Buyouts and Decreasing Returns Towards Equilibrium
The struggle to find consistent high yield stocks, in businesses generating consistent, high yield returns
(1) Most investors (or wanna-be ones) aim for a 7-10% return in large, “less risky” equities, give or take.
(2) Businesses usually aim for a 20-30% profit margin on their ongoing investments/costs of goods sold. After all their operating costs, they are happy with a 1x% return to pass onto the shareholders, whether between dividends and stock growth, or just stock growth. This is typical of corporations like Imperial Oil, MEG Energy, Enbridge, TD, CIBC, etc…
Anything lower than the mid 10s %, they’d rather just buy blue chip stocks and work some salary job elsewhere – as the opportunity cost of that lost income would reduce their return to 0 (economics perspective)… Why would somebody go through the grief to make 10% when he/she can just get that sitting at home??
(3) A business that has proven itself to consistently generate net return of 15%+, and has a market value of less than P/E 10 (i.e. less than 10x their yearly earnings), OR somebody with money expects it to generate such returns in the future, is highly likely to be bought out by a larger corporation.
(a) This larger corporation has more cash flow to absorb present losses, or invest in the business to flip it around to profitability.
(b) Large corporations are less vulnerable to investor risk aversion, as their shares are much less volatile due to much larger corporation size/market cap (i.e. they have a much easier time getting funding from investors). Smaller companies flucuate wildly as their earnings dramatically vary upon every quarter, and their shares also on a daily basis. For reference, “penny stock” usually refers to companies of under $100M market value. For companies that buy smaller companies losing money, they spend money to turn them around… so in the long run, they usually profit 1x% return. If they do so more, investors will keep buying the shares until their share prices rise to the point where you’d be happy to make about 7-10% over the year of buying the stock.
For this reason, it’s hard to find stocks that consistently generate 15%+ returns (or net a similar amount between dividends and growth) without taking on a lot of risk. Or, shares in companies that consistently generate 15%+ ROI (return on their investment), but are priced below P/E 10 and thus still obtainable at a significantly undervalued price.
