Green Shoots For Deere

We are in the camp that believes the economy will show positive numbers by the fourth quarter of this year and that the stock market has seen its bottom. With our view being what it is, what kinds of stocks are attractive to us? What sectors should do well in the scenario that we see unfolding? Let us deal with the sectors first: We believe the leading sectors over the remainder of this year will likely be small caps, consumer cyclicals, techs, financials, and industrials. Of these sectors, the surprise to many may be our inclusion of the industrials. Normally the industrials do better a little later in the business cycle. We think this time will be different and the main reason is that the developing economies of the world are still expanding. China and India both had positive growth in 2008 and will do so again in 2009. The industrials are primarily about automation and the movement and manufacturing of equipment and materials. These are all elements greatly needed in the developing world. We believe a very important stock among the industrials is Deere (DE). Deere has long been a great company, and there are numerous reasons for liking it. However, to us DE is a play on China, India, and other developing nations. Here's the reason. People by the hundreds of thousands are leaving the lands and moving to the cities to take manufacturing and service jobs in the developing world. The peasants from the countryside in China and India must now be fed by a mechanized process. Where once all of these people provided for their own food, now a supply chain of some magnitude is needed to feed them. At the front of that supply chain is the agricultural equipment that produces the food. Today's tractors and other farm equipment are automated and computerized at a level that is simply remarkable. My brother-in-law farms thousands of acres in Southern Indiana. He recently told me that he no longer drives his own tractors. His John Deere GPS drives the field rows and he makes the turns. He says that the yields from his corn crop have risen by 10% just from the precise line the GPS-driven tractor takes. There is less human error and greater efficiency. The chart above shows DE has made a very sharp correction from the ethanol-induced euphoria of 2007. Deere has fallen deep into undervalued territory. While the analysts are estimating lower earnings for both 2009 and 2010 for DE, we believe they are being too pessimistic. If the US economy turns positive later in 2009 and Europe turns up by mid 2010, Deere's earnings should turn higher much sooner than the analysts are now forecasting. With the stock very undervalued and better news on the rebound, we like Deere at these levels. We own Deere. This blog is for information purposes only. Please do not make investment decisions based on this blog.

Dividends Are Still the Linchpin

With all of the dividend cuts of the last 18 months, many pundits are sounding the death knell for the dividend. There are lots of reasons they give:

1. Companies can't afford them anymore
2. They complicate capital adequacy and flexibility
3. The capital they represent is too hard to raise
4. Obama tax hike will make them less attractive to investors

The arguments that dividends are a relic of the past or a fatality of the credit crunch are silly. The recession we are crawling through will not last forever, and when it ends, companies will once again reinstate most of the dividend cuts as soon as they are able.

The reason is simple: almost all of the companies that have cut their dividends by any significant amount have faced a hornet's nest of angry shareholders. In addition, it is hard to find a company whose price is higher after a dividend cut. Indeed, in most cases, if a company has cut its dividend, it has been hammered.

According to Bloomberg data, dividends are very much alive. Bloomberg shows that of the 500 stocks in the S&P Index, 362 currently pay a dividend. During the past twelve months, 94 companies reduced their dividends, 115 paid the same amount as last year, and 130 raised their dividends. Thus, in a year when the headlines have been full of dividend cuts, there were actually more dividend hikes than cuts.

The median dividend hike for the 130 companies that raised their dividends during the year was about 6%. Importantly, the median total return of these companies outperformed the S&P Index by nearly 8%.

There are still many great companies that are quietly raising their dividends and in doing so, reconfirming their commitment to give back to their "owners" a fair cut of the profits.

As I have said before, the root of the word dividend is dividere, which means to cut or divide. Dividends are not a bonus or a gift; dividends are the shareholders' cut of the profits. Corporate managers who ignore this may find themselves looking for a new job.

The linchpin that best ties the interests of corporate America together with its shareholders is a consistent and intelligent dividend policy. Most shareholders understand that recessions mean lower earnings and dividends. But, in my judgement, the pundits are wrong if they assume that shareholders will be less interested in dividends after the recession than they were before. I think it will be just the opposite.

Stocks: Climbing a Wall of Worry

With first quarter earnings for the S&P 500 now expected to be down nearly 34%, it is a fair question to ask why the stock market has been so excited recently? There are many answers but the simplest one is that when the first quarter earnings season began, earnings were expected to be down nearly 39%. It appears that the market has translated the 5% better-than-expected earnings growth into a 13% move in stock prices. At first that may not add up. How does a 5% earnings surprise translate into a 13% price hike? Actually, the nominal difference between negative 39% and 34% is 5%, but on a percentage basis, it is 12.8% (5/39). So stocks have rallied by about the amount of their better-than-expected earnings. That would almost seem to be too perfect. Surely there have been other factors driving stocks higher in recent weeks? There has been some isolated good news in real estate, durable goods, and more recently in a slowing of initial unemployment claims, but I believe the main driver of the recent market rally is the better-than-expected earnings for the first quarter. The market apparently now believes that first quarter 2009 earnings are as bad on a year-over-year basis as we are likely to see. According to Bloomberg, for companies in the S&P 500 that have reported thus far, there have been 236 positive surprises and 111 negative surprises. That may sound impressive until you realize that positive surprises usually outnumber negative surprises by about this margin. I believe the earnings data point that is driving the recent surge in stock prices is the higher than normal average surprise of 12%. Importantly, the financials have produced an average positive surprise of 36%. Almost all of the big banks have reported earnings that were better than expected. These results have been cussed and discussed, but in this very tough environment when the accountants are tougher than waterfront cops, the banks appear to be doing better than most people expected. That, my friends, is cause for a modest rally in stocks. Now many of you will say that there is still lots of bad news coming for the banks and that this quarter's earnings were a case of financial engineering. In addition, the stress test results will be released later this week, which could cause all of the positive momentum for the banks to evaporate. I believe the markets have discounted these issues. The recent sharp rally in bank stocks is clearly signalling that the need for additional capital resulting from the stress tests is expected to be manageable and won't result in widespread nationalization of the banks, as was feared only a few months ago. We have been saying for the last couple of months that the market was bottoming. There are many who are saying the rally can't last. We continue to believe that this rally is for real. It won't continue straight up, but we believe it will continue to climb a wall of worry.

Johnson and Johnson Raises Dividend 6.5%

In recent days, almost everyone was expecting a dividend hike announcement from Johnson and Johnson (JNJ). Predicting an increase wasn't a tough call. JNJ had raised their dividend for 44 years in a row. What was a tough call was the amount of the hike. On April 23, they announced a 6.5% dividend increase. In these days of dividend cuts, I applaud JNJ's hike, but I thought it was a bit light. The estimates ranged from 6% to 9.5%. The consensus was in the 8% range. With earnings over the last twelve months having risen nearly 9.5%, I was hoping for an increase between 8% and 9.5%, say 8.5%. Thus, the increase of 6.5% was at first a bit disappointing. To find reasons why the hike was less than expected is not a tough task. The current administration seems bent on sticking their noses and fingers deeper and deeper into America's economic system. With the administration's talk of big changes to our current health-care reimbursement programs, JNJ may be signaling a new, less optimistic view of their long-term prospects. That notion is also born out by Wall Street analysts' 3-5 year forward earning estimates for JNJ, which are now at 8%. In these days of weak earnings reports, 8% long-term growth sounds exceptional, but in JNJ's case that is far lower than their last 5-year earnings growth rate of 11.5%. Indeed, current estimates project that 2009's earnings will be about flat with 2008. As I think about it, however, I believe JNJ is just being pragmatic. I think they are building in a cushion that will enable them to hike their dividend again in 2009 when earnings growth may be meager. I just can't be too pessimistic about a company that has done as many things right over the last 20 years as has JNJ. Furthermore, is it not remarkable that JNJ is currently selling at about 11 times trailing 12-month earnings. That is about half their 20-year average of 22x. Combine this low PE with a dividend yield of almost 4% and you have one of those old fashioned "value" stocks. Funny, I always thought JNJ was a growth stock. These metrics, however, would suggest that it is now being priced like a value stock. That seems odd especially when we consider it has a strong consumer brand (33% of sales) that is not encumbered by health-care pricing issues. In these days, it is very easy to beat up on any stock, but I have a very strong feeling that investors are underestimating JNJ's broad product line and worldwide clout. We own the stock. Please do not use this information for investment purposes. Please consult your own investment adviser.

Procter and Gamble -- Dividends Talk

Procter and Gamble announced late Tuesday that they were hiking their dividend by 10%. This increase was nearly twice what many analysts were estimating and offers important clues about PG's view of the current economy. Here's the reason: Dividends have been under attack over the last year as a result of the weak economy, but also because of many companies' need to conserve capital. For these reasons and others, the notion has developed that even companies with plenty of free cash flow like PG would use this opportunity to set their dividend growth rates on a lower track. PG's 10% dividend hike blows that idea away. Indeed, it is a message that I believe will be corroborated by many more companies. Companies that are committed to a dividend aren't going to change their ways very much. They will only do so if it is a matter of sound business practices or survival. PG could have raised their dividend by anything between 5% and 7% and most people would have been happy. In my judgment, by hiking the dividend 10%, PG is making a statement about their view of the unfolding economic landscape. In short, they believe the world hasn't changed as much as the headlines might suggest. They must believe their worldwide business is still on a double digit growth track, and that people won't abandon brand name products for cheaper private label offerings. Dividends are the most tangible link between a company and its long-term shareholders. We are going through a very difficult time in some industries, but wise companies will think twice before tampering too much with this link to their most patient and dedicated owners. Thank you Procter and Gamble for showing us your stuff.

We own the stock. This blog is for information purposes only. Please consult your own investment advisor.

Is This The Bottom? Part III

I think it is; I think it is. Maybe if I say it twice it will make it so. On March 20, I asked the "bottom" question for the first time. My reasons for asking were mainly technical in nature, although I said I believed the enormous under girding of the banking system by the Fed and other governmental agencies was starting to have an effect. I asked the "bottom" question again on March 26. This time I explained that my reasons for leaning to the affirmative were not only based on the technical action of stocks, but most importantly on the fundamentals. The last two weeks of March saw four economic releases for February housing data that were all better-than-expected. Good grief surely housing could not be turning, especially when home prices were still falling and defaults were still on the rise. But yes, new housing permits, new home sales, exiting home sales and pending home sales all turned higher in February and beat estimates by between 6% and 22%. I think yesterday's Wells Fargo pre-announcement of better-than-expected earnings validates the February housing data. It was clear from Wells Fargo's earnings pre-announcent that a big increase in mortgage originations was driving their good results. Now for some additional good news. I'm hearing anecdotal reports from realtors that I know around the country that March real estate readings in many of the most troubled areas of the country, such as Florida, California, and Arizona are turning up. In almost all cases the year over sales are up substantially, and the inventory of homes is shrinking. Home prices in all areas are still falling, but unit sales are increasing and walk-through business is growing rapidly. I have said many times before that real estate got us into this mess, and improvements in real estate will need to get us out. Increases in unit sales are good news for real estate and the economy, but we need for real estate prices to stabilize. That would seem to be many months off. However, the Fed's purchases of long-term Treasury bonds and mortgage backed securities has driven down 30-year mortgage rates to about 4.75%. That is proving to be a boon to refinancings as well as new buyers. My brother in Indianapolis says he has a number of buyers who are ready to buy, but they cannot sell their houses. That may not sound like good news, but it is. Just a few month ago, he said things were completely dead. The fall in mortgage rates is definitely putting more people in the market, and I'm hoping that one of them is interested in one of my brother's clients' homes, so a fortuitous chain reaction can begin. My sister-in-law in Arizona, says she has had more activity in the last few weeks than she has seen in months. It may seem early to call a bottom in the economy with only one month's data and a few anecdotes. Indeed, the good news may later be seen as false hope, but when you combine good data and anecdotes with the fact that stocks have staged a bona fide technical rally, the turn around appears to be sprouting legs.

Is This The Bottom? Part ll

Last week with the stock market having turned modestly higher, I asked if this turn could hold when so many other recent upturns have failed. I concluded that my answer was yes; not because the chart of the Dow Jones Industrial Average looked good, but because of the massive under girding of the economy by the various government programs that would shore up the banking industry, unfreeze consumer lending, and stimulate spending. I should have added something that I have been saying for months: the law of supply and demand. Sometimes I think the US media are the most economically illiterate people in the world. They simply have no idea of the power of the free market and the law of supply and demand. The free market (of course with proper regulation) is simply a marvel at setting price where the merchandise will sell. As we are all too familiar, the US has been in an incredible housing recession over the last two years, which has caused prices to fall by 25% and more in certain areas. Countless news media reports I have read have been saying that there was no end in sight. Prices and housing unit sales could only go lower. They were partly right. Prices are going lower, at least for a little while, but housing on a unit sales basis has had some very good news in recent days, and I believe it is one of the big reasons that the stock market has risen nearly 600 points since last Friday. Last week new building permits and housing starts were surprisingly strong, and this week new and existing home sales were much higher than expected. Home prices, indeed, have fallen and will continue to do so until excess inventory is worked off, but unit sales of homes appears to be turning up in many parts of the country. Importantly, if unit home sales have bottomed and are turning up, they will ultimately take home prices . . . and stock prices with them. I do not want to discount the good durable goods orders data this week, or the new program announced by Treasury Secretary Geithner to rid the banks of toxic loans. The latter particularly is vital to the health of the banks. Having said this, housing on a unit basis appears to be bottoming, and housing is the key to a sustained rally in stocks. The simple reason is this: housing got us into this mess, and I believe housing will have to get us out. As I write this, the market is pushing 8000 on the Dow. I would be a very surprised person if the recent upturn races right through 8000 and keeps going. If you look at the chart above, you will see that 8000 was an important level of support from October through November. There are plenty of sellers waiting at the 8000 level to sell out and get their money back. Thus, I would predict some back and forth sideways motion for a few weeks as we digest recent data and evaluate new housing statistics for a corroboration of the recent good news. If this is the bottom in housing unit sales, it has come the old fashion way: by prices falling to a point where the buyers were waiting, and the same goes for stocks. A bottom in housing unit sales would be welcomed news, but for a full turn around to begin in the economy, we need home prices to at least flatten out. That has not happened yet, so the stock market will remain on edge. But this was a very good week for stocks and lends credence to the notion that we have seen the bottom.