Update: Goldman Sachs Indicates ACA Management Was Largest Long Investor in ABACUS

That was quite an interesting press release issued by Goldman Sachs (GS) after the closing bell tonight. All day today investors concluded from the details of the SEC's fraud charges that Goldman worked with Paulson and Co. to weaken the composition of the ABACUS transaction in some fashion, perhaps in an effort to boost the odds that Paulson would profit from taking the short side of the trade. The SEC seemed to indicate, judging by the fact that it charged the Goldman employee in charge of the deal for lying, that someone from Goldman told ACA Management that Paulson was actually making a $200 million long investment in ABACUS. Goldman's latest press release seems to tell a much different story. The side that makes their case the best could potentially make the other side look a bit foolish here.

What did Goldman claim tonight? First, they state that their firm lost $90 million on the transaction, as it had a net long position that soured when the CDO went bust. Next, Goldman denies that their employee ever told ACA that Paulson was taking a long position in ABACUS. That directly contradicts the SEC's claim that ACA was told Paulson was going to be long alongside them, which if true, would seem to imply that ACA was fooled into thinking that collaborating with Paulson while structuring the CDO would not be problematic for them.

Another Goldman claim in the release seems to be the most important, in my view, if it is accurate. Goldman says that the single largest long investor in ABACUS was, believe it or not, ACA Management (with an investment of $951 million). If ACA truly was the largest long investor in the CDO, they had every incentive to structure the deal correctly (and Goldman is quick to point this out). In such a scenario, why would ACA ever allow Goldman and/or Paulson to hand-select mortgage securities for the CDO that might jeopardize their investment?

Now, it will take a lot of time to determine whether Goldman's defense is true or not. However, their press release seems to make a bit more sense. If ACA was the firm that selected the portfolio, and also was the largest long investor in the CDO, the ABACUS deal goes from looking like a huge conflict of interest (as it did earlier today) to having interests aligned quite nicely. If you were the largest investor in a deal, it makes sense that you would want to be the firm that got to approve the mortgage securities that were included in it.

Did ACA consult with Paulson and Co. as well as other firms while structuring the deal? The Goldman press release essentially admits this to be true. Should those discussions have been disclosed in the CDO's marketing materials? Maybe. But as long as ACA had the final say, it really does not seem to be a big deal.

After all, would it be considered fraud if a Wall Street analyst recommended clients buy stock in Company XYZ, but before doing so consulted numerous sources, including Company XYZ's CEO? Would that single discussion with the CEO need to be disclosed in the analyst report in order to assure that investors knew that one of the analyst's sources for the research was biased in their assessment of the company's prospects? Of course not.

Like I said, we cannot take Goldman at face value at this point, just as we cannot take the SEC at their word either. After all, the SEC recently brought insider trading charges against high-profile Dallas Mavericks owner and high-tech entrepreneur Mark Cuban --- and lost. If most of what Goldman has said in this latest press release can be proven, it looks like the SEC's case this time around might not be a slam dunk either.

Full Disclosure: Peridot Capital was long shares of Goldman Sachs at the time of writing, but positions may change at any time

SEC: Goldman Sachs May Have Crossed the Line from Conflicted Investment Banker to Fraudulent Communicator

It always disappoints me when the financial media cannot wrap their hands around certain business stories. Here I am today watching the CNBC coverage of the SEC's fraud charge on Goldman Sachs (GS) and the network has half a dozen reporters and anchors all talking at the same time and confusing what exactly was happening, even though they played the SEC's conference call live on the air and it was pretty clear what was being alleging.

At any rate, let me review what exactly the SEC claims Goldman Sachs and its Vice President Fabrice Tourre did that was fraudulent in this particular case. The SEC is charging both the firm and the employee in charge at the time with omitting and misstating important disclosures related to the structuring and issuance of a CDO called ABACUS which was backed by sub-prime residential mortgage securities.

One of Goldman Sach's most prominent hedge fund clients, Paulson and Co, actually helped create the CDO by deciding which mortgage-backed securities were to be included in ABACUS. In addition, Paulson and Co took a short position in ABACUS after it was issued, meaning that it helped structure a CDO that it planned on shorting.

Many on CNBC are incorrectly reporting that this clear conflict of interest is what the SEC is targeting in its complaint. In fact, Paulson and Co. is not being charged at all. Not only that, having a hedge fund help structure a CDO in and of itself does not violate any securities laws. Neither would it be illegal for that same hedge fund to short the CDO after it was created and sold to the public. While this is yet another situation where Goldman Sachs appears to be engaging in transactions that are filled with conflicts of interest with their various sets of customers, these conflicts are not illegal. Rather, they simply beg the question whether Goldman will lose customers due to the perceived conflicts.

All of that said, what exactly is the SEC's charge related to? It turns out that in the marketing and disclosure materials prepared for potential investors in ABACUS by Goldman Sachs, it was claimed that ACA Management LLC, an independent third party expert in mortgage-backed securities, was hired to select which mortgages were packaged into the CDO. There were no disclosures made to investors that the hedge fund Paulson and Co. was also involved in selecting the securities.

Now you may be wondering why on earth ACA Management would agree to let a hedge fund assist them in structuring ABACUS, given that they are supposed to be an independent third party taking on such a job. The SEC hints it may have the answer. They are charging that the lead Goldman Sachs employee on this deal told ACA that Paulson and Co. was going to invest $200 million in ABACUS, which would likely calm any fears they had about the interests of ACA and Paulson and Co. being aligned while they collaborated on the creation of ABACUS. Fabrice Tourre, the Goldman VP in charge of the deal, seems to have both omitted disclosures related to Paulson's involvement, as well as misrepresented to ACA what Paulson's investment objectives were once ABACUS was issued.

The key point here is that the SEC is charging Goldman Sachs with fraud related to the disclosures made (and not made) relating to the creation and issuance of ABACUS. Therefore, the obvious conflicts of interest here by themselves would not have been illegal had Goldman adequately disclosed to investors the true facts behind the creation of ABACUS.

Now, how does this news alter my opinion of the stock, if at all? Goldman Sachs shares opened today at $185 and are now trading down 15% ($25) to around $160 each. You may recall I wrote a bullish piece on Goldman Sachs back in March explaining why I was accumulating the stock in the 150's. Until today that investment had proved very timely and given that even with today's drop, the stock is still above my purchase price, I am not likely going to be doing any heavy bargain hunting at current levels.

If the shares fall back to around the 150 level or even lower as more people react to the SEC's charges, it is quite possible that I would get more of my clients involved with the stock and/or add to existing positions for those who are already long. While I do not expect there to be much of a negative financial impact on the firm from these charges (Goldman's fees related to ABACUS were only $15 million), it is reasonable to expect that customers of the firm will have even more questions about conflicts of interest surrounding Goldman's dealings, including the possibility that other employees are lying about deals they are putting together personally.

Goldman surely has its hands full trying to alleviate these concerns with clients, but they can likely argue that this was an isolated incident involving a rogue employee and minimize the customer fallout from these allegations (as long as this proves to be an isolated incident rather than a pervasive problem at the firm). Given the stock's valuation based on book value and earnings, I still believe it represents a solid long-term value for investors interested in owning part of the most dominant investment banking firm in the world.

Full Disclosure: Peridot Capital was long Goldman Sachs at the time of writing, but positions may change at any time. And yes, you can be assured that there are no material omissions or misstatements in this disclosure.

Homebuilder Stock Favorites with Data

This week I have taken a closer look at the valuation metrics for a dozen large publicly traded home building companies with a goal of identifying attractive investment opportunities to play the likelihood of a rebound in new housing starts over the next few years. As a value investor, I looked mainly at valuation data rather than fundamentals for each individual company. For the most part these stocks trade together as a group, so I am trying to find ones I think could outperform the sector based on a lower entry point price relative to the rest. The fundamental backdrop (i.e. housing market conditions) are likely going to impact them all in a similar fashion.

Below you will find a summary of the 12 stocks I looked at. I created my own screening criteria to weed out smaller companies, those with above-average debt levels, as well as those that, for some reason or another, have a valuation metric that is meaningfully above the rest of the group.

The four stocks highlighted in yellow are the ones that fit my criteria and therefore are the companies I am going to focus on for this investment thesis. The black boxes indicate a data point that eliminated a certain company from contention. Not all of the black boxes indicate bad metrics. In fact, they include market values below $1 billion (which itself is not a negative) as well as one outlier metric that actually indicates company strength (NVR trades at a premium to the group on a price to book basis because it has the strongest balance sheet). This does not mean NVR is a bad investment, but I eliminated it because I am not getting enough value in the market because investors have already identified NVR as being in a strong financial position. I did eliminate stocks with a high proportion of debt relative to cash and investment holdings, so that was a negative metric that I used.

As you can see, I have identified four home building stocks that appear to have strong valuations relative to the group as a whole. Among these companies there is not much valuation differential, so other factors may play into how I would go about choosing one to invest in for the longer term. As with most of my potential investment candidates, these housing stocks are contrarian ideas. The housing starts data is unlikely to rebound in the short term, so investors looking to play this potential improvement should take a multi-year view of the investment thesis.

Full Disclosure: Peridot Capital had no position in the common stocks of any home builders at the time of writing. However, clients of the firm do currently own positions in the debt securities of Pulte Homes, although positions may change at any time

More Housing Start Data from Hovnanian

After reading my housing starts post from yesterday, Hovnanian Enterprises (HOV) CEO Ara Hovnanian was kind enough to have his investor relations department send over some additional information on trends and demand for U.S. housing starts. Of course, we need to keep in mind that Hovnanian is a home builder, so they have a dog in this fight, but their data certainly jives with the other figures I have seen. Here are some of the more interesting data points included in their materials as it relates to what I wrote yesterday.

• Average U.S. housing starts since 1971 have been 1.6 million per year

• Demographers estimate new home demand of 1.7-1.9 million units per year going forward

• Prior cycles all showed housing start troughs of at least 1 million units per year (1975, 1982, 1991), compared with about half that level in 2009, indicating an over-correction during this current housing cycle

• Housing starts per capita have hit the 7th lowest level on record, with the prior six lows occurring during World War I, World War II, and the Great Depression

Now, one of the reasons we are likely seeing this "over-correction" in housing starts is due to the credit crisis and the huge number of foreclosed properties coming onto the market. Foreclosure filings are running at about 300,000 per month right now, which equates to more than 3.5 million foreclosed properties per year. As long as foreclosures are at such a high level, in my view, it is probably unlikely that housing starts could rebound to a more historically normal level. However, as the economy continues to improve and unemployment slowly drops, foreclosures will decline as well. At that point, there appears to be nothing in the demographic data that suggests that housing starts should not rebound to a level of at least 1.5 million annually over time, which is nearly three times greater than today's annual run rate.

Later this week I will post some information on the dozen or so large publicly traded homebuilding companies I have taken a look at and will highlight a few that I think represent excellent ways to play an eventual rebound in residential housing starts.

Full Disclosure: No position in Hovnanian Enterprises at the time of writing, but positions may change at any time

Is a Boom in U.S. Homebuilding Coming?

Crazy headline, right? At first I thought the same thing. After all, with nearly 10% unemployment and a flood of foreclosed properties hitting the market, why would anybody need to dramatically boost new home construction anytime soon? Last week I saw a statistic from a former Goldman Sachs economist that estimated new home demand in the United States (from the combination of new household formation and the replacement of old homes) of approximately 1.5-1.6 million units per year. Given that the U.S. population is around 300 million, this figure does not really stand out as being unreasonable, and it is in-line with other forecasts I have seen.

In the short term, current inventory combined with foreclosures, weak loan demand from the recession, and tighter credit standards all contribute to the fact that new housing starts in the U.S. today are near record low levels, coming in at an annualized rate of around 500,000 per year. At some point, however, it does seem likely to me that housing starts would have to begin to trend upward toward that 1.5 million figure, which is three times the current annual run rate.

Before you dismiss this potential need for new homes as being years and years away, consider the graph below showing annual U.S. housing starts from 1991 through 2009.

You can easily see the effects of the housing bubble (from the early 2000's through the 2005 peak of more than 2 million units), which resulted in home construction far outstripping demand (by 400,000-500,000 units if you use the 1.5-1.6 million base demand estimate). However, we also see if we ignore the bubble period that housing starts of 1.5-1.6 million per year would simply put us back to the level housing starts were in the mid 1990's, when the U.S. population was much lower than today.

Despite the foreclosure glut we have in many states nowadays, this chart makes me think that the current housing start rate of 500,000 or so per year really is not sustainable for any prolonged period of time. Such a thesis would lead one to consider analyzing the leading homebuilding companies to try and find some attractive long term investment opportunities. Accordingly, I will share some data and thoughts on specific companies with you once I conclude my work on the leading publicly traded U.S. homebuilders. Do you have any favorites, or do you think this investment thesis is unattractive?

Contrary to Initial Reports on CNBC, Garmin Dividend Hike a "One-Time" Event

Despite reports on CNBC yesterday that GPS maker Garmin (GRMN) had doubled its annual dividend from $0.75 to $1.50 per share, a thorough reading of the company's press release shows that this increase is "one-time" in nature, meaning that Garmin has decided to add $0.75 to its dividend this year, but that investors should not assume it will necessarily stay at that level in 2011 and beyond. A few firms choose this type of dividend policy; paying out a standard rate every year and then, based on cash flows at the time, perhaps choose to pay out special dividends as well. Oil driller Diamond Offshore (DO) is another company that uses this policy.

Had Garmin actually boosted its core dividend to $1.50 per share, it would have been very good news (technology firms typically do not sport 4%+ dividend yields), but without assurances that this is not just a one-time event (the company actually used "one-time" in its own handpicked wording) investors who bid Garmin stock up $2 on Wednesday based on an extra $0.75 of dividends may be a bit optimistic.

I wrote about Garmin recently (Introducing Smartphones Unlikely To Save GPS Hardware Firms Like Garmin) and although the stock is not expensive based on current earnings, I simply do not think the fundamental story for standalone GPS device makers is all that positive. As more and more devices come equipped with GPS capabilities in the future, profit margins are set to decline. If margins do drop, low P/E ratios today may be giving investors a false sense of security, as earnings could fall faster than revenue. Below is a look at some other large cap hardware companies along with their current trailing twelve month price-to-sales ratios.

I use price-to-sales as my preferred metric here because I do not have confidence that Garmin will be able to keep its margins as high as they have been in the past. Traditionally the hardware industry has been characterized by lots of competition and low margins. As you can see from the data provided, only a few unique firms can really maintain high margins in the hardware space (Apple and RIM leading the way right now due to product and brand loyalty). Low price-to-sales ratios indicate low profit margins because investors know that a lot of revenue per share is needed to made good money selling products.

Not only do I continue to be cautious on Garmin from a fundamental perspective, but Wednesday's announcement and investors' reaction to it (with help from some confusing reporting on the dividend hike) made it worth mentioning again.

Full Disclosure: Peridot Capital clients had no position in Garmin at the time of writing, but positions may change at any time.

Despite Recent Rise, Goldman Sachs Still Fetches Single Digit P/E

In recent weeks I have been accumulating shares of Goldman Sachs (GS) for my clients, more so now than any other time since I began managing money. In a market environment where over the course of a single year most stocks have gone from severely undervalued to fairly valued, it remains pretty easy to make the case that Goldman stock is undervalued, despite a $20 increase just recently.

Why is the stock still cheap? No doubt due to the negative press coming from both political and consumer circles. Somehow Goldman Sachs is being made out to be a bigger problem for our financial services economy than sub-prime mortgage lenders and insurance companies that chose to insure everything on the planet without ever setting aside any money to pay future claims. Goldman Sachs never gave out mortgages like candy on Halloween and although they did benefit from the AIG bailout (their claims were paid out 100 cents on the dollar after the government bailout) people should be mad at AIG and the government long before blaming Goldman Sachs for owning insurance policies.

The investment case for Goldman stock, however, does not really involve a political or moral viewpoint (many of us will disagree on those points anyway). The real issue from an investor standpoint is that Goldman is the best of breed investment bank in the world ( this was one of the key takeaways from the credit crisis, in my view anyway), has seen many of its competitors go out of business or dramatically scale back operations, and yet at around $170 per share the stock still trades for less than 10 times estimated 2010 earnings.

Why do I think such a valuation is too meager? Well, all we have to do is rewind the clock back to before the credit crisis and recall what the investment banking landscape looked like. Back when the Big 5 investment banks were still in existence (Goldman, Morgan, Merrill, Bear, and Lehman) there was often a valuation discrepancy. It is actually very interesting to revisit how these stocks used to be valued by the market. Ever since it finally went public back in 1999, Goldman typically fetched a premium to the group (they have always been seen as the cream of the crop). Morgan Stanley and Merrill Lynch were very diversified and strong global franchises, and therefore were close runners up while Bear Stearns and Lehman Brothers were generally seen as less attractive, mainly due to an over-reliance on fixed income businesses for their revenues. They typically traded at a discount to Morgan and Merrill (about 10 times earnings versus 12 times) while Goldman often commanded a premium (15 times earnings or more).

This is interesting, of course, because the credit crisis essentially proved that the market was very accurate in its evaluation of the five large investment banking institutions. Bear and Lehman collapsed thanks to their heavy concentration in fixed income (many of those bonds and securities were backed by mortgages). Merrill Lynch and Morgan Stanley were on the brink but managed to find partners to help them back (Bank of America bought Merrill and Morgan got a large investment from overseas). Goldman, meanwhile, came through the credit crisis relatively unscathed (and would have been okay even if they had only gotten 80 or 90 cents on the dollar for their AIG contracts). For the most part, the market got it right.

Fast forward to today. We know that Lehman and Bear were the worst of breed and that Goldman is still tops. And yet Goldman Sachs stock today trades at a lower valuation than Bear Stearns and Lehman did pre-crisis. How does that make any sense? Has the credit crisis not proved that Goldman traded at a premium for good reason?

Going forward, I believe the valuation range we will see for investment banks will continue to be 10 to 15 times earnings. Maybe the lower end of the range is more likely near term as investors worry about political and consumer backlash. Maybe Morgan Stanley fetches a 10 P/E instead of 12 times, but Goldman should still command a premium to reflect their investment banking franchise. Granted, maybe that premium is only 12 times earnings.

Still, from my perch buying Goldman stock at less than 10 times earnings is a tremendously attractive risk-reward opportunity. The only way such an investment comes back to bite anyone is if either, one, the P/E drops significantly below 10, or two, Goldman's earnings have peaked and will trend lower in coming years. Frankly, I see both of those possibilities as extremely remote, especially longer term. Instead, I think Goldman Sachs should be able to earn around $20 per share and after the policy fallout has passed longer term, the P/E ratio should rise to 12 or higher. In that scenario, Goldman shares would fetch $240 each, or about 40% above current levels.

Full Disclosure: Clients of Peridot Capital were long shares of Goldman Sachs at the time of writing, but positions may change at any time

AutoZone: Ripe for Investment at the Right Price

In today's economic and financial market climate investors have to balance a stock market that is no longer cheap and an economy that has obvious structural damage. The consensus has concluded that below-average economic growth and employment could be with us for at least several more years. Given such circumstances we must be even more careful than usual in selecting companies to invest in.

In my mind, there are four things investors should look for when choosing new investments today. The first, valuation, is the obvious one for me as a value investor. No matter how much you like the story behind a stock, if you do not pay a fair price, the odds are stacked against you if you are trying to beat the market.

With so many economic headwinds, however, investors are likely to find their fair share of inexpensive stocks. Three other factors that I think are important, in no particular order, are:

1. A predictable and stable business outlook

There is no doubt that we are currently experiencing a fragile economic recovery. Any numbers of things could reverse the trend of the last several quarters and undo much of the progress that has been made. As a result, investors should focus on businesses where the outlook is predictable and relatively stable. This will make it fairly unimportant if GDP grows by a lot, a little, or not at all.

2. A strong market position that faces very few, if any, competitive threats in the near to intermediate term

A predictable and stable overall business outlook is great, but if a particular company is unable to successfully navigate and compete in that business, it could still falter. Not only must end demand be predictable, but the company's own market position within that market is crucial as well.

3. Company management needs to put shareholders' interests first

Unfortunately, this does not happen as often as it should (which is all of the time). Corporate executives routinely flush capital down the toilet at the expense of shareholders. They seem to all too often forget that they are working for the shareholders, not themselves or their cozy boards of directors. Management teams should have a clear focus on creating shareholder value and have a strong track record of putting shareholders first, ahead of themselves.

A company that I believe fits all of these criteria, and therefore would make an excellent investment in the current economic climate (at the right price, of course), is AutoZone (AZO), the large automobile parts retailer.

In this case, both the industry (automotive repair and maintenance), and the company (one of the largest and most profitable auto parts retailers in the country) epitomize stable and predictable businesses. The auto parts industry is largely non-cyclical, as cars need to be maintained no matter what the economy is doing.

Some may even argue that a weak economy bodes well for auto parts retailers because as new car sales decline, demand should rise for parts needed to keep older cars on the road longer. This is certainly a strong argument, and an incremental positive for the story, but even so AutoZone and their competitors have not seen any meaningful cyclical upswing in sales as the economy has struggled, and I would not expect one to occur going forward.

In addition, AutoZone has a very strong market position (more than 4,000 stores in the U.S. alone) and there is little in the way of new competition in the pipeline. One of the effects of the recession was a dramatic reduction in retail-related new construction and expansion, which had become a staple during the credit bubble.

The most enticing part of the AutoZone story for investors, however, is the shareholder-friendly nature of the company's management team. Not only does management run a very tight and efficient operation (operating margins for the last fiscal year were 17% -- very high for a retailer), but they allocate capital very intelligently.

Unlike some managers who crave growth, AutoZone has grown its store base meagerly in recent years, as it realizes that its industry is mature and population growth and some pricing power are the only real drivers of sales. The company is quite pleased growing sales in the low to mid single digits each year, rather than expanding too much, cannibalizing existing stores, and earning sub-par returns on its capital.

Where does this excess cash flow go? Mostly to share repurchases, which directly translates into value creation for shareholders. In fact, during the last decade AutoZone used free cash flow to buy back huge amounts of stock. Entering fiscal 2000, the company had 150 million shares outstanding. By the end of fiscal 2009 that number had been cut by two-thirds to an astonishing 51 million. Not surprisingly, AutoZone's share price rose from $24 to $147 during that decade, for a gain of more than 500%.

Too many times managers and investors equate growth with stock price returns, but AutoZone is a perfect example of how you can create massive amounts of shareholder value without rapid expansion. The company can generate strong double digit earnings growth, while only growing sales in the low to mid single digits, if it allocates capital in shareholder friendly ways. During fiscal 2009 AutoZone's revenue grew by less than 7% but earnings per share rose by nearly 20%, largely due to an aggressive stock buyback program.

There is no doubt that the company is a strong investment candidate, especially in the current macroeconomic environment. As is always the case, however, investors need to make sure they pay the right price.

Full Disclosure: Peridot Capital was long AutoZone at the time of writing, but positions may change at any time

KBW is Right, Berkshire Hathaway Stock No Longer Cheap

From MarketWatch

"Berkshire Hathaway was downgraded to market perform from outperform Monday by insurance analysts at Keefe, Bruyette & Woods who said a recent rally has left the shares fairly valued. Berkshire's class B stock was included in the Standard & Poor's 500 index this year and a lot of mutual funds that track the equity benchmark had to buy, pushing up the price. They also cut their price target on Berkshire's class A shares to $125,000 from $135,000."

I think this is a good sell-side call, and I am not one who typically praises Wall Street analysts. Since it was announced that Berkshire was being added to the S&P 500 on January 26th, the stock has surged nearly 20% in about a month. It now trades for 1.4 times book value and 1.8 times tangible book value. While neither ratio is extremely high, the stock does trade at a premium to both its peers (rightfully so) and near the upper end of its historical average. It appears the S&P 500 announcement has resulted in such a large surge in the share price that I would agree with KBW that buying at current levels is not a very attractive entry point.

Steve Jobs Wrong About Stock Buyback Impact

Reports out of the Apple (AAPL) shareholders meeting today are not very encouraging if you are an investor in the company. One of the first questions posed to Steve Jobs during the Q&A session, the first Jobs has attended since his medical leave of absence, concerned the odd decision made by the company to sit on a cash hoard of about $40 billion, earning little or no interest.

Apple has previously taken the position that keeping cash on-hand for acquisitions or large research and development projects made sense. I can buy that for the first $10-$15 billion, but the kind of cash balance held today is not only silly, but a disservice to investors.

So how did Jobs answer when shareholders asked about the possibility of using some cash for a dividend or stock buyback plan? Not well. Jobs said that not only does Apple need to keep that cash for growth opportunities, but even more disturbing, he stated that paying a dividend or buying back stock would not change the stock price.

Given that Peridot Capital has a position in Apple stock, this comment is not only wrong, but it indicates to me that Jobs does not really care about shareholders very much. He is right that paying a dividend would not change the stock price. A dollar of cash is worth the same on Apple's balance sheet as it would be in the pocket of a shareholder, so any transfer of cash from the company to investors would serve merely as a partial cash out of one's investment (and would possibly be taxable for the investor).

To assume the same for a share repurchase plan, however, is simply incorrect. Apple could retire 10% of the company's outstanding shares and only use half of its unused cash balance! How can Jobs argue that a 10% increase in Apple's earnings per share would not positively impact the stock price? That is exactly why companies use free cash flow to repurchase shares; each investors' share of the ownership pie increases, which makes each share of stock more valuable.

For those of us hoping Apple would boost earnings by investing its cash hoard more wisely, it appears our voices won't be heard anytime soon. Unfortunate, but true.

Full Disclosure: Peridot Capital was long shares of Apple at the time of writing, but positions may change at any time