Dividends Talk -- Northern Trust

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.

Stock Market Models--Which One to Believe?

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.

Dividends Talk -- Emerson Electric

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

Economy Watch -- What's Right with This Picture?

There was big news on Friday. News that was a shock to us all. News that changes paradigms, mind sets, and bottom lines. News that assaults our notion of "what's going on 'round here." This news had nothing to do with Scooter Libby or the bloodsport that politics has become. This news was so good, that I could find almost no mention of it in the Sunday version of the New York Times, and it generated only a brief mention in my local paper. This "good news" that the media chose to ignore was that in spite of the hurricanes, the US economy grew at an inflation-adjusted rate of 3.8% for the third quarter. Remarkably, this was a higher rate of growth than the previous quarter's 3.3%. Pardon me, but I thought Katrina et al, were sending us into certain recession. Isn't that what the "Main Stream Media" told us; isn't that what the headlines in your local paper said? There is something else the MSM is not reporting: strong corporate profit growth of nearly 13% vs. a year ago. The odd thing about this is one of the few industries that is in a recession is the media business. Newspaper circulation is plummeting, network television viewership is collapsing, and movie theatre box office receipts are trending lower. Maybe that is the reason the media in this country are so disconnected from reality in their reporting, they are depressed from observing their own fate. This is the opposite of the orchestra playing waltzes as the Titanic sank. The MSM are like the choir singing dirges on Easter morning. Stay tuned, I'll keep you informed about the true state of the economy and profits. There are lots of economic releases coming. We expect some softening, but, as we said in our recent quarterly letter, the downtick will be followed by a big uptick as the rebuilding of the damaged areas reaches full speed.

Dividend Talk - Carnival Cruise Lines

I have been watching recent dividend increases from large corporations for clues they might offer about the company's projections for the year to come. In some respects, we are flying blind with regards to the real strength of the economy and corporate profits because of the disruptions of recent storms. I took a very positive read from Paychex's 23% hike a few weeks ago, because of its implications for employment. Today I take another positive read from Carnival Cruise Lines. This week CCL hiked its dividend 25%. Our dividend discount model was estimating a 13% hike and Value-Line was estimating a 7% increase. Let me see here, let me count the ways that CCL is in the eye of the storm. 1. Many of their main bases of operation are along the coast of the United States; 2. They consume huge quantities of petroleum; 3. They do not sell an essential service, and their customers have to travel long distances to reach them; and 4. They have a terrorist threat because cruise ships are a known target. This does not sound like a recipe for surprisingly good news, but their 25% hike is just that. Again in my judgment, as in the case of Paychex, a 12%-13% hike would have been fine with investors and Wall Street. So, why a 25% dividend hike, unless it says something about next year's business? They know they are in the eye of the storm. They know the aforementioned four points. They go to bed with them every night and wake up with them every morning. I believe the answer to that question is obvious: Come heck or high water they think their business is going to be better in spite of the obstacles than does Wall Street, and in my judgment they are putting their money out to prove it. This kind of dividend talk is priceless, because it is tangible, comes from the source, and, finally, because most people ignore it. We do not own CCL in any of our styles of management, but as a result of this dividend action, we are studying it very closely. We'll comment later on our final decision, but either way, as a signal, CCL's hike is valuable.

I'm for Ben

Today Ben Bernanke was announced as the successor to Federal Reserve Chairman Alan Greenspan and the Dow Jones jumped 170 points. Wall Street is voting with their dollars and it is clear they like the new man. This morning before the announcement, I was asked by a friend about the strong rumors that Bernanke was going to get the job. I said that ever since he was appointed Chairman of the Council of Economic Advisors, he was considered the front-runner for the job, but I was surprised that he was apparently getting it, and I thought it might take awhile to get used to him. He was a virtual unknown among investment people even 4 years ago. He had built a strong reputation in academic circles while at Princeton University for his study of the Great Depression and the Fed's role in it. My friend said what is your gut feel of the guy? I said three things come to mind immediately. He is said to be utterly brilliant, he is a strong believer in encouraging the private sector to grow the economy instead of the government, and he is a bit of an unusual duck. I'm guessing the stock market's uptick today was its approval that his positions are considered to be along the lines of Alan Greenspan's. He is considered by many as a supply side proponent, meaning he favors low taxes on income and capital gains. His brilliance was on display when he began talking about the possibility of deflation in 2002 and 2003. It is dangerous stuff to talk about deflation because the word in many economists' minds has a direct link to the depression. When he was not shouted down by the economic elite of this country, it was clear that, even though I did not know who he was, the power-elite did. I remember I had the clear impression that his statements were so bold that he would not be saying them if they did not have the blessing of Alan Greenspan. When I looked into who Ben Bernanke was, I found a somewhat unusual man for the job of operating in the public light. He wore a beard and did not like to wear suits. He wore cowboy boots and rode a motorcycle. I remember the Wall Street Journal commenting that if he were to become Fed Chairman things would be a whole lot different during Fed reports on capitol hill. Whereas Mr. Greenspan would humor every question and drone on for indeterminable minutes on the esoterics of economics, Ben did not suffer fools well, and his speaking style was short and . . . short. Today's Wall Street Journal had a funny piece about President Bush noticing that Ben had on light socks with his dark suit at a formal occasion and suggesting to him that black socks might be more appropriate. At the next Council of Economic Advisors Ben arrived early and passed out light socks to all the members, who were then wearing them when the president arrived. Ben Bernanke is a character, but he is no fool, and he possesses one of the great minds of our time on economic theory and how to apply it in the real world. I have been a fan of Alan Greenspan's since the beginning. I remember that rumors appeared soon after he was appointed Fed Chairman that outgoing chairman Paul Volker did not think he was tough enough to handle the politics of the job. I'm glad Mr. Volker was wrong. The same questions will, no doubt, be asked of Ben Bernanke. Time will tell, but most guys I know who ride motorcycles are not all that easy to push around. If white socks can give the market a boost, count me in, Ben.

Thank You Brian Wesbury

Brian Wesbury is the Chief Economist at Claymore Securities in Chicago. He is a frequent contributor to the Wall Street Journal and other publications. I think you could describe him as a supply side economist. I have followed him for years and find that he offers a very fresh voice in a world too full of the weary dronings of the prophets of gloom and doom. His most recent weekly investment letter is so right on that I am sharing it in its entirety. Risk-Phobia and Faith Throughout history, adventure and risk-taking have led to great progress and wealth. Early explorers risked their lives sailing rickety ships, negotiating mountain passes and experimenting with new medical procedures. Of all countries, the United States has most embraced this model of progress. The results have been nothing short of miraculous. In the past 200 years, the number of people living in freedom, and not tyranny, has grown exponentially. US life expectancy has doubled over the past 100 years, while others have seen life expectancy grow more. While relative poverty is still with us, in most industrialized nations the lowest incomes still afford a lifestyle better than royalty had in the past. Technology allows us to see storms before they make landfall. Helicopters rescue terrified citizens from rooftops afterward. Computer-based risk management systems allow companies to find workers after a calamity, re-open businesses faster than ever before and move essential supplies to people who need them. While we will never conquer calamity, all of this saves lives and reduces risk. Despite four major hurricanes in 2004 and two monsters in 2005, the US economy continues to grow as it absorbs the damage. On the other hand, attempts to use government to reduce risk have not succeeded. The levees in New Orleans did not work as they should and intelligence systems failed at detecting the plots of 9/11. At the same time, Sarbanes-Oxley did not stop the CEO of Refco from doing immense damage to the firm he was supposed to shepherd. This does not mean we should not work at improving government. But nothing will quell the sinful nature of man or stop the immense forces of nature. These things, we will always have to live with. This brings us to the seemingly limitless fear of recent months. Volatility indices have climbed sharply, equity prices have fallen, new tropical weather systems boost oil prices, and fears of bird flu generate hundreds of thousands of words of warning in national news sources. We have no way of knowing whether or not these fears will come to fruition, we do know that history is a story of overcoming such events. We also know that these fears are most often overstated. Despite these facts, many people continue to look toward government for some reassurance that it can stop bad things from happening. They are succumbing to riskphobia and lack faith that a flexible and free market economy is an efficient shock-absorber. Looking back at the past few years should give pause to excess fear. The US economy remains robust. Jobs, incomes and profits continue to climb. Keeping faith, while others doubt, leads to progress and wealth. Brian Wesbury