Wednesday, November 30, 2005
Donaldson Capital held its annual client appreciation dinner in Evansville last night. The event was held at the Evansville Museum of Arts and Science. We ate a wonderful meal surrounded by beautiful art and artifacts. Everything went great except for our Texas friends hanging their coats on a piece of contemporary art, which they mistook for a coat rack. Mike Hull offered our thank yous to clients old and new and shared a bit of our strategy for the future. I cut my speech in half at the request of some of the oldtimers, who said the wine, hors d'ouevres, and conversation were more fun than speech making. I have to agree, but I still got my 8 charts on the wall which showed some of the research that we have conducted on dividends and their correlations to prices. It was a great night, and the only person I saw nod off was JWB (he's heard it all before). For those of you who were there, that is the reason I had to pick on him a little. He's promised to get his beauty rest next year. Blessings to all of you. You are our only reason to be. You humble us with your kindness and your trust. We are deeply honored to serve you. As I said earlier, we will be having other dinners in cities where we work in the months ahead.
Monday, November 28, 2005
The Dow Jones has rallied almost 800 points since mid-October to stand at near 10,900 and many of our clients have asked why? Not that they don't appreciate the bounce, but they question if the news has really improved as much as the rise in prices now reflects. First, let me remind you that our most reliable model has been pegging the value of the Dow at near 11,800 for most of the year, so a part of this bounce is based on stocks having gotten very cheap, especially when you consider that earnings and dividends have grown at double digit rates. I don't believe that stocks will rise to 11,800 is a straight line, but I do believe there is a high probability that the path of stocks will intersect that level within the next year. The main reason stocks are doing better, though, is as a result of the economic data that have been released since the conclusion of the Gulf Coast storms. It resolves many of the questions that we cited in our October quarterly letter that need to be answered. 1. The US economy, contrary to the doom and gloomers, has not been materially affected by the storms , and certainly is not headed for recession. 2. Oil prices have softened dramatically to $57 p/bl, down from over $70 p/bl. 3. Inflation spiked in September, but was flat in October. With oil at the current level, November's reading is likely to be tame, as well. The market is now rubbing the worry beads over the Christmas selling season. I'm not as concerned about Christmas sales as most. My friends in the retail business have told me for years, that everyone always worries about the Christmas season because it is such a big deal to total retail sales in such a short period of time. But they say not to worry, Christmas always comes. It is a part of our culture. Terrorists, hurricanes, tornados, war, oil shocks, political battles -- all these forces show us just how precious and fragile our lives really are. Christmas and Hanukkah remind us that there is Someone bigger and wiser than us, Someone who has blessed us down through the ages in spite of our folly and the vicissitudes of nature. Giving gifts to someone we love is as natural as breathing. Do we stop breathing because of the forces we face? Certainly not. Indeed, we will give more purposefully, perhaps more generously, because we will see the faces of those we love, and we love to see them shine. And shining faces have been in short supply during the past many months. I also encourage you to give to faces you do not know or love. These faces may have borne the brunt of the storms or man's inhumanities to man. A gift from a stranger is almost too good to be true. You will likely never see the face of a stranger light up when they unwrap your gifts, but you know as well as I do that the shine will come -- it's a part of every culture, a part of being human. And you will become a blessing and blessed in the same moment. How can you beat that deal?
Wednesday, November 23, 2005
The pastor of my church ends each service with a beautiful blessing: "May the Lord bless you and keep you; may He make His face shine upon you, and be gracious to you; May the Lord lift up his countenance upon you and give you His peace. Numbers 6: 24-26. At this Thanksgiving season, I want to express to you how grateful all of us at Donaldson Capital Management are that you have chosen us to work for you. You are a blessing to us. We are honored by the trust that you have extended to us, and in everything we do, we seek to be worthy of it. Happy Thanksgiving, Greg Donaldson
Sunday, November 20, 2005
GE announced a 14% dividend hike last week. As usual the news of this hike was like a piece of juicy gossip. It traveled all around the world before Chairman, Jeffrey Immelt, could get the whole sentence out of his mouth. **Not** No, the truth is the news of the dividend hike did not even make some financial websites that I watch. And yet, in the few words it took to announce the hike, GE said more about the coming year than a stack of Wall Street research reports. Before I discuss the implications of GE's dividend action, let me show the blog I wrote on December 13th of 2004. December 13, 2004 So goes GE . . . . GE's announcement of a 10% hike in its dividend this week is very good news. GE has long been a bellwether of the US economy, and the double digit increase is a plus not only for GE, but also for the entire US economy and stock markets. CEO Jeffrey Immelt also announced future earnings growth in the range of 10-15%%. We believe this guidance says three things: 1. Earnings will grow faster than 10%, 2. Dividends should also grow at least at 10%, and 3. Average US profit growth should be also close to 10% over the next few years. More importantly, GE's dividend and earnings growth pronouncements allow us to compute its intrinsic value. Starting with a dividend of 86 cents,growing at 10% per annum over the next five years then gradually slowing it to a long-term growth rate of 6.0%, all discounted at 9%, produces an intrinsic value of just under $42.00. We think its just a matter of time before the stock trades there. It is currently trading at $37.26. This is the best news on dividends I have seen in a long time. GE is so big and so important to our economy that their guidance sheds a light on the whole economy. Well done Mr. Immelt. GE had been wallowing around ever since Jack Welsh left the throne, and the 10% hike, to me, was a clear indication that Mr. Immelt was signaling that things were about to get better. With regards to the three things I said the dividend hike was implying, (1) GE's earnings, indeed, will be above 10% for 2005, at near 13%;(2) The 10% 2005 dividend hike is now being followed by a 14% increase for 2006 (I continue to think 10% will be a floor for the next several years); and (3) US corporate earnings growth will be near 14% for 2005, well above my projection of 10%, which was 50% higher than Wall Street consensus estimates. The only part of the December 2004 blog that has not come to fruition yet, is GE's price. I said in the December blog that our dividend model was producing a present value of $42.00 for GE. Well, not only is GE not trading at $42 per share, it is actually trading at $36 per share, lower than it was last December 2004. If you are a momentum investor, you don't care a twit about talking dividends, or valuation. You care only about price, and "what have you done for me lately." But if you are a dividend-value investor, you know that prices and values can disconnect for long periods of time, but sooner or later GE is going to not only trade at $42 per share, but it will also trade at $47.00, which is what our dividend model says it is now worth. In my judgment, GE is the most important company in the United States. They are very large and so diversified that they are a bit of a microcosm of our entire economy. If GE is upping its dividend and earnings targets for the coming year and thereafter, I believe it is unwise to be too pessimistic about future economic and profit growth for the whole country . The terrorists cannot stop our economy, the hurricanes cannot stop our economy, even the blood sport that the politicians are playing cannot stop our economy. A year ago the best clue we could have used to tell us the shape of things to come was GE's dividend hike. I think you can do the same today. The only difference is I strongly believe GE's price will catch up with its valuation over the next 12 months.
Friday, November 18, 2005
Template Change Ok, so you noticed that the template for the blog has changed. That was not an aesthetic decision that was gremlins on Google which dismembered the custom template I was using and left it unusable. Since I am not much of a techie, I, along with all the king's horses and men, could not bring the template back together again. The template I am using now is a standard version that is idiot proof. I have a cry for help into Google, but with 40 million people using the service, it might . . . be forever before I hear from them. In the meantime, I'll be orange for a while. The red template was just to hot for a conservative money manager. Client Appreciation Dinner -- Indianapolis The DCM team just returned from our client appreciation dinner in Indianapolis. It was just wonderful to see old friends and new. We had a full house and everyone was particularly interested in our presentation for the evening which was entitled: Retirement Roulette. We will be having our Evansville dinner at the end of this month. If you are a client from outside the Evansville area and would like to attend, please call Carol Stumpf at 800-321-7442. We are planning client dinners in Birmingham, Alabama and other cities where we work right after the first of the year. I am pretty sure we will continue to speak about the looming problems facing retirement. I will put the highlights of the speech I gave in Indianapolis on this blogsite in the coming weeks. Market Comment All the major indices are approaching 2005 yearly highs. The market is doing what it always does -- climbing a wall of worry. In this case, I believe it is way over due. As I discussed in a previous blog, only by using the actual inflation rate could you justify a Dow Jones of near 10,000. As PPI and CPI came out this week and showed inflation had dramatically receded, stocks have pushed much higher and are now positive for the year. I said in Indianapolis that I believe the Dow is at least 1,000 points undervalued. It will take more good news on inflation to get there, but I have little doubt that we will see a Dow Jones of near 12,000 in the next twelve months, unless something catastrophic happens.
Thursday, November 17, 2005
Northern Trust hiked its dividend 9.5% today. That was about in line with estimates, though a bit lower that our model was predicting. Northern Trust derives 75% of its earnings from fees, most of which come from wealth management. They have a unique franchise and brand in the money management business: they do business with the super wealthy. They have it down to a science because all banks know what they are doing and, yet, no other bank has been able to duplicate Northern's success. Lots of rumors are constantly circulating about a bigger bank buying NTRS, but there are at least three reasons why NTRS will likely remain independent. 1. They are growing rapidly and few other banks could offer them stock that would have the growth potential as does NTRS's stock; 2. They are not cheap; and 3. They don't want to sell out. No matter, we think they are just fine on their own. In our judgment they have the most focused, most understandable strategy of any bank in the US. When, as, and if the stock market regains its uptrend, NTRS is a huge benefactor. They have solid organic growth, and a rise in stock prices would give them an added boost. NTRS is in our Blue Chip Growth Portfolio. We rate Nothern Trust's dividend hike, neutral.
Thursday, November 10, 2005
I have been mystified all year that large cap stocks have not fared well. I know there have been headwinds: oil prices, terrorism, natural disasters, political intrigue, inflation, and interest rate hikes by the Fed. But, my work has indicated that the surprisingly good economic and earnings growth should have been able to overcome the headwinds. Corporate Earnings for the S&P 500 are likely to be near 14% above last year, almost twice what many analysts were forecasting at the beginning of the year. Dividends will likely rise 12%, well above projections; and GDP is likely to grow near 3.7%, again, well above the estimates at the beginning of the year. I cannot remember the last time such good economic and earnings news was so totally ignored. My most reliable valuation model, which looks at the historical relationships between price, dividends, and interest rates, currently points to a fair value for the Dow Jones of 11,800, over a thousand points higher than the Dow's current level. This model has been able to explain nearly 95% of the annual movements of the Dow over the last 45 years. A second tool, our dividend discount model, which computes the present value of future earnings and dividend growth, says the intrinsic value of the DJ30 is over 12,000. Both of these models are time tested and have seldom been wrong for lengthy periods of time. But they have been overly optimistic in 2005. In attempting to understand why large cap stocks have utterly ignored their excellent fundamentals, I fell back on one of my old models, the P/E model. I stumbled across this simple relationship between P/E and inflation in the early 1990s. It has not been as precise as the other two models, thus, I don't spend a lot of time with it. This model does not pay much attention to projected earnings, dividends, or interest rates. I have tested them in the model but they do not improve the model's correlation with actual price to earnings ratios. The formula uses only the Consumer Price Index and a 3% premium. Here's how it works. To find the appropriate P/E for today's market you add 3% to the current rate of inflation. The current CPI core rate of inflation is 2.3%, year over year. 3% +2.3% = 5.3% This produces an expected 5.3% earnings yield (E/P) for the today's market. To determine the predicted P/E ratio, we divide the expected earnings yield into 1. 1/5.3% = 18.7X P/E (Projected) The formula says the Dow Jones should be trading at 18.7 times trailing 12-month earnings. With last the last 12 months DJ earnings at $650, that produces a price of 12,155 for the Dow. That's great, but it does not help us understand why stocks are selling at only about 16X earnings. Then it hit me. I did all the original research on the P/E model using the actual average annual CPI, not the core CPI. The core CPI, which excludes food and energy, is the measure of inflation that is most used on Wall Street because it is less volatile;it is also the inflation indicator that the Federal Reserve watches most closely. As I was thinking about this, it occurred to me that the relentless rise in oil prices may well have tipped the scale in favor of investors using the actual CPI instead of the core CPI, because they may have come to believe that oil prices and inflation are only going higher. They may have also abandoned using the core CPI because the difference between it and the actual CPI is as wide as it has been in decades. Over the last 12 months, the actual CPI has averaged 3.4%. If we insert this figure into the data, we get the following result. 3%+3.4% = 6.4% 1/6.4% = 15.6X P/E (Projected) 15.6 X 650 = 10,140 Yikes, that is not very encouraging, yet the DJ 30 did touch 10,156 in mid-October just after the hurricane-induced spike in inflation. It was also at about that time that investors became more worried about the economy and earnings because of the possibility of rising interest rates. Thus, the terrible storm along the Gulf Coast have created a kind of perfect storm in the financial markets. The Katrina, et al, spiked oil prices and inflation and which dampened prospects for economic growth and profits. Even though I wrote here and elsewhere that oil supplies were fine and that the economy would weather the storm without great effect, apparently the stock market was not buying my argument(it seldom does in the short run). But, in recent weeks as economic and corporate growth data has shown only a modest impact from the storm, the market has shaken off much of its lethargy and begun to rise. So what do we believe, the simple, old fashion P/E model that uses actual CPI and says stocks should be having a tough year, or the P/E model that uses core CPI and says stocks should be 12%-20% higher? The world thinks the value of a stock is what it is selling for today. I do not believe that, and I can show you proof after proof that, during times of crisis, the stock market almost always goes the wrong direction at first, before recovering it senses and more accurately pricing earnings and dividend growth. With oil prices now at $57.50, well off peak their peak of $70+ per barrel, the CPI should moderate dramatically in the coming months. I predict that by the middle of 2006, the CPI will be below 3% on a average year over year basis. The reason is simple, the Fed's target for inflation is about 2%, and moderating oil prices will help them get there. For your information, I have provided below a chart showing the actual P/E vs. the level projected by my simple PE Model. I think you will agree that the model has done a surprisingly good job of capturing the trend of the actual PE. It will change again next week when new CPI data come out. I'll report here what it looks like then.
Thursday, November 03, 2005
I am on the lookout for the dividend increases of important dividend-paying companies. My belief is that in these post-hurricane times, the amount of the increase will say as much about the future as the past. Thus far, I have commented on Paychex, a payroll processing company, and Carnival Cruise Line, an entertainment company. Both blew away their dividend estimates, which is important because both companies offer a glimpse of the thinking of corporate America about the prospects for the coming year. Emerson Electric -- EMR raised their dividend 7.2%, or about three times what Value-Line was estimating. EMR is a major industrial company providing process management and industrial automation to companies worldwide. It is a clear Dividend Star, having increased its dividend for over 48 years in a row. Earnings grew 18% for the quarter, which was also above the estimates. The reason EMR's above-estimates dividend hike is important is because they are are a leading company in the capital goods sector, which has been very strong in 2005. Some people are worried that this sector will slow in the coming year due to a slowing worldwide economy, resulting from rate hikes in the US and abroad. While I believe EMR could have increased their dividend just a bit more, they do have a stated dividend policy and the 7.2% increase was within those guideline. I'm going to rate the EMR dividend increase as neutral. We'll keep a running score on dividends hikes for a few months. So far Dividend Scoreboard Number of positive surprises 2 Number of neutral increases 1 Number of negative surprises 0