The collapse of stock prices in late 2008 has been nothing short of dramatic. Although stocks had generally drifted lower since the major averages reached all-time highs in October 2007, few investors were prepared for the carnage that started after the collapse of Lehman Brothers and AIG.
The disaster only worsened after Congress passed the Paulson $700 billion bailout legislation. The S&P 500 dropped more than 20 percent in just the first eight trading days of October. Although the remainder of October saw a modest recovery, the S&P still ended almost 17 percent lower for the month.
Investors fared no better in November. The stock market celebrated no honeymoon for the newly elected President Obama. Over the 12 trading days following election day, the S&P dropped a staggering 25 percent, leaving it more than 50 percent below its October 2007 high, eclipsing its losses in the 2000-2002 bear market, and eradicating all of the index’s gains since April 1997.
Unlike the 2000-2002 bear market, this year’s carnage has not been confined to the United States. Global asset allocation, a practice popular with modern money managers, has proven to be no help in avoiding severe losses this year. Every asset class except cash and U.S. Treasuries has been badly beaten up. Let’s look at some performance numbers for 2008 through October 31:
Dividend Growth Stocks -24%
S&P 500 Stocks -33%
Global Stocks -39%
Developed International Stocks -44%
Emerging Market Stocks -53%
Commodities -41%
Global Real Estate -44%
Is the world coming to an end? Are we witnessing the collapse of global capitalism? Or are we just being rudely reminded that, despite all the sophistication and high tech resources that have been brought to bear on them, financial markets remain fundamentally human undertakings and thus subject to the foibles that appear to be hard-wired into the human brain?
Let’s look at three examples of how the market has treated stocks of very well managed companies.
United Technologies (UTX) is a diversified manufacturer producing Otis Elevators; Carrier air conditioning systems; Pratt & Whitney jet engines; Sikorsky helicopters; and various communications, fire protection and security systems. Sales outside the United States accounted for 52 percent of its revenue in 2007.
On the Friday before Thanksgiving, UTX closed at a share price of $46.67, having traded as low as $41.76 during the day. The most commonly used valuation measure for stocks is called the price-earnings ratio, or “P/E.” Various analysts estimate that UTX will earn between $4.75 and $5.50 a share in 2009. Using the most pessimistic of these estimates, $4.75, means the forward-looking P/E for UTX at a share price of $47 is about 10.
Over the past five years, UTX has traded at an average P/E of 17. The last time UTX traded at a P/E below 10 was in 2001, during the depths of the 2000-2002 bear market. Because the company has doubled its revenues and increased its earnings by two and a half times since 2001, those who invested in UTX in 2001, when it last traded at a P/E of 10, enjoyed returns of better than 12 percent annually, even at November 2008’s depressed prices.
Meanwhile, owners of UTX stock enjoyed dividends that have grown from $0.41 a share annually in 2001 to the present $1.54. On October 6, 2008, during the height of the market panic, the UTX board of directors gave us some insight into how they view the company’s prospects for the coming year by raising their annual dividend by 20 percent. At a share price of $47, UTX was yielding about 3.3 percent, more than the corresponding yield on a 10-year Treasury bond. The market was offering UTX on sale at 40 percent off.
Next, let’s look at Colgate-Palmolive (CL). Everyone knows this 200-year-old company with its familiar line of soaps and other branded household staples now sold in every corner of the world. Last year, more than three-fourths of Colgate’s sales came from overseas. Again, using the most pessimistic analyst estimate of CL’s earnings for 2009, on that same Friday before Thanksgiving, CL shares traded at a P/E below 15. Before the recent meltdown, CL hadn’t traded at a P/E below 20 this decade.
In late October, Colgate announced its revenues for the quarter ending September 30 increased 13 percent and its profits increased 22 percent over the same quarter a year earlier. Colgate pays a quarterly dividend of $0.40 a share, giving it a yield of 2.6 percent, about the same as a five-year Treasury. Colgate was on sale at one-third off.
Finally, let’s look at CH Robinson Worldwide (CHRW). This lesser-known company arranges transportation via truck, rail, ocean and air for a wide variety of shippers operating throughout North and South America, Europe and Asia. CHRW maintains a pristine balance sheet with no debt. Since 2000, CHRW’s revenues have nearly tripled and its earnings have increased fivefold.
Because of the stellar long-term growth of its business and profits, investors have accorded CHRW a premium earnings multiple, and it’s typically traded at a P/E of between 25 and 35 for the past decade. With the most pessimistic analyst earnings estimate for 2009 of $2.09, CHRW was trading at a P/E multiple of 21 in mid-November.
On November 6, at a time of extreme market pessimism, the CHRW board of directors raised the dividend by 10 percent. CHRW has raised its dividend every year since becoming a publicly traded stock in 1997. I think it’s safe to assume the CHRW board sees something other than gloom and doom going forward. Like Colgate, CHRW is also on sale at one-third off.
Only time will tell if the stocks of these and other successful companies are the extraordinary bargains they appear to be. But I don’t plan to bet against the long-term profit making potential of well-run global businesses. It appears that in the panic of 2008, many babies have been discarded with the bathwater.
