S&P 500 global sales

I was looking through PR Newswire the other day and spotted a press release from S&P highlighting a research article on global sales data for S&P 500 companies.  I decided to take a look.  The reading is a little dry, but I’m glad I did.  Here’s why:

1.  stuff I sort of knew, but couldn’t have told you the details about

a.  Today the US accounts for 16.8% of the world’s GDP, calculated on a purchasing power parity basis.  I just wrote about this a short time ago, so that’s not the surprise.  But although I knew the US share of world output was shrinking, I didn’t realize that at the end of 2003, the US accounted for 29.6% of the world’s economic value generation.

Wow.  What a drop!   Of course, the US economy has expanded over the past six years–but China and other developing countries have made enormous strides in closing the size gap.  If we look at this from a relative market share perspective, the US would have been 50% bigger than its nearest rival.  Now it’s one of three roughly equal economic groups–NAFTA, the EU and the BRICs.  Within ten years, as I’ve pointed out in a previous post, the US will most likely be in third place in world economic rankings, behind #1 China and #2 the EU.

b.  The estimates of foreign sales that the S&P produces is just that, an estimate, and is based on reporting data from 250 of the 500 companies in the index.

S&P has decided to discard data from companies that have either less than 15% of total sales outside the US, or more than 85%.  That eliminates 72 companies.  Of the ten firms with over 85% international sales, seven are IT firms.

The remaining 178 don’t report numbers broken out by region of the world.  Some have graphs or charts, some have nothing.  Of the firms reporting only US and foreign, the largest (by foreign sales) are really big names:  HQP, IBM, PG, ADM, MSFT, DELL AIG, COP, CAT, AAPL, F, DOW, PEP and AMZN.

I can understand that there are issues of keeping data from competitors, as well as transfer pricing and tax planning considerations, but these firms can surely reveal to shareholders more than US vs. non-US.

2.  where the growth in foreign sales is coming from

These are the foreign sales by sector of the S&P as of yearend 2009 (2008 for financials and utilities) as a percent of total sales, and the growth rate of foreign sales over the past six years:

S&P     46.6% of sales, + 11.3% since 2003

IT          56.0% of sales, + 6%

Utilities     52.2%, flat

Materials     52.1% of sales, +13%

Healthcare     47.1% of sales, +8%

Staples     46.6% of sales, +35%

Industrials     44.2% of sales, up 9.8%

Energy     43.7% of sales, -14%

Consumer discretionary     42.4% of sales, +22.7%

Financials     34.1% of sales, +19.5%

Telecom     insufficient disclosure

It’s interesting to note that the fastest diversifiers away from the US over the past six years have been consumer companies.  Presumably they have been propelled by a combination of he maturing of the US market and strong growth prospects in emerging economies.  Staples have risen from being the sector with the lowest percentage of foreign sales, ex financials, to a first division status.

Energy is conspicuous in its sharp drop in percentage of foreign sales.  I presume, but don’t know, that this is not a deliberate choice but instead a function of foreign sovereign production sharing agreements, which typically call for a decreasing percentage of production to go to the developer of a field as prices rise.

The level of foreign sales doesn’t seem to be a differentiating factor among sectors, since almost all have large foreign exposure.  But the rate of growth does seem to be, if the consumer-related sectors are any indication.  Given the strongly defensive nature of the market at present, it’s difficult to draw strong conclusions.  As the market rebounds, however, I think it will be important to watch stock performance both vs. the level and the growth of foreign sales.  My guess is that growth will be the more significant indicator.

prospects for deflation: Andre Meier and Gavyn Davies

Gavyn Davies as blogger

Gavyn Davies, formerly chief economist for Goldman Sachs, then head of the BBC, is now among other things a blogger for The Financial Times.

My experience as a portfolio manager has been that Goldman’s economic commentary has always been truly excellent, and the high spot of the firm’s research offerings. As to Mr. Davies in particular, I read and admired his work for years.  (Equity strategy and individual stock research at Goldman is another story—lots of facts, no useful opinions would be my call.)

A recent post on his FT blog talks about deflation.

The  deflation problem, in a nutshell,  is this:  the main tool governments use to treat a sick economy is to lower interest rates to the point where the real (that is, after adjusting for changes in the price level) cost of funds is less than zero.  But an agency like the Fed can only lower rates to zero, where they are now.  It draws the line at actually paying us for the privilege of lending us money.

Because of this, a deflationary economy, i.e., one with a falling price level, is like having a patient with an antibiotic-resistant virus.  You can’t make real rates negative.  So tried and true treatment methods for curing a slumping economy are ineffective.  The monetary authority can either try unconventional methods, which have no track record, or stand on the sidelines with fingers crossed, hoping the patient recovers on his own.

It doesn’t help matters that the word deflation conjures up images of the worldwide depression of the 1930s or the decades-long stagnation of Japan.

Andre Meier on deflation threats

In his post, Mr. Davies cites work by Andre Meier of the IMF in cataloging and analyzing all the instances of recessions in the developed world over the past forty years that have been serious enough to pose a deflation threat.

Mr. Meier’s conclusion:  while inflation does rapidly approach the zero level in the twenty-five instances he looks at, it doesn’t seem to want to cross over into negative (deflationary) territory.  The higher the previous inflation, the faster the plunge downward, but in all cases save two the rate of descent slows and the inflation rate stabilizes as the zero line is reached.

In pre-1990 instances, which tend to originate at higher inflation levels, the march to zero is relatively steady.  Post 1990, the initial fall is sharp, but disinflation then tends to decelerate in later periods.  In the two exceptional cases from the past paragraph, which start from very low initial levels of inflation, Sweden in 1992-94 and Japan 2001-2003, the price level actually starts to rise as the recession deepens (presumably because of currency weakness and imported commodity strength, but odd nonetheless).


Both economists interpret the data as indicating that there’s something very unusual about the occurrence of deflation, and that it seems to take negative economic shocks of much larger magnitude than the world has seen at any time in the post-WWII era–including now–for deflation to take hold.

The question is why this is the case.  Both Meier and Davies point to structural rigidities around zero.  As a practical matter, firms are reluctant to cut the wages of highly skilled employees, for fear they’ll leave when economic conditions improve.  They don’t want to cut the prices of their output, either.  Experience has taught them that it’s extremely difficult–in many cases, nearly impossible–to raise them back again.  In addition, in many cases legally binding agreements–government workers’ salaries, for example, or long-term materials supply contracts–mean price cuts aren’t possible.

On a macroeconomic level, it may be that inflationary expectations–there’ll be low inflation but at least some–have been very deeply established in our collective economic psyches.  World governments response to recent crises, much as we may want to criticize the details, may have been enough to preserve or reinforce these attitudes.

In any event, the experience of the last forty years says deflation is not likely to happen.

my thoughts

No deflation doesn’t mean everything is ok.  But if we take the idea that general price levels are not going to decline as a working hypothesis, we can draw conclusions that may have useful investment implications.  For example, if salary levels aren’t going to decline, then firms will only be able to lower labor costs by laying workers off, or by pruning high-cost but unproductive workers and replacing them with lower-cost, more productive ones.  Companies could also prioritize between high value-added tasks and low value-added ones–and focus all/most compensation increases to workers in the former areas.

One might also try to distinguish countries where limited economic gains may be a chronic problem and those (like the BRICs) where it will not.

In discussing its most recent earnings performance, Procter and Gamble seems to be saying that these sorts of patterns are already becoming evident in their customers’ behavior.  For example, PG is finding that consumers of mainline/premium brands are beginning to trade up.  Value-brand users are continuing to trade down.

My experience is that in uncertain economic times, investors tend to become mesmerized by worry over the worst possible outcome and do little else except wring their hands.  True, we need to be concerned about even low probability events that have significant negative consequences.  But typically this doesn’t take much time.  I think there’s potentially a lot of money to be made by looking for hot spots of growth even in a world that may not be expanding that quickly.  And there’s certainly money to be made by working out the economic implications of having something better than the worst-case scenario unfold.

Intel acquiring McAfee

the announcement

Last Thursday INTC issued a press release and held a web news conference announcing that it had reached an agreement with the board of directors and top management of McAfee to acquire MFE for $48 per share in cash.  This would be a total of about $7.7 billion, or $6.8 billion after subtracting the cash MFE has on its balance sheet.

Assuming regulatory and shareholder approval, the merger could be completed before the end of this year.  Presumably, the two firms are aiming to have this happen, to save the effort and expense of producing a superfluous, pre-merger set of audited accounts.  Senior management of MFE have agreed to stay on at INTC for an unspecified period of time–probably at least a couple of years–operating as a more or less autonomous unit and reporting to one of INTC’s division heads.

the numbers

MFE rose almost 60% on the news, to $47 a share.  INTC fell about 3%.  To me, this looks like ordinary risk arbitrage activity, making a statement that no other bidder is going to emerge (I can’t imagine who would) and that the deal will face no real obstacles to completion.

Over the past five years, cash generation at MFE has been growing at about a 15% annual pace and now stands at a what I estimate to be a touch over $3 a share annually.  There are enough unusual non-cash expenses charged against operations that net income is only about 40% of that.  But because earnings are so unreflective of cash flow, I think they shouldn’t be the standard used in evaluating whether the acquisition makes financial sense.

MFE has no debt and about $2 a share in working capital, a quarter of that in cash.  Net of cash, the acquisition cost is $46 a share.

INTC says that, ex unusual items, MFE will be accretive to INTC earnings immediately.  This is at least in part due to the fact that MFE’s profits will replace interest income on the cash deposits INTC will use to pay for the MFE shares.  At today’s rates, that income has to be very close to zero, so being accretive right away isn’t saying much.

Let’s assume I’m correct that current MFE cash generation is about $3 a share and is growing at a 10% annual rate (given competition in the internet security business, that may be high).  Let’s also say that the appropriate rate to discount MFE’s future cash flows back into the present is 5% (that’s probably too low, but its halfway between the zero INTC is earning on its cash and the 10% it would cost the company to issue new stock).  On these assumptions, it takes MFE about ten years to pay for itself.

That’s a long time.  So the rationale for the acquisition can’t be that MFE stock is really cheap.

INTC’s reasoning

Continue reading

more on equity dividends, a badly misunderstood topic


For the last twenty-five years, dividends have played virtually no role in the thinking of most equity portfolio managers in the United States.

For one thing, the quarter century has been a time of great and rapid technological change–and has therefore presented unusually good investment opportunities.  So there was no need for dutiful managements to return   profits to shareholders for lack of lucrative reinvestment possibilities.

For another, increasing affluence and the rise of discount brokerage meant stocks were becoming accessible to most adults, not just coupon-clipping tycoons.  Baby Boomers were just coming of age and looked to stocks for capital gains.  Boomers simply weren’t interest in dividends then.

…and now

The Baby Boom is nearing retirement.  Age-appropriately, Boomers have begun to shade their investment choices away from pure capital gain toward vehicles that mix in an element of income as well.  At the same time, the domestic economy has matured.  Even before the financial crisis, economic growth had begun a secular slowdown.  In addition, the corporate field has become much more crowded with competition from Asia and Latin America.

As a result of both these developments, many American corporations are beginning to pay significant dividends again.

why misunderstood?

Three interconnected reasons:

1.  The last market cycles in the US where dividends made a real difference were during the accelerating inflation of the late Seventies (dividends were a bad thing) and the early disinflation years of the Eighties (dividends were very good).  Most of the portfolio managers who actually worked in these periods have either retired or are senior executives no longer managing money.

2.  Portfolio management is a craft skill.  You learn by practical experience as the apprentice of a skilled practitioner who is willing to teach, or at least willing to let you observe what he/she does.  Dividends just haven’t come up as a key topic in the training program for a very long time, so (I think) managers under fifty years of age have little clue about how to react to the change in investor preferences I think is going on currently.

3.  Academic finance, surprisingly, has (for a change) some useful information.  But it’s not very much. So you won’t learn about dividends there.   It’s unusual to see a faculty member with any practical knowledge of experience as a professional investor.  It’s rarer still to see a securities analyst of portfolio manager with tenure.  The best analogy I can come up with is that if you want to be a creative writer you don’t learn how by studying to be a literary critic.  But even that’s not quite right, since the literary critic and the writer share common assumptions about the value of the written word.  Finance academics deny that portfolio management is possible.

the Jeremy Siegel op ed article in the Wall Street Journal

I’ve written about this column in an earlier post.  In it. Mr. Siegel, a professor at UPenn, suggests that dividend-paying stocks can be a viable alternative to bonds.

I think the observation is correct and should be relatively uncontroversial.  Of course, I’ve been writing the same thing for months.  But the Siegel article has generated a mini-firestorm of protest  and it has spawned a number of pronouncements “correcting” what the authors consider Mr. Siegel’s misconceptions.

I’ve been fascinated–maybe stunned is a better word–by the counter-articles, which seem to me to reveal the authors’ ground level lack of understanding of what dividends are all about.  I’ve gone back and forth in my mind about whether to link to some examples and have decided, for good or ill, not to.  But careful readers of the Financial Times will have seen a particularly egregious example of what I’m talking about–a rare reversal of form between the FT and the WSJ.

So I decided I’d put down what I consider some of the fundamentals about dividends.

Here goes.

dividend basics

1.  From a credit analysis perspective, common equity dividends (I’m going to ignore preferreds in this post) are riskier than interest payments on the same company’s bonds.  If a firm gets into financial trouble, it can much more easily decrease of eliminate dividends to shareholders than it can interest payments to bondholders.

2.  Most bonds have a specified term, usually ten years or less.  Although the bonds may be far less liquid on a day-to-day basis than stocks, the bondholder will–absent financial problems with the bond issuer–receive his principal back at the end of the term.  Generally speaking, equities have no similar feature.  You may receive more than your original investment if/when you sell, depending on market conditions at the time.

3.  In theory, any company is continually looking for high return projects to reinvest the cash its business is currently generating.  If it can find such projects, it spends its cash on them.  If not, however, rather than  invest in projects where it thinks prospects are at best mediocre or let lots of idle cash build up on the balance sheet, the company should return funds to the shareholders (the legal owners of the company) for them to reinvest elsewhere.

As a practical matter, companies don’t always do this.  Sometimes, shareholders may make it clear to management that they don’t want the money back, that they’re rather have management reinvest even in cases where the returns may not be so high.  Most often, however, CEOs’ egos get in the way of doing the right thing by admitting that industry growth is slowing and that harvesting an investment is more appropriate than sinking new money in.

4.  Dividends are paid out of profits.  Typically, as income rises so too do dividends–unlike the case with bonds, whose coupon payments are typically fixed.

5.  Dividend levels are set by a firm’s board of directors. In well-managed companies, dividends are always backward-looking.  That is, they are set without consideration of possible future profit growth, but only at a level that historical experience says is appropriate.  Dividend increases are only made where there is strong evidence the business will be able to maintain the new payout even in weak economic times.

6.  Although dividend payout ratios are usually expressed as a percentage of profits, I’ve always found the correlation with cash flow to be stronger.

7.  Managements have different levels of skill in the dividend setting process, as well as different levels of commitment to maintaining the dividend during lean times.  As a general rule, firms that have cut the dividend in the past are more prone to do so in the future.

8.   The highest current yield isn’t always the best. It may simply be signalling the market’s belief that the dividend has no chance of growing–or, worse still, that the current payout is likely to be reduced.

9.  Dividend growth prospects count, too.  To my mind, the ideal combination is a stock

–with, say, a 2.5% yield but which is

–a leading firm in a maturing industry, and

–where management recognizes its obligation to shareholders not to continue to expand rapidly but rather to return an increasing amount of the cash it generates to shareholders.

Remember the rule of 72:  a 10% annual grower doubles cash generation every seven years.  A 15% grower does this in less than five.  In a firm like I’m describing, dividends have a chance to grow faster than that.  In the latter case–admittedly not an everyday find–dividend payments ten years from now would be 4x+ the current level, meaning a 10% dividend yield on an unchanged stock price.

state of New Jersey–the latest strange SEC decision

New Jersey is an odd state.  On the one hand, this small but densely populated region contains a famous research university, Princeton.  It generates much of the pharmaceutical research done in the US.  It contains bedroom communities for New York City and Philadelphia, as well as miles and miles of rolling beaches, and the hills, lakes and horse farms in the western part of the state.

On the other hand, its reputation in the minds of many Americans is determined by the HBO series The Sopranos, about an organized crime family operating in NJ; the reality show Jersey Shore, whose “stars” are, ironically, New Yorkers; and a short–but heavily used–stretch of the New Jersey Turnpike that seemingly threads its way through every oil refinery, chemical plant and natural gas storage area in the Northeast. Local politicians have also done their bit to define the state’s character, as they have sued for the right to remain in office, or to run for reelection, while in their jail cells.

New Jersey has been in the financial news recently for another signal achievement–it’s the first state ever cited by the SEC for securities fraud (San Diego, CA has the dubious distinction of being the first government entity to be the subject of an SEC securities fraud action).  The charges, which New Jersey settled in an administrative proceeding this week, are basically that while Jim McGreevey and Jon Corzine were governors, the state continually deceived potential investors in its municipal bonds.  In bond offering documents and in other official state records, New Jersey either misstated or failed to disclose the increasing underfunding of state workers’ pension plans–caused in part by the fact that the state was “balancing” the budget by no longer making contributions to them.

You might think that this is the strange part.  It isn’t.  The really strange part is that in the cease-and-desist order linked in the paragraph above, no individuals are cited for this misconduct–not the governors who knew what was going on, nor the state treasurers who prepared the fraudulent financials, nor the investment bankers whose due diligence was non-existent.  In this regard, Mr. Corzine’s name in particular jumps out to me, not necessarily because his actions were any worse than the others’ but because his long career at Goldman Sachs, including serving as its CEO, make it very difficult to believe he wasn’t completely aware of the relevant securities laws and of the gravity of what New Jersey was doing.

The rationale for the SEC’s inaction–cooperation from New Jersey, which has promised to mend its ways.

The fact that this is not a court proceeding means there’s no judge to evaluate the SEC’s decision.  But it seems to me that this enforcement action–particularly in an apparently simple and straightforward case–reinforces critics (including judges, in court cases) who say that the SEC is a relatively toothless regulator, more interested in fast settlements than in adequate ones.