In my last post, I made the argument that preferred stock is very expensive debt. To give you a sense of the differences in costs between the different types of financing, consider a company like GE that has common stock, preferred stock and conventional debt outstanding. In March 2009, the cost of equity was close to 12%, the preferred dividend yield was about 9-10% and the pre-tax cost of debt was about 6-7%. On an after-tax basis, the pre-tax cost of debt was closer to 4%.To understand why firms use preferred stock, given its high cost, we have to look at the two groups of firms that are its...
Preferred Stock: Fish or Fowl?
In my last post, I talked about hybrids but I stuck with the conventional example of convertible debt. In this one, I would like to draw attention to another source of financing - preferred stock - which I find much more difficult to work with.Before I begin, though, let me also draw a distinction between preferred stock in the United States and preferred stock in some other parts of the world (such as Brazil). In the United States, preferred stock commands a fixed dollar dividend that is set at the time of the issuance. If you buy preferred stock, your returns come primarily from the dividends...
My thoughts on the AIG fiasco
As I watch the AIG circus unfold, I don't whether to laugh or cry. First, the people running these banks must be tone-deaf not to recognize that once you appeal for government bailouts (and get them), the rules have changed. If something appears unseemly, it is so. And when there people are scared - about losing their jobs and seeing their savings meltdown - the notion that AIG paid bonuses in the millions strikes many as unfair.There do seem to be two separate components to the AIG actions. One relates to the billions that AIG supposedly funneled out to investment and commercial banks. I noticed...
Dealing with Hybrids
One of my favorite devices to introduce concepts in valuation and corporate finance is a financial balance sheet. Unlike an accounting balance sheet, a financial balance sheet is a forward looking instrument. On the asset side of this balance sheet, there are only two categories for assets: assets in place, i.e., the value of investments that have already been made by the firm and growth assets, i.e., the value added by investments that I expect the firm to make in the future. On the liability side of the balance sheet, there are only two items as well: Borrowed money (debt) or owners' funds (equity).While...
The Yankee infield and debt...
I have been a sports fan all my life, following (and playing) cricket, tennis and now baseball (especially since my sons are all big baseball fans). Since I have lived in New York now for almost 25 years, I have become a New York Yankee fan.. As some of you may know that Yankees have built a new billion dollar stadium (actually the city did...) and opening day is April 17. I was able to get on EBay and buy three tickets for the game.I am really looking forward to that day but as the Yankees run on to the field, my thoughts will turn to debt and leverage and here is why. The Yankees have the most...
What is debt?
Figuring out how much debt a company has outstanding is not only critical to assessing its default risk but is a central input into much of what we do in corporate finance (cost of capital, cost of equity and valuing equity). It is a topic we have been examining in both the corporate finance and valuation classes this week. I use three criteria to classify an item as debt. 1. It gives rise to contractual (fixed) payments that have be made in both good times and bad.2. These payments are tax deductible.3. Failure to make these payments results in loss of controlUsing these criteria, it...
My favorite novels on financial markets
After that last rant, I am ready to get back to matters that are more pleasant. I love reading crime fiction and I consume everything I can get my hands on. Since I love reading about markets as well, a few of my favorite novels combine the best of both genres.One of my favorite authors is David Liss. For those who have never had the pleasure of reading his novels, I would recommend his first novel, titled "The Conspiracy of Paper". Set in London at the time of the South Sea Bubble, the book is a fascinating period piece, describing the social setting of the city then. What makes it fun to read,...
Why I cannot stand George Soros!
Let me start with a confession. There are some people I will pay not to listen to, and one of them is George Soros. First, let's dispense with the myth that this guy is a great investor. I don't know Buffett, but if I did, I would tell you that Soros is no Buffett. George Soros is a speculator who got lucky at two levels. The first was timing.. betting against the British pound in the early 1990s was perfect. The second was that he has made his big score betting against central banks that refused to face the facts. There are many investors who mistake luck for skill and I would not blame Soros...
Buffett: Man or Myth
Warren Buffett is now more myth than man. The investors who claim to follow Buffetology, read the Berkshire Hathaway annual report and actually make the trip to Omaha (the value investing Woodstock) numbers in the tens of thousands, if not millions. I think that we do a disservice to Buffett, when we put him on a pedestal and treat every word he says as gospel. At the risk of sounding like a curmudgeon, here is my take on Mr. Buffett.Let's start with the obvious. Warren Buffett has been an incredibly successful investor and his string of successess cannot be explained by luck. He has been able...
