How Today's Stock Market Valuations Compare to 2000 – and What to Do About It

Opinions on stock market valuations flow easily around Wall Street, too often without backing.

Looking at the typical measurement used to determine stock valuations, I'm increasingly cautious.

Indeed, some of the numbers are downright scary just now, both in nominal value and in terms of red-light factors blinking on the horizon.

When you put it all together, here are some of my concerns about our hard-earned gains, and what we can do to profit...

Market Conditions Today Echo 1999-2000

Overvaluation measures are emitting early warning signs that we can heed now.

The S&P 500 is trading at 18.5x forward earnings, above the historical average of about 16.5x. The Shiller cyclically adjusted P/E ratio is currently about 26x the historical average of 16x. One popular measure used by bulls to justify current valuations and to deny that stocks are overvalued is to compare today's prices to those at the market peak in 1999-2000 during the Internet bubble.

Recently, MarketWatch columnist Brett Arends published a report suggesting that today's market is actually just as expensive as it was in 1999-2000. The dot-com era was notable for ridiculous valuations for companies that had no revenues or earnings.

Still,the overvaluations hit a limited number of large-cap growth stocks that rose with the tide especially hard, such as Microsoft Corp. (Nasdaq: MSFT), Cisco Systems, Inc. (Nasdaq: CSCO), Intel Corp. (Nasdaq: INTC). The rest of the market was not as overvalued. The median valuation for the top 1500 stocks by market cap today is actually higher than it was in 1999-2000, according to Mr. Arends:

Median P/E today is 20x compared to 16x in January 2000. Median Price/Book today is 2.5x compared to 2.2x in January 2000. Median Price/Revenue today is 1.8s versus 1.4x in January 2000.

There are aspects of the markets that point to better valuations today. Dividend yields are higher today (1.3%) than in January 2000 (0.8%), partly due to the lower tax rate on dividends that now exist. And the earnings yield of the S&P 500 is 6.8% today versus 2.5% back then. But earnings today remain at record levels as a share of GDP, and these have normally mean-reverted. With earnings flattered by record low interest rates, low effective tax rates, and high levels of stock buybacks (which are occurring, in case nobody noticed, at pretty high stock prices), the likelihood of conditions continuing to support high stock prices should, at the very least, be questioned.

Understand the Risks, and Profit

The real question is whether high stock valuations are justified today in view of the significant risks that are staring stocks in the face.

The most significant risk is the end of the Federal Reserve's unprecedented easy money policies. The Fed has continued to employ crisis-era policies well beyond the end of any crisis. The result is that stock market investors have benefitted from zero interest rates long after the rationale for such low rates has vaporized. While the Fed is clinging to reasons such as a sluggish labor market and low inflation to justify the extension of low rates long past the time when they are justified, recent employment and inflation data indicate the time has come to raise rates.

The second most significant risk is the geopolitical havoc occurring around the world. Ukraine attacked Russian troops moving into its territory, sending stock prices around the world plunging (and bond prices rallying even further, sending bond yields to new lows for the year as investors sought the safety of Treasuries and German bunds). ISIS continues to carve its way through Syria and Iraq, threatening the uneasy balance of power in the Middle East and threatening vital Western interests and oil supplies. Geopolitical stability is decidedly bad for stocks, particularly stocks that are trading at very high valuations.

The third most significant risk to stocks is that corporate earnings will not keep pace. Recent retail data was very disappointing. Wal-Mart Stores, Inc. (NYSE: WMT) reported decreased earnings and told a story of higher healthcare costs and reluctant consumers. Worried consumers are also causing problems in other non-retail areas. Regional gaming is a high-profile example, with the collapse of four casinos in Atlantic City resulting in the loss of an estimated 8,000 jobs.

Corporations may have squeezed about all of the cost savings they can out of their businesses. While companies continue to "beat" expectations, the truth is that they are more leveraged than they were in 2007 on the cusp of the financial crisis, and they live in fear that interest rates are going to rise and they will not be able to service their debt.

The lesson for investors is simple. An expensive market is always vulnerable to bad news and sell-offs. Today, the bad news is not a sudden "Black Swan," but more obvious risks out there for all to see: The risk of a geopolitical blow-up is extremely high, the Fed is about to end QE and is likely to raise rates by the end of the first quarter of 2015, and corporate earnings are under pressure.

Investors should take heed of these realities and move defensively before they start giving back the hard-won gains of the last five years. Trailing stops and informed stock shorts are just some of the ways that investors can retain, or create, gains when anticipating a downturn.

Editor's Note: Special Contributor Michael Lewitt publishes the highly regarded The Credit Strategist, and was recognized by the Financial Times for forecasting both the financial crisis of 2008, and also the credit crisis of 2001-2002. His 2010 book, The Death of Capital: How Creative Policy Can Restore Stability (John Wiley & Sons) was included in the curriculum at the University of Michigan and Brandeis University.

Can an Old Favorite Save Apple from Being All About the iPhone?

www.apple.com Apple's (AAPL) latest quarter suggests that there may be hope for the world's most valuable tech company to shake the tag of having all of its eggs in the iPhone basket. It won't be the iPod that saves Apple. The portable media player has been steadily declining for a couple of years. It also apparently won't be the iPad, which is coming off of back-to-back quarters of sharp year-over-year declines. The eventual savior may come in the form of a smartwatch, fitness tracker or whatever Apple is cooking up in the realm of wearable computing. However, we'll have to wait until Apple is ready to roll out these new products -- and even longer before they gain enough traction to move the needle. But, let's not forget about the Mac. The product line that initially put Apple on the map -- its unique take on the personal computer -- is starting to have a surprising resurgence. This could be Apple's ticket to diversifying its revenue stream, but it's not going to be easy. Mac Daddy Apple posted encouraging news on the personal computing front on Tuesday afternoon. Mac sales soared 13 percent since the prior year's fiscal third quarter, sparked by an 18 percent surge in the number of units sold. Apple's Mac business grew faster than the 9 percent uptick in iPhone revenue, but we need to frame this dynamic appropriately. Apple's $19.8 billion in iPhone revenue accounted for a record 53 percent of its overall revenue. The 4.4 million Macs it sold -- ringing up $5.5 billion in revenue during the quarter -- accounted for just 15 percent of Apple's top-line results. Then again, with Mac sales closing in on the diminishing iPad's $5.9 billion in sales, we may be seeing passing ships here. Unless Apple raises the bar convincingly in its suddenly tired iPad line, we could see Macs return as Apple's second-largest category in a quarter or two. Homeward Bound The Mac's momentum may be largely an international phenomenon. Industry tracker IDC reported earlier this month that Apple was the only one of the five major American PC makers to post a year-over-year decline in shipments in the U.S. during the three months ending in June. This would seem to contradict Apple's own results after the market close on Tuesday, but the key distinction is that IDC is measuring just stateside shipments. Apple is faring better overseas, and its latest financials bear that out with overall revenue climbing 6 percent -- but just 1 percent in the Americas. However, it does seem as if sentiment for the PC is starting to come back as the global economy shows signs of life and many people realizing that a tablet can't do everything that they used to do with a PC.

China's Raiding the Offices of These Major U.S. Companies – and You Won't Like Why

China isn't happy with how a lot of U.S. companies do business in their country, and has become much less shy about showing it.

The most alarming example was on July 28, when nearly 100 Chinese government investigators raided four offices of U.S. software giant Microsoft Corp. (Nasdaq: MSFT).

Without warning, the agents from China's State Administration for Industry and Commerce (SAIC) showed up and proceeded to copy financial records and download sensitive data from the company's servers. They also questioned the company vice president as well as other senior managers.

The reason?

Last year Chinese regulatory authorities dug up a 2008 antimonopoly law and started using it as a club on both U.S. and other foreign companies to encourage them to cut the prices they charge to Chinese customers. Since last year dozens of companies from the United States, Japan, and Germany have come under investigation from Chinese regulators for breaking the antimonopoly law.

Whether a violation of the law occurred or not doesn't seem to matter.

And few companies bother to fight back because, well, in China you can't. The court system, controlled by the Communist Party, has little sympathy for foreign corporations.

China's Crackdown Hits Tech, Autos, Big Pharma

So far, China's crackdown seems mostly focused on three sectors: tech, autos, and pharmaceuticals.

In addition to Microsoft, tech companies that China has targeted include San Diego-based Qualcomm Inc. (Nasdaq: QCOM), and Delaware-based InterDigital Inc. (Nasdaq: IDCC).

Last year, China conducted raids on several Big Pharma companies, including Novartis AG (NYSE ADR: NVS), AstraZeneca Plc. (NYSE ADR: AZN), and Eli Lilly and Co. (NYSE: LLY).

And in some cases China has put real bite in its bark. Several GlaxoSmithKline Plc. (NYSE ADR: GSK) executives were charged with bribery in May following a lengthy government investigation.

The latest group to be targeted has been automakers. Last week China announced that both Audi AG Vormals (OTCMKTS: AUDVF) and Chrysler would be punished for violating the antimonopoly law.

The investigations had the desired effect. Both companies announced price cuts, as have several other automakers, including Toyota Motor Corp. (NYSE ADR: TM) and Honda Motor Co. Ltd. (NYSE ADR: HMC).

It's a chilling trend for multinational companies, who have watched their profits from China grow along with the Asian giant's economy.

The government arm-twisting has already slammed GlaxoSmithKline, as its China revenue plummeted 61% in the third quarter last year.

Unfortunately for U.S. companies, the Chinese government has plenty of incentives to maintain this policy of harassment - and may even ramp it up in the months ahead.

Why China Will Keep Hammering U.S. Companies

While U.S. investors could get hurt as companies with operations in China lose profits and revenue, for the Chinese government there are only benefits, and no downside to the antimonopoly crackdown.

"This is about China's ruling elite consolidating power on behalf of the Chinese Communist Party," said Money Morning Chief Investment Strategist Keith Fitz-Gerald.

He said forcing foreign companies to reduce prices provides several key payoffs for the Chinese government.

"It demonstrates that the 'Party' has forced powerful Western influences to bend to its will," Fitz-Gerald said. "And China's political elite also need the lower prices because it keeps consumption high, and, more importantly, will keep the Chinese economy moving. The last part is really the linchpin, because if the economy stops, then revolution starts - and that's the one thing, above all else, China doesn't want."

The Chinese have defended this policy by pointing out that many foreign companies charge more for their products in China than they do elsewhere. The same 16 GB iPhone 5C, for example, costs $549 in the U.S., but $730 in China - a 33% difference.

Companies don't argue that point, but say a variety of factors, such as high real estate and an array of taxes, increase their costs in China.

Needless to say, the Chinese government is unsympathetic.

And it's likely that the trend will accelerate. For one thing, it's been wildly successful.

But the crusade against so-called foreign monopolies is also part of a turf war within the Chinese regulatory system.

Three agencies play a role in enforcing the 2008 law, and each sees victories against foreign companies as a way to enhance their power and reputation within the complex Chinese bureaucracy.

This is an increasing risk to doing business in China, and one that all investors - as well as any multinational company - need to keep on their radar screen.

Follow me on Twitter @DavidGZeiler.

UP NEXT: Some multinationals in China are having problems even without the Chinese government harassing them. Trouble with a Chinese food distributor is one reason why McDonald's (NYSE: MCD) stock is sinking...

Related Articles:

The New York Times: China's Energetic Enforcement of Antitrust Rules Alarms Foreign Firms The Wall Street Journal: China Using Antimonopoly Law to Pressure Foreign Businesses Financial Times: Multinationals Fret as China's Antimonopoly Probes Intensify

Local police get billions in military equipment

The militarization of local police in the U.S. came into focus this week as heavily armed police faced off against protesters in Ferguson, Missouri. NEW YORK (CNNMoney) Local police departments are looking more and more like small armies, stocked with billions of dollars worth of military-grade equipment.

The Department of Homeland Security pumped $1 billion into local law enforcement last year, according to a report from the ACLU, while the Department of Defense kicked in another $449 million worth of equipment for police forces.

The extent to which local police in the U.S. have become militarized came into focus this week as heavily armed police faced off against protesters in Ferguson, Missouri, which itself received two Humvees from the Pentagon last fall.

The scene "resembles war more than traditional police action," wrote Sen. Rand Paul, a potential Republican presidential candidate, in an opinion piece for Time.

Attorney General Eric Holder also expressed concern. "We must seek to rebuild trust between law enforcement and the local community," he said. "I am deeply concerned that the deployment of military equipment and vehicles sends a conflicting message."

Ferguson Police Chief Thomas Jackson denied his department has become militarized.

"It's not military, it's tactical operations," he said on Thursday. "That's who's out there, police. We're doing this in blue."

The Defense Department began arming local police with surplus equipment in 1997 as the Cold War wound down. Since then, the DoD has distributed more than $5 billion worth of vehicles, weapons and other supplies. Separately, after 9/11, a Homeland Security program launched providing cash grants to help small towns and big cities alike prepare for terrorist attacks and other disasters.

Critics say that local police don't need much of the equipment. For instance, twenty mine-resistant, ambush-protected (MRAP) vehicles were distributed to police departments all over Missouri in the last eight years, although none went to Ferguson.

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"An MRAP is built to withstand armor-piercing bombs. This is not something that we need in American communities," said Kara Dansky, who authored th! e ACLU report on militarization. "Increasingly the police are trained to view the people in the communities that they're supposed to be protecting and serving as enemies."

Some experts worry all this heavy equipment could lead to the use of more deadly force than might otherwise occur.

"You bring out the equipment, you add to the likelihood that you might be shot at," said Tom Fuentes a former FBI assistant director and a CNN Law Enforcement Analyst.

Senate Armed Services Chairman Carl Levin said in a written statement Friday that Congress established the program out of concern that local law enforcement agencies were literally outgunned by drug criminals. But he said his committee will review the program to determine "if equipment provided by the Defense Department is being used as intended."

But others say there can be a legitimate need for the supplies, and that anticipating who will need it is impossible in advance.

"When it comes to equipment like this, it's better to have it and not need it, than to need it and not have it," said Mike Brooks, a CNN law enforcement analyst.

-- CNN's Evan Perez, Brian Todd and Dugan McConnell contributed to this report.

Comcast agent's 'belligerent' tone prompts apology

  Comcast's future for your TV DALLAS (CNNMoney) Comcast never wants a customer to go -- but says one of its representatives went too far trying to convince one account-holder to stay.

On Tuesday, the cable company apologized to Ryan Block and his wife, Veronica Belmont, after the couple's attempts to cancel were stymied by a phone call with a customer service representative that Block called "straight up belligerent." The incident garnered attention because Block and Belmont posted a partial recording of the conversation on the Internet.

In the eight-minute recording, the unnamed Comcast (CMCSA) employee badgered Block with questions such as "Why is it that you're not wanting to have the No. 1-rated Internet service, No. 1-rated television service available?"

In the employee's defense, he explained one of the reasons for his questions: "If we don't know why our customers are leaving, how are we supposed to make it a better experience for you next time?"

The recording went viral Tuesday morning, partly because the prominence of Block and Belmont. Block, a former editor of Engadget, works for AOL, and Belmont is a Web show host and writer.

In a statement, Comcast said it was "very embarrassed by the way our employee spoke with Mr. Block and Ms. Belmont." The company said it was contacting them to "personally apologize."

"The way in which our representative communicated with them is unacceptable and not consistent with how we train our customer service representatives," the statement said. "We are investigating this situation and will take quick action."

Block responded on Twitter: "I hope the quick action you take is a thorough evaluation of your culture and policies, and not the termination of the rep."

Of course, setting aside specific tactics like the pestering experienced by Block and Belmont, customer retention is a critical component of the cable and satellite business.

Comcast, DirecTV (DTV), Verizon (VZ, Tech30) and other companies work hard to keep "churn" -- a term for customers coming and going -- as low as possible.

This has been particularly important for cable-based companies such as Comcast, which have been losing television subscribers in recent years to satellite (DirecTV) and fiber-optic (Verizon).

Overall, TV subscriber totals have remained pretty consistent despite pressure from alternatives such as Netflix (NFLX, Tech30), but there's been significant share-shifting from cable to newer forms of distribution.

Comcast recently impressed Wall Street by reversing the trend . For the past two quarters, it has actually gained small numbers of TV subscribers, after shedding them for years.

On its first quarter earnings call in April, after it gained 24,000 video subscribers, the company credited "improved products, improved customer support and better retention efforts."

  How the Comcast-TWC deal will hit your TV

Separately, Comcast has been growing its base of broadband subscribers rapidly. It is the country's largest cable company. It is awaiting government approval for its merger with Time Warner Cable (TWC), the country's second-largest cable company.

Comcast's statement on Tuesday said that within the company, it would use the recording made by Block to "reinforce how important it is to always treat our customers with the utmost respect."

Zynga and Groupon Are the Duds of the IPO Class of 2011

www.zynga.com Some of the hottest Web-based companies went public three years ago. LinkedIn (LNKD) and Zillow (Z) have gone on to become big winners for early investors. Groupon (GRPN) and Zynga (ZNGA), on the other hand, have gone on to not-so-great things. Groupon went public in November 2011 at $20. Zynga followed a few weeks later with underwriters pricing its debut at $10. But their early buzz faded quickly, and investors turned sour on the daily deals leader and the mobile game publisher behind "FarmVille" and "Words With Friends." Both stocks have gone on to shed more than two-thirds of their value. Dumb and Dumber Zynga reported disappointing quarterly results after Thursday's close. Analysts were holding out for improvement, but Zynga merely broke even, with gross bookings declining 7 percent. The company's gross bookings peaked in 2012, and apparently have still not bottomed out. Daily active users and folks paying to play them continue to fade as Zynga's roster of games just isn't as appetizing as it used to be. Zynga isn't seeing the light at the end of the tunnel. It now sees $695 million to $725 million in gross bookings for all of 2014, well below the $770 million to $810 million that it was targeting just a few months ago. The week wasn't really much better for Groupon. The company reported two days earlier, and while it's holding up relatively better, its performance still isn't enough to please the market. Groupon's revenue surged 23 percent to $751.6 million, but that's coming largely from international expansion and a domestic emphasis on selling physical goods. These are moves that weigh on margins, explaining why gross profits were essentially flat with last year's showing despite the top-line advance. Groupon also hosed down its outlook. It now expects adjusted EBITDA -- or earnings before interest, taxes, depreciation and amortization -- to exceed $270 million. When the year began, the flash sale specialist was hoping to "slightly exceed" the $286.7 million it rang up in 2013. Both companies did roughly break even in their latest reports. That's significant since Groupon and Zynga are still flush with a lot of the cash they raised when they went public nearly three years ago. Groupon had $868 million in cash and equivalents in its coffers at the end of June. Zynga is holding on to $1.15 billion, and that's a big deal since it translates into a little more than $1.30 a share in cash. Zynga's stock is trading for roughly twice that amount so there's a pretty big cash mattress there. What If You Had Bought All Four IPOs? Zynga and Groupon have certainly been disappointments, but it doesn't mean that 2011 was a regrettable year for IPO investors. Those that bought into Zillow and LinkedIn are going pretty well. Like Groupon, Zillow went public at $20. Unlike Groupon, the fast-growing real estate website operator's been a hot property. It has come through with a nearly 600 percent pop. LinkedIn went public at $45, and shares of the social networking site for career-oriented movers and shakers have more than quadrupled in value. It all adds up in the end for the ballyhooed class of 2011. An investor that put an equal investment into all four IPOs would be doing pretty well today. Even after seeing Groupon and Zynga lose more than two thirds of their value, $40,000 divided into $10,000 investments of Groupon, Zynga, Zillow, and LinkedIn would be worth $121,817 as of Thursday's market close. This doesn't take the sting away from the portfolio disasters that Groupon and Zynga have become, but it's an important lesson in diversification and the importance that owning just a single winner or two can more than offset sharp declines elsewhere. It's definitely a mixed portrait for the class of 2011, but let's give it some more time. Groupon and Zynga sill have two more years to get things right in time for their five-year class reunion. More from Rick Aristotle Munarriz
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Select Comfort Corp (SCSS) Earnings Report: Will Investors Sleep Well? MFRM & TPX

The Q2 2014 earnings report for mattress stock Select Comfort Corp (NASDAQ: SCSS), a potential peer or competitor of other mattress players like Mattress Firm Holding Corp (NASDAQ: MFRM) and Tempur Sealy International Inc (NYSE: TPX), is due out on Wednesday after the market closes. Aside from the Select Comfort Corp earnings report, it should be said that the estimated release date for the Mattress Firm Holding Corp Q2 2014 earnings report is the the week of September 4th while the estimated date for the Tempur Sealy International Inc Q2 2014 earnings report is the week of July 21st. And while the last earnings report from Select Comfort Corp did not cause shares to move much, shares plunged 19% in January as preliminary fourth quarter results reignited concerns over growth going forward. This came after a 25% plunge after an October earnings report badly missed expectations.

What Should You Watch Out for With the Select Comfort Corp Earnings Report?

First, here is a quick recap of Select Comfort Corp's recent earnings history from Yahoo! Finance:

Earnings HistoryJun 13Sep 13Dec 13Mar 14

EPS Est	0.24	0.43	0.15	0.32
EPS Actual	0.18	0.36	0.12	0.31
Difference	-0.06	-0.07	-0.03	-0.01
Surprise %	-25.00%	-16.30%	-20.00%	-3.10%

 

Back in mid April, Select Comfort Corp reported a 7% first quarter net sales increase to $276 million, operating income decreased to $25.8 million from $35.2 million in the first quarter of 2013 and earnings per diluted share of $0.31 verses $0.41 on an as-adjusted basis (excluding CEO transition benefit). Select Comfort Corp was also expecting full-year 2014 earnings per diluted share to approximate full-year 2013 adjusted earnings per diluted share of $1.07 with this outlook assuming mid- to high-single-digit total revenue growth and the addition of 20 to 30 net new stores during the year.

This time around and according to the Yahoo! Finance analyst estimates page, the consensus expects revenue of $223.74M and EPS of $0.14 - down from EPS of $0.16 expected ninety days ago.

On the news front and in late May, Piper Jaffray said April sales for the mattresses industry increased 3% year-over-year according to ISPA. They see these numbers as in-line to slightly better than anticipated but they continue to favor Mattress Firm Holding Corp and Tempur Sealy International Inc in the mattress space.

What do the Select Comfort Corp Charts Say?

The latest technical chart for Select Comfort Corp shows that after taking two big hits late last year, the stock has slowly clawed back to higher levels:

However and since the end of the recession, Select Comfort Corp has been a real outperformer plus Mattress Firm Holding Corp and Tempur Sealy International Inc have also put in respectable performances:

The technical charts for Mattress Firm Holding Corp and Tempur Sealy International Inc also show uptrends albeit the latter has produced a multiple top:

What Should Be Your Next Move?

Investors might want to review what happened last October and again at the beginning of this year to see whether they will sleep comfortably going into another Select Comfort Corp earnings report. Then again, perhaps the worst is over and there could be some upside if there is a positive surprise.  

Warren Buffett: The Only Time Share Buybacks Make Sense

There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds -- cash plus sensible borrowing capacity -- beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively calculated.
-- Warren Buffett, 2000 

Investors love share buybacks. When a company buys shares of its own stock and retires them, it leaves fewer shares outstanding. This boosts earnings per share, because the company's net income is spread over fewer shares. Additionally, the buyback program tilts the supply demand balance for the stock in favor of sellers, which can push the share price higher.

Warren Buffett believes that share buybacks make sense only when two key conditions are fulfilled.

However, buybacks don't always make sense. Investing legend and Berkshire Hathaway CEO Warren Buffett has said that two conditions must be fulfilled for share buybacks to be a good use of capital. The company must have excess cash and borrowing ability to fund the buyback, and the stock needs to be clearly undervalued.

Unfortunately, not all management teams are as savvy as Warren Buffett when it comes to share repurchases. For example, Netflix executed a poorly conceived buyback a few years ago, which has cost present-day shareholders more than $1 billion.

When do share repurchases make sense?

In the quotation above, Warren Buffett explains when share buybacks make sense -- and when they do not. The first key ingredient is adequate liquidity. Some businesses have minimal capital requirements, but others require high capital investments. Making necessary investments is critical to a business's long-term health -- skimping in order to buy back shares could erode competitiveness.

Additionally, while it sometimes makes sense to borrow money in order to repurchase shares, that's only true up to a certain point. Buffett points out that it is important not to take on an unwieldy debt load to fund buybacks.

The second requirement is that the stock must be selling for less than its "conservatively calculated" intrinsic value. In other words, a company's management should take a sober look at its future business prospects and stock price compared to those of competitors. Unless the stock is clearly undervalued, a buyback is the wrong way to go.

These two requirements are significant hurdles, but they are certainly not insurmountable. In late 2011, Berkshire Hathaway announced a share buyback program that was expressly guided by Buffett's two key principles.

Netflix's buyback gaffe

Netflix's behavior in 2011 demonstrated the cost of ignoring Buffett's buyback criteria. In early 2011, Netflix management openly admitted that the company was not "price sensitive" when it came to buybacks. Whenever executives felt Netflix had excess cash, they used it to repurchase stock, regardless of the price.

Netflix didn't follow Warren Buffett's buyback rules in 2011.

That clearly violates Warren Buffett's second rule for stock buybacks. According to Buffett, Netflix executives should have made some effort to ensure that they weren't overpaying. Alternatively, Netflix could have returned cash to shareholders through dividends.

As it turned out, Netflix's management team also did a poor job of calculating its excess cash. In the first three quarters of 2011, Netflix spent approximately $200 million to repurchase 900,000 shares of stock. However, Netflix's subscription price increase that summer caused a customer backlash, while the company's international expansion turned out to be very costly.

With more obligations looming and an uncertain path to profit recovery, Netflix decided to raise money that fall. It sold 2.86 million shares at $70/share, for a total of $200 million. Between the buyback in the first three quarters of 2011 and the share sale in Q4, Netflix essentially gave away 2 million shares (worth over $800 million at today's market price).

Netflix also issued $200 million of convertible debt in late 2011. This eventually converted to another 2.3 million shares (worth about $1 billion today: a gain of nearly $800 million for the holder). By spending freely on share buybacks when it should have been bolstering its balance sheet, Netflix was forced to raise capital on extremely bad terms, costing shareholders more than $1 billion.

Foolish final thoughts

Properly executed buybacks can create plenty of value for shareholders. A company that repurchases its stock for less than its intrinsic value makes all of the remaining shares more valuable. However, a poorly executed buyback can just as easily destroy shareholder value: a lesson that Netflix's management learned the hard way.

For other management teams trying to decide whether to buy back shares, Buffett has some simple rules to follow. First, don't spend beyond your means -- make sure you have more than enough cash and borrowing ability to run the business properly. Second, don't buy back shares unless they are clearly undervalued.

Investors should thus be cautious when a company announces big buyback plans. If it seems like the company has thoughtfully evaluated its cash needs and the stock's intrinsic value, it may be good news. If not, then the chances of a good outcome are much lower.

Warren Buffett: This new technology is a "real threat"
At the recent Berkshire Hathaway annual meeting, Warren Buffett admitted this emerging technology is threatening his biggest cash-cow. While Buffett shakes in his billionaire-boots, only a few investors are embracing this new market which experts say will be worth over $2 trillion. Find out how you can cash in on this technology before the crowd catches on, by jumping onto one company that could get you the biggest piece of the action. Click here to access a FREE investor alert on the company we're calling the "brains behind" the technology.

Chipotle Mexican Grill: It Doesn’t Get Any Better Than This

It’s been a very good year for Chipotle Mexican Grill (CMG), which has gained 26% so far this year. But is this as good as it gets?

Longbow’s Alton Stump thinks it is. He explains why he downgraded shares of Chipotle Mexican grill to Neutral from Buy:

Our outlook on Chipotle's fundamentals undoubtedly remains positive. Chipotle's impressive same-store sales recovery over the last 4-5 quarters was driven almost entirely by accelerated traffic, which we believe helped set the stage for Chipotle to implement a mid single-digit list price increase during late 2Q14.

Chipotle's industry-leading same-store sales growth potential, cash-on-cash return profile, double-digit new store story and loyal consumer following justify a multiple well ahead of its peer average. However, with Chipotle's shares trading ~35% higher since early May, we believe the company's positive fundamentals are already baked into Chipotle's share price.

Shares of Chipotle Mexican Grill have dropped 0.4% to $669.68 at 1:43 p.m. today.

Recession Safeguards Are Coming Under Heavy Attack

Lackluster economic growth in the U.S. has nothing to do with financial services regulatory overreach inherent in new Dodd-Frank rules - as some neo-conservatives would have the American public believe.

Let me say, I'm a staunch fiscal conservative. I am a dyed-in-the-wool free markets entrepreneur. But there's a world of difference between free markets and a free-for-all for financial services oligarchs and officers.

In a July 21, 2014 American Banker article commemorating the four-year anniversary of the signing into law of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Paul H. Kupiec, a resident scholar at the American Enterprise Institute (AEI), makes the misguided case that Dodd-Frank is what's holding back the recovery.

Here's a look at how a recession prevention backstop is coming under siege...

Understanding the (Flawed) American Banker Argument

Just because Mr. Kupiec has been a director of the Center for Financial Research at the Federal Deposit Insurance Corporation and chairman of the Research Task Force of the Basel Committee on Banking Supervision, before hanging his hat at the AEI, doesn't mean his position on behalf of the big-business-centric American Enterprise Institute is objective. It's not.

You can see the July 21 issue for the entire article, but here are excerpts of what Mr. Kupiec wrote in American Banker with my counterpoints attached; see the July 21 issue for the article in its entirety.

The primary goal of Dodd-Frank - preventing another financial crisis - is not at issue. However, well-designed policies must balance costs against benefits. This is where Dodd-Frank fails. It excludes controls that prevent over-regulation and thereby creates incentives that encourage financial stability at the expense of financial intermediation - the monetary transactions that allow goods and services to be efficiently produced and traded, and the means by which consumers' savings are invested.

Shah: The goal of Dodd-Frank preventing another meltdown has not been remotely achieved. Dodd-Frank is barely 60% written and what's been put into place to safeguard the financial system from imploding and ruining the economy again is being challenged by academics and regulators as being unworkable. Dodd-Frank hasn't already failed, that's neo-conservative rhetoric. Mr. Kupiec would rather encourage expensive financial intermediation (for the sake of big banks profiteering) over financial stability. He's got it backwards.

Dodd-Frank grants the Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corp. and the Financial Stability Oversight Council vast new powers to regulate, with no checks on the exercise of these powers. Regulators are directed to exercise their new powers to ensure financial stability and mitigate systemic risk, but financial stability and systemic risk are never defined in the legislation.

Shah: One reason financial stability and systemic risks aren't defined is that the rules and regulations are still being written. Another reason they're not defined is that bankers don't want them defined, they don't want transparency into their inner workings. Mr Kupiec says, "Regulators are directed to exercise their new powers to ensure financial stability and mitigate systemic risk," isn't that the whole point?

Mr. Kupiec seems to worry that the Financial Stability Oversight Council (FSOC), whose members are supposedly the most-in-the-know heads of the country's regulatory agencies, wouldn't be up the task of determining which institutions actually pose a threat to the economy if they were to fail.

The ambiguity of the designation standard provides the FSOC with virtually unlimited discretion. For example, under what conditions should the consequences of failure be evaluated: when the firm fails in isolation, or when the firm fails in a recession during which many other financial institutions are also distressed? Two very different standards may generate very different FSOC conclusions, and yet Dodd-Frank is silent on the issue.

Shah: There is no ambiguity as Mr. Kupiec believes. He asks:

"Under what conditions should the consequences of failure be evaluated: when the firm fails in isolation, or when the firm fails in a recession during which many other financial institutions are also distressed?"

Shah: Who cares if a firm fails in isolation or in a recession along with other distressed institutions? A failure is a failure and any failure of any too-big-too-fail institution, by definition, is a threat in isolation and especially en masse to the system they're all interconnected to. Dodd-Frank isn't silent on the issue, Mr. Kupiec's rhetoric is deafening.

Moreover, recent speeches by senior Federal Reserve officials suggest that they will push to use Dodd-Frank powers to extend the Fed's ability to restrict financial investments and the use of short-term debt finance beyond the banking system to control the activities of shadow banks. The stated goal in each case is to prevent "bad" financial intermediation and promote financial stability. But in no case do any of the new rules recognize the cost on economic growth.

Shah: Mr. Kupiec wants us to consider the "cost on economic growth" of bad financial intermediation. Really? The cost is immeasurable once the damage is done. Bad financial intermediation is what Dodd-Frank is trying to address. No-one cares about plain vanilla, transparent lending with reserves and transparency. It's the exotic intermediation conducted in the shadows, most of which are cast by big banks, that has to be considered.

It is easy to understand how the imbalances in the Dodd-Frank Act led to over-regulation. Regulators' highest priority is ensuring that the financial system is stable; for them, slow or moderate economic growth is simply business as usual. But should a financial crisis arise, regulators would be disgraced. Dodd-Frank creates a clear bias encouraging over-regulation in the pursuit of financial stability because, for financial regulators, regulations are costless.

Shah: Apparently, we all don't get it, "Dodd-Frank led (emphasis added) to over-regulation" and that's why we have no economic growth. Who knew we were living in the past already? I also didn't know that regulators ensuring financial system stability empowered them to simultaneously ratchet down economic growth (do they have a lever somewhere?) to their "business as usual" low-water mark.

Four years after the passage of Dodd-Frank, it is clear that Congress needs to revisit the legislation to prevent over-regulation in the pursuit of a single goal of financial stability. Dodd-Frank must be amended to require a balance of the following goals: financial stability, economic growth, and full employment. Otherwise, the economy will continue to get too much regulation and be short-changed on economic growth.

Shah: Mr. Kupiec's closing paragraph speaks to the failure, not of regulators' abilities to prevent economic catastrophes, they've certainly failed, but the failure of financial services institutions to safeguard their own businesses and the country from their greed-mongering. Congress needs to have Dodd-Frank legislation finished before it's revisited midstream by lobbyists and the financial power elites who've commandeered once free markets and the country.

The Great Recession wasn't caused by over-regulation; it was caused by over-leveraged financial intermediaries who hid their pyramid scheming from regulators.

As far as our slow recovery from that travesty, that has nothing to do with regulation, and everything to do with what inadequate regulation wrought...

The oligarchs of D.C. and Wall Street wish Shah would just be quiet... But he's not going to stop anytime soon. And you'll never guess who he's going to take on next. To find out, and to get Shah's Insights & Indictments delivered free, twice weekly, click here.

A Goodbye and a Challenge

I'm sorry to report that this is the final article for 401k Millionaire. Even publications with the best of intentions aren't always successful enough to continue, but we hope the many stories about creating, managing and funding a great 401k account have helped put you on the path to a safe and secure retirement.

It's fitting that I write the final piece for 401k Millionaire. Though I didn't join the Investing Daily team to work on 401k Millionaire, much of my last job was devoted to improving 401k plans, specifically improving them using behavioral science. Behavioral science can be used to leverage how people naturally think and act to help them grow a bigger retirement nest egg. You can read about how you can use these techniques for your own savings in Adopt Best Behavioral Practices in Your 401k Account.

Part of my last job was speaking around the country to audiences of financial advisors and administrators of 401k plans. We'd help them understand how just a handful of changes could radically improve the success of a plan. We defined success not by a plan that would be free from interference by regulators or which cost the company a minimal amount of money – many of those who run 401k plans make these their main goals – but by a plan that served employees best.

You can be a catalyst to improving your company's 401k plan for not just your own benefit, but also for the benefit of all your coworkers.

This isn't a pipe dream—I know it happens in real life.

For example, before I gave a talk in Southern California about a year ago I met a woman who served in her company's human resources department. A year earlier she had found herself on the 401k committee, which apparently came with her job as being a benefits administrator. At that time the 401k plan suffered from many classic problems. The employer didn't match contributions, and the investment menu had too many ! choices. Most workers, she said, were overwhelmed by the choices and so defaulted to the "stable value fund," which meant their savings lost ground to inflation every year.

Less than 40% of workers even participated in the plan, and the average savings rate of those that did was less than 3% of their annual pay. In short, it was a mess.

The problem wasn't that the employer didn't care about the workers. It was a family-owned business with a history of treating its employees well, including offering a good medical plan and base pay well above the minimum wage.

The problem, she said, was priorities.  The company's first priorities were expanding sales, fending off competitors, keeping the trucks running on time, etc.  And the plan was such small potatoes (less than $5 million in retirement assets) that the company that administered the plan didn't work to improve it. Then again, many plan administrators, I found, don't know how to improve a plan.

Many are simply focused on the "three F's." Those are the funds in the plan, the fees and the "fiduciary" – or who takes responsibility for the plan.

By the time we met, this HR staffer had convinced her boss that the 401K plan could be so much more, and that is was failing to provide for the needs of employees when they retired. Her boss, the HR director, convinced the company president, and together they shopped for and found a financial advisor that could overhaul the plan.

The workers in the plan had jumped to more than 80% when it implemented "automatic enrollment," which means employees are automatically put in the plan, but have the simple choice to opt out, if they wish. The average savings rate had doubled.

Many other positive changes had been made, and when I met her she was searching for ways to further improve the plan. I was teaching lessons from the book "Save More Tomorrow: Practical Behavioral Finance Solutions to Improve 401(k) Plans," (By Shlomo Benartzi, with Roger Le! win. Avai! lable on Amazon for $38.39 new or less than $5 a copy used.) It's filled with powerful ways to improve retirement savings.

She's since left that firm and is working to improve the 401k plan at her new employer. We had a chance to swap emails recently, and I asked her what advice she'd give to others who want to start a 401k revolution, or at least an evolution, at their own workplace. "Create a vision," she said. "Help people imagine the tremendous impact a great 401k plan can have on your workers and their families."

So let me sign off with this challenge: With what you know about 401k plans, consider working to  improve your company's plan for the benefit of others. Create a culture of 401k Millionaires.

A Few Reasons Why This Apparel Retailer Is a Good Long-Term Bet

The clothing retail market has been sluggish for a long while, and the first five months of 2014 haven't been excessively great either. The aftereffect of a powerless Christmas season and a harsh winter climate in the U.s. headed numerous retailers to post poor practically identical store sales, or comps, and miss estimates while reporting earnings.

In any case, ANN (ANN) finished fiscal 2013 on a strong note, boasting earnings development for the second consecutive year consecutively. It also registered comps development at both Ann Taylor and LOFT. The energy looks set to keep going ahead despite rivalry from the likes of Francesca's Holdings (FRAN) and Chico's FAS (CHS). How about we see why.

Solid performance

Amid the final quarter of fiscal 2013, ANN posted 3% year-over-year top line development despite soft movement and lukewarm consumer spending across the industry. Notwithstanding, the development was adversely influenced by poor performance at industrial facility outlets at both ANN Taylor and LOFT brands, and the great winter climate.

The route ahead

As customers are getting to be digitally-inclined, ANN is investing in infrastructure and systems upgrade that climaxed in the dispatch of its omni-divert stage in 2012. For long haul development, ANN is focusing on quickening development and proficiency in its omni-channel segment.

The organization is realigning the association to support a coordinated stores and e-trade business model to quicken development and bolster general money related performance. This will result in annualized pretax operating savings of give or take $25 million by the year end, and subsequently drive the bottom line up. ANN will also give customer access to online products from physical stores.

Looking forward, in 2014, the organization will be growing the LOFT mark in small and mid-level markets, as well as in the outlet channel, to drive development. The organization is also wanting to grow its foot shaped impression in Canada by opening more LOFT stores. Also, in the second a large portion of fiscal 2014, ANN will enter into Mexico with the LOFT brand . With Lou & Gray piece of the LOFT brand and resonating great with the consumers, this move should be a development driver going ahead.

With a strong asset report and zero long haul obligation, alongside cash of $202 million at the end of fiscal 2013, ANN can keep investing in its development without much constraints.

The opposition

Francesca's also boasts of zero long haul obligation like ANN. In any case, it is struggling and it faulted the feeble retail environment and the terrible winter climate for its sales performance amid the final quarter of fiscal 2013. The headwinds also resulted in a deferral in spring season the maximum selling, and the organization's performance remains questionable in the close term.

Going ahead, Francesca's plans to redesign 50 boutiques in fiscal 2014 . Furthermore, it is just as focused on enlarging the span of the Francesca's brand however control to-consumer, or DTC, initiatives. It is also streamlining its portable solutions to change over movement. What's more, search motor enhancement, or SEO, and search motor advertising, or SEM, alongside universal shipping solutions and computerized catalogs to improve purchaser experience should drive development later on.

Then again, Chico's final quarter sales declined 6.4% year over year and its earnings also neglected to meet expectations for the fourth consecutive quarter. The decline in sales was because of a powerless retail environment and a harsh climate. As a result, comps declined 3.4% year-over-year.

Looking send, Chico's is redoing its item blend to pull in more consumers. It is also extending its foot shaped impression in the universal markets. Chico's is foraying into Toronto this year, and is also wanting to wander into Mexico.

Chico's is also investing in engineering in stores as a feature of its omni-channel drive. It has made a holistic model that it calls "Computerized Retail Theater, " a cloud-based stage with round the clock access. Its Tech Table 2.0, with ultra-high-res display, is also being tested in White House Black Market locations.

The organization is also conveying a state-of-the-workmanship purpose of-sale, or POS, incorporated with Digital Retail Theater. These innovative initiatives, alongside ios7 and Android apps, will be completely useful before the end of fiscal 2014 and will help development.

Conclusion