The Meaning of Stock Splits

Apple Store

Last week Apple announced that it would undertake a 7-for-1 stock split in June. Such a split will result in every Apple shareholder will getting six additional shares for each one that they hold when the split takes place, and as a result the price of Apple’s shares will start trading at one seventh of their price before the split. In other words, since shareholders will have 7 times as many shares at one seventh of the price, the value of their holdings won’t change.

So why would a company like Apple want to do a split if it doesn’t affect the stock’s value? Matt Yglesias at Vox wrote a good explainer detailing the reasons.  Companies generally split their stock to reduce the price so that it’s slightly easier for people to buy and sell in round numbers of shares. Apple had the additional motivation that its split increases the chances that it will be included in the Dow Jones Industrial Average. There can also be aesthetic benefits to having a stock price that’s not perceived as “too high” or “too low”: in 2011 Citigroup pulled off a 1-for-10 reverse stock split to increase the price of the its stock after its plunge during the financial crisis.

The overall effects of these changes, however, are minuscule compared with other factors that affect stock prices, such as companies’ profitability, financial condition, and growth prospects. Stock splits change a few numbers around, but they don’t affect shareholders in any meaningful way.

Should You Prepare for a Long Period of Slow Growth?

Larry Summers 2

More than 5 years after the most acute phase of America’s financial crisis, the US unemployment rate is still far above its pre-crisis level. In a series of articles during the past few months, former Treasury Secretary Larry Summers suggested that the economy may be in a persistently depressed state (a “secular stagnation” in the technical jargon). The article sparked renewed debate among economists about whether such a prolonged slump was theoretically possible, and if so, whether the economy was in one right now.

An extended period of slow economic growth should be good for bonds (due to low inflation and interest rates) and bad for stocks and commodities (because of weak demand for goods, services, and raw materials). Yet there are reasons to think that even if the pessimistic side of the secular stagnation debate is correct, trying to adjust your portfolio in response could be a mistake.

One reason is that there’s only a very weak link between economic growth and stock market returns. A long period of low economic growth and high unemployment would hurt companies’ ability to grow their revenues, but it would also keep a lid on how much they have to pay their employees. The lack of pressure to raise employees’ wages is part of the reason corporate profits in the US have been so high since the financial crisis.

A second reason is that Summers and the other proponents of his hypothesis aren’t arguing that a prolonged slump is inevitable, but rather than the government would simply have to use some different policies to overcome it. They argue that policy changes such as increasing government spending on infrastructure, raising the central bank’s inflation target, and allowing more immigration would help boost investment in the economy and reduce the unemployment rate.

Shifting your portfolio to prepare for an extended period of weak economic growth therefore wouldn’t just be a bet that the pessimists are correct; it would also be a bet that the government wouldn’t properly adapt and that no unforeseen occurrences lead to a surge in investment. The secular stagnation idea was previously peddled by an economist named Alvin Hansen in the 1930’s, when he argued that trends such as a declining population growth rate would lead to persistent high unemployment. The unexpected baby boom following World War II invalidated his prediction.

Meeting Your Income Needs with a Total Return Approach

If you need to generate income from your investment portfolio to pay for expenses, the process of selecting investments can seem a lot more complicated. Since almost all bonds, many stocks, and some alternative investments provide periodic income in the form of interest or dividends, almost any portfolio will generate some cash. But in the current low interest rate environment, there aren’t many investments that yield more than a few percentage points.

Instead of trying to generate enough income by limiting your choices to only high-income investments, a better tactic may be a “total return” approach.  This philosophy suggests ignoring your income needs when choosing your investments, and instead focusing only on selecting investments that create the portfolio most likely to have the highest total return (i.e. the combination of income and capital gains) for the amount of risk you’re willing to take.

If you need income from the portfolio, you can then “create your own dividend” by selling a portion of your holdings. For example, if your portfolio happens to only produces $1,000 of income but you need $3,000, you can simply sell $2,000 of your holdings to meet your income needs (of course your calculations need to account for how much you’ll owe the government, since interest income, dividend income, and capital gains are all taxed).

With this approach you can maintain a better-diversified portfolio: focusing on hitting a specific income target can result in a portfolio too heavily weighted toward bonds or too heavily weighted toward stock sectors (such as Utilities and Consumer Staples) that tend to pay higher dividends. By thinking about the total return rather than a specific income target, you don’t have to worry about your income needs skewing your portfolio.

Will Elections Revive India’s Economy?

After soaring in the middle of the last decade, India’s economy has struggled in recent years. The country’s GDP growth rate has declined from over 10% in 2010 to less than 5% in 2012 and 2013. At the same time the inflation rate has remained close to 10%. Many of the root causes of the economic woes are related to the government: the India suffers from poor infrastructure, stifling bureaucracy, and endemic corruption. Optimists therefore think that India’s election, which started last week and continues until May 12th, could be a turning point for the country’s economy.

The great hope for the optimists is Narendra Modi, the leader of the Bharatiya Janata Party, which has been leading in the polls. While he was leader of Gujarat, a state in western India, it attracted business investment and grew substantially faster than the country as a whole. His supporters argue that he could pull off a similar trick at the national level, reviving India’s economic fortunes.

It’s not much of a stretch to think that a new leader could have a profound effect: renewed economic optimism after the election of Shinzo Abe in Japan at the end of 2012 led to a surge in that country’s stock market. Yet even if Modi’s party wins the election, he’ll have a number of challenges to overcome.

Political power in India is split between the federal government and the states, and even at the federal level the leading party often has to share power with smaller parties to get a majority in Parliament. And the vested interests that benefit from the current dysfunction could prove too powerful an obstacle. After all, the recent economic slowdown has been overseen by Prime Minister Manmohan Singh, an Oxford-educated economist who was himself a hero to reformers for his role in transforming India’s economy as Finance Minister during the early 1990’s.

The Pros and Cons of Target Date Funds

Calendar

“Target date” funds, which gradually shift their exposures from higher-risk assets such as stocks to lower-risk assets such as bonds as their investors’ target retirement date approaches, have proliferated in recent years. (These are the funds whose names typically include a year, such as the “Fidelity Freedom 2045 Fund”.) According to Morningstar, more than $500 billion is invested in these funds. So should you put your retirement savings into a target date fund? Like many questions relating to managing your wealth, there’s no one-size-fits-all answer: it depends on your investing preferences.

The benefits of target date funds are straightforward: they take care of managing the retirement portion of your portfolio for you. A target date fund shifts its allocation toward lower-risk investments over time, so you don’t have to worry about having the right mix of asset classes or deciding when you need to rebalance them. You also don’t need to worry about picking investments for each asset class since each target date fund has a pre-set list of funds that it uses (typically ones managed by the same company that runs the target date fund). So for investors who take a very hands-off approach and want someone else to make the decisions, a target date fund can be a good solution.

The flip side, of course, is that with target date funds you don’t have control over what you’re invested in. If you want a different allocation or you don’t like the underlying funds that the target date fund uses, there’s no way to customize your investment. Target date funds can also be more expensive than a do-it-yourself approach, since they charge a management fee for maintaining the allocation among the different asset classes on top of the management fees of the underlying funds. So for investors who want more control over their investment decisions, a target date fund may not be the right choice.

What Just Happened to Google’s Stock?

Google Search

If you own stock in Google, you may have noticed something a bit odd: what used to be shares in GOOG stock on Thursday became shares in both GOOG and GOOGL, each worth about half as much as the GOOG shares used to be worth. What happened?

What happened was basically some financial trickery by Google founders Larry Page and Sergei Brin to make sure that they retain control of the company. Ordinarily when someone owns a stock, the financial investment comes with the right to vote on issues such as who should be on the company’s board of directors. As companies issue more shares of stock over time—perhaps to give stock grants to their employees or fund acquisitions of other companies—the voting power of the founders decreases.

Google’s founders didn’t want this to happen to them, so they split their stock into shares that have voting rights (GOOGL) and shares that don’t (GOOG). Now when they issue more stock, they can simply issue more of the ones without voting rights so that their voting power isn’t affected.

For investors in Google (and the many other companies that use similar ploys, such as Facebook and LinkedIn) this change may not be good news. Many executives have a tendency to grow their company and therefore enhance their power even if it’s not in the best interests of their shareholders (the technical term for this practice is “empire building”). Critics might contend, for example, that the money used for Google’s attempts to build self-driving cars or Facebook’s $19 billion acquisition of the messaging company WhatsApp could have been better utilized by simply returning it to shareholders.

Google’s tactics do have defenders, however: some argue that by not having to worry about losing control of their company to activist investors who are too focused on the short-term, cementing control of a company’s voting rights can allow founders to stay focused on the company’s long-term goals. So far investors seem to be buying this argument: Google, Facebook, and LinkedIn have substantially outperformed both other technology stocks and the broader S&P 500 index since the start of last year. Whether they’ll continue to outperform as the companies grow and the founders retain full control remains to be seen.

Q1 Recap: US Stocks Overcome Russia, China to Stay in Positive Territory

The first quarter of 2014 had a few bumps in store for financial markets, yet in the end almost every asset class ended up with positive returns. Bonds performed well as interest rates declined and the US inflation rate remained below the Federal Reserve’s 2% target. US stocks recovered from January jitters to end the quarter in positive territory. Even emerging market stocks, buffeted by fears of financial instability in countries such as Turkey, Russia’s military adventurism in Ukraine, and weak economic data from China, finished the quarter only slightly down.

Q12014 Asset Classes

Despite the continued US stock market gains in the first quarter, the economic optimism that fueled last year’s stock market surge showed signs of fading. Weak housing market data helped more defensive sectors such a utilities and health care outperform the broader market.

Q12014 Stock Sectors

The Russian stock market was pummeled in the first quarter as fears mounted that the country’s annexation of Crimea would crimp its economy and its ability to export natural resources. Russia’s troubles may have obscured a more important development, however: disappointing economic data in Japan and China led to a weak first quarter for Asian stocks.

Q12014 Countries

The outlook for the Chinese economy is likely to be one of the key drivers of financial markets for the rest of 2014. For years bearish analysts have been predicting a financial crisis in the world’s second-largest economy, and declining property prices in China could be the start of a broader collapse that finally validates these gloomy prognostications.

Yet so far the Chinese government has overseen a fairly orderly decline in the country’s economic growth rate, and it has the capacity to stimulate the economy if it fears that trouble in the real estate market is spreading. Success in containing the fallout from the economy’s slowing growth would provide a boost for stocks around the world, particularly in China itself where valuations are very low compared to other countries.