Smart Investing

There are many secrets to investing that the average person or investor may miss. Why? Part-time investing or part-time anything is hard to do.

I spend maybe 60 hours a week, probably more, dealing with investments. Let me share with you a little secret about pension accounting: Don't be surprised that you never heard of it, many have not.

In lunches that I hold for my clients and my public workshops, I've been talking about since last year the underfunding of defined benefit plans. The most recent data available from JP Morgan Asset Management reveals that 92 percent of S&P 500 companies are underfunded on their defined benefit plan. Data also reveals that of the allocation that corporations fund their contributions, 51.6 percent is invested in equities. This could be beneficial for the stock market as corporations step in and buy equities to fund their obligations, which must be done by law.

There is another strategy that corporations like 3M, Honeywell and Caterpillar are using to meet their obligations, putting their own newly-issued stock into the defined benefit plans. You may be saying you've never heard of this; well, you would have to dig deep to find this information. Honeywell disclosed it in its Securities and Exchange Commission filing, while 3M mentioned it in a press release about dividends and board changes. It is hard to find this information, but it can give an investor important knowledge to stay on track.

This idea is not something new; it actually has been around for years. It can preserve cash for the company and still meet obligations to fund the company's defined benefit contribution. Also by funding its defined benefit, the company will receive a tax benefit, which will also increase its earnings. By increasing its earnings, the company's PE ratio will also decline -- another positive.

You may be thinking, wait a minute: If they are issuing new stock, won't that dilute their earnings? If you thought that I would say congratulations on thinking about that, the good news is, in this instance the issuing of new stock will not dilute earnings. Stock that is granted to a pension plan is generally accretive to earnings. Pension accounting rules (I'm sure you were wondering when I was going to talk about pension accounting) allow the company to record higher pension income after the contribution is made.

The company can also leverage this in some circumstances like JCPenny did. JCPenny carries a large pension relative to the size of the company; management said it would use the tax savings to increase its debt-repurchasing and restructuring program. So in JCPenny's case not only will the earnings increase, but the company will lower its debt, which should make the company's balance sheet look better. The debt-to-equity ratio should increase, which is positive, and also with the reduction of debt the equity for the company should increase as well.

What should you look out for down the road? When companies do this transaction keep in mind that the pension plan generally uses a trust company to manage the pension plan. This third party has a fiduciary responsibility to employees in the plan. Sometimes this trust company that was hired to manage the plan for the benefits of the retirees may elect to sell off the stock to convert it to cash. The trust company would do this to avoid being overweighted in the company's stock. It is a management decision of the trust company, so if one were to see a lot of company stock in the pension plan, this could be a signal that the stock contributions could be liquidated.

This is one of the many items that investors should be looking at and understanding. This is also why I don't get too excited or concerned if I see a company's stock drop 20 percent to 30 percent. I keep my eyes focused on the business, not the day-to-day fluctuation in the stock or the hype about the company on TV or in the papers. Remember: Buy the company, not the stock.