 million shares, resulting in a reduction of its share count by 906 million over the decade.
The acquisition gave Exxon 45 trillion cubic feet of gas in the U.S. market, an area of weakness for the company at the time. That is not the case today, as it is one of the largest producers in Texas’s Permian Basin.
Exxon Mobil’s debt might have increased, but so did its cash flow. As cash flow increases due to higher oil prices, the company is able to pay down its debt, and repeat the cycle.
It works for the company.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.