Since 2009,
stock prices are up well over 100%. The stock market has moved higher for
a variety of reasons - including an economy that has improved dramatically from
the Great Recession and continued stimulus from the Federal Reserve to keep
interest rates low (read our post on the economy and interest rates here).
The primary
driver for growing prices has been improving fundamental values.
Long-term stock market appreciation cannot exist without increasing dividends
and earnings. As we have said many times, dividends
have shown to be highly correlated with stock prices over the long-term.
Since dividends are real cash paid out to shareholders, they ultimately
must be backed by actual corporate earnings.
With the U.S.
economy expected to continue its sub-optimal growth in the face of continuing
political and fiscal headwinds, some are questioning whether or not businesses
will continue to be able to increase profits the way they have over the past
several years. Without much economic growth in the United States, how can
there be sustainable long-term earnings and dividend growth?
Earnings and
dividends growth for the stock market as a whole have historically been
correlated with GDP growth. Over the past decade, we have seen a
disconnect between U.S. earnings growth and GDP.
The chart
above shows real earnings growth (inflation taken out) for the S&P 500
compared to real GDP for the past 30 years. Between 1983 and 2000,
earnings and GDP tracked together closely. Real GDP growth for the period
was 3.8% compared to 4.3% earnings growth. During the past 10 years,
however, earnings growth (3.8%) has been more than twice as high as GDP growth
(1.6%).
Earnings have
outpaced U.S. GDP growth for a couple of reasons. (1) Companies have
become very efficient. Those who survived the 2008-09 recession have
become leaner and more productive than ever before. (2) As the U.S.
economy has slowed, corporations have looked for new markets to do business in.
They have found those markets in Europe, Asia and the Far East.
According to S&P research, nearly 48% of the total sales by S&P 500
companies in 2013 have come outside of the United States. That's up from
under 42% just 10 years ago. Lower labor costs and other expenses have
made it even more attractive from a profitability standpoint.
Very large,
multinational companies have expanded their overseas businesses at even faster
rates than in the United States. The Coca-Cola Company (KO) has become an
increasingly global company, which has been very profitable. Nearly 80%
of total operating income for the world’s largest soft-drink manufacturer now
comes from countries outside the U.S. Procter & Gamble (PG) generates
nearly the same amount of revenues from Western Europe and Asia as they do from
the United States. In total, over 60% of PG’s 2013 revenues come from
non-U.S. markets – up from less than 45% in 2002. Johnson & Johnson
(JNJ), another multinational giant, has grown revenues from $36.30B in 2002 to
$67.22B in 2012. Over 75% of that revenue growth came from outside the
U.S.
As the value
of the dollar has dropped over the past several years, the competitiveness of
products produced by U.S. companies has gone up. Companies are more
exposed now than ever before to international markets. Even with sluggish
growth continuing in the U.S., very large, multinational companies can continue
to produce earnings growth for many years to come.
While we
expect companies to grow earnings much faster than the U.S. economy seems to
suggest, we expect dividend growth to be even better. Payout ratios
(dividends / earnings) are near historic lows. With investors placing
more value on the dividend, we expect companies will increase their payout
ratio to more normal levels. As dividends continue to grow, investors are
increasingly turning to dividend-paying companies growing income in an
environment where there is very little opportunity in the fixed income market.
Disclaimer: Donaldson Capital Management
employees and clients own shares of KO, PG and JNJ.
