Readiness is All
Slow growth continues. This is a generally favorable environment for stock investors as it discourages the booms and busts that accompany apparent but unsustainable growth surges. Recent examples were the dot.com frenzy of 2000 and the popping of the housing price bubble in 2007-2008. The ensuing financial crisis left persisting scars as many homeowners had fallen to the siren calls of mortgage brokers offering bags of cash for refinancing and zero down payments for homebuyers.
Bursting the dot.com bubble rattled financial markets but they snapped back in good order. Few investors had “bet their houses” on high-flying tech stocks but tumbling home prices in the housing bubble wiped out financial reserves of many borrowers. These reverses probably contribute to the laggard pace of new home sales despite remarkably low interest rates.
The Federal Reserve and other central banks have been calling the tunes by policies that add liquidity to troubled economies. Mario Draghi led the European Central Bank into stepped up bond buying last fall. European stocks then gained 30%, hardly a coincidence. Japan began aggressive easing (“Abenomics”) in 2012 and Japanese stocks more than doubled.
In contrast, the Federal Reserve is poised to raise rates as soon as data convinces it that the economy can handle higher rates. Anticipation of its moves strengthened the dollar, weakening U.S. exports and contributing to the meager advances in our stock markets this year. The consensus is that the Fed will finally act this fall.
Chairwoman Yellen recently canceled she would skip the August conference in Jackson Hole, where Chairman Bernanke used to tip future Fed moves in his keynote speech. She thus keeps flexibility to move on data with the first key figure the August employment report due September 4.
Rather than join in the speculation about the date when the Fed will move, it is better to prepare for it. As Prince Hamlet said, “We defy augury . . . If it be not now, yet it will come-the readiness is all.” (Act V, Scene ii)
The successful strategy is to choose and maintain a portfolio of solidly financed companies with management that has demonstrated an ability to grow the company and reasoned prospects for further growth. Apple (AAPL-$131) comes to mind and it is not necessary to cling to flabby old favorites like IBM, GM or AT&T.
In last week’s column, I added Irvine-based Broadcom (BRCM-$55) as a new buy. Its earnings went through a soft spot but its base of advanced semiconductor products gave promise for future growth. Another portfolio member, Avago Technologies (AVGO-$140), added as a new buy on April 24, concurred and agreed to buy Broadcom for $37 billion, the largest deal ever in the chip industry.
Avago is offering Broadcom shareholders $17 billion cash and $20 billion of its stock. Broadcom stock popped up ten dollars on the news and has settled back, now trading around the initial value now of $54.50. Broadcom shareholders can choose either $54.50 cash or about 0.44 shares of Avago, subject to proration. Broadcom stock buys now thus offer an attractive merger arbitrage spread, however, the transaction will take several months to close, a period when nimble buyers should consider Broadcom on any dips to below $52.
Emphasis on larger growing companies has kept our portfolios ahead of the general market so far this year. Earnings growth pushes up stock prices as P/E ratios increase in response to investor enthusiasm. Avago, for example, trades at a current P/E of 80, however, analyst estimates look for around $8.45 for its fiscal year ending in October. That’s a P/E on forward earnings of 17, quite reasonable if it can continue its recent growth. Adding Broadcom is projected to provide $750 million in reduced costs to the combined company.
Increasing stock prices always bring articles warning of excessive valuations, often using comparisons of P/E ratios. (Stock price/Earnings) Investors often spend too much time fussing over their stock prices, neglecting to keep tabs on their prospects for increasing earnings. Looking back to periods before the 2000 and 2007-2008 market plunges, the P/E ratios may have been high but lost their relevance when the earnings collapsed. It’s earnings that keep stocks on course.
Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1995. [email protected] 949.494.1376/800.697.2622
