July 25, 2011

A few remarkable things have happened over the past number of months. One was much reported on and the other was barely mentioned.

The first was the decline of the S&P TSX market index by about 8% largely due to the inevitable Greek default, rising interest rates in China and the end of the US printing of money in the name of QE2 (Quantitative Easing round 2) as well as the pending August 1st deadline for the US to raise their debt ceiling so as to prevent default on outstanding bonds.

The other is that the rise of corporate revenues, cash flows, earnings, dividends, stock buybacks, cash positions, merger and acquisition activity continued unabated.

The result of these two occurrences is that the great businesses of the world have become even cheaper while the prospects for future growth have increased dramatically.

Consider, for a moment, what’s happening to a few of the largest multinational companies in the world. (Note that this is not a recommendation to purchase these businesses, rather just an illustration of what is happening in this equity market to some of the great companies of the world.)

Looking first at Walmart which is the world’s largest company. With the increase in gasoline prices, lower consumer spending due to high debt and increased food inflation and high unemployment you would think Walmart would be suffering. Walmart has purchased $28 Billion of its own shares since June of 2010. It’s notable first, that they had the cash and second, that this decreases the available shares on the market by about 8% which reduces supply and increases the future potential for demand. Walmart also increased its dividend last March by 21% – capping another year of annual dividend increases since 1974. Walmart executives obviously feel good about their future as they feel the best use of their cash is to purchase their own shares and increase dividends setting up strong growth for the stock in future.

Let’s consider another multinational business – Microsoft. Microsoft shares recently traded for less than half what they peaked at in 1999 – even though their earnings grew compounded at 11% for the last 10 years. Microsoft earns a 44% return on its equity and generates almost $2 Billion in free cash every month, raised its dividend recently by 23% and bought back 2 Billion shares in the last five years.

Lastly, consider Exxon Mobil. Its stock is still less expensive than it was in 2008 when oil was $140 a barrel. Its return on capital is above the market and it has grown it’s dividend by over 9% for the past five years. It also uses its significant cash flow to continue to make discoveries and to buy back 300-400 million of its shares per year.

Recent earnings announcements by Apple and IBM are higher than analyst estimates confirming many large companies are still making money.

My purpose in describing these stocks is to illustrate that while governments are suffering from the poor decisions they have made over the past decades, many of the large, multinational businesses on this plant are in the best shape they have ever been. In my own practice I have been recommending a 20-30% allocation to a large cap multinational fund because in my opinion it and must be one of the most attractively valued asset classes on earth.

The Shift to the East

Consider this:

1 – In 2004, General Motors sold 10 cars in the U.S. for every one car sold in China;

2 – Currently GM is selling about one car in the US for every one care sold in China. China will be a bigger market than the U.S. for America’s largest automaker.

3 – In 2008, Nokia, the largest cell phone maker in the world, had net sales of $8.2 billion in China, more than three times its U.S. revenues.

4 – In the 14 years since opening its first store in China, Walmart has gone on to open an additional 267 retail units.

These factoids are from a paper by Homi Kharas and Geoffrey Gertz of the Wolfensohn Center for Development at the Brookings Institution. They suggest the beginnings of a growing shift in global consumer demand from the West to the East. The authors suggest:

1 – By 2015, for the first time in 300 years, the number of Asian middle class consumers will equal the number in Europe and North America.

2 – By 2021, if the present trend continues, there could be more than 2 billion Asians in middle class households. In China alone, there could be over 670 million middle class consumers, compared with perhaps 150 million today.”

If you are wondering why the great businesses of the world are performing so very much better than the domestic U.S. and European economy seems to be doing – pay attention! We are seeing the exponential growth in the sheer numbers, not to mention the purchasing power, of the middle class outside of the developed world.

Headlines Shmedlines

Linked to this newsletter are a few interesting articles you may have missed.

Buying Equities in a risk Averse Market

Don’t Miss your Chance to Catch a Bull Market

The Debt Ceiling “Crisis”

60 Ways to make life simple again

Life is not complex. We are complex. Life is simple,
and the simple thing is the right thing.
– Oscar Wilde

Worth reading when you have a quiet moment to reflect: