Dividend Aristocrats Performance With One Week Remaining In The Year

Standard & Poor's Dividend Aristocrats are maintaining a large performance edge over the Dow Jones Industrial Average Index, the S&P 500 Index and the Nasdaq Index. With a little over one week remaining in 2008, the Aristocrats' market cap weighted return on a year to date basis is -24.2% versus the S&P 500 Index return of -39.5%. Detail on the specific Aristocrat companies is noted in the below spreadsheet.

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Dogs Of The Dow Are Dogs This Year

One strategy that has gained a fairly good following over the years is investing in the Dogs of the Dow. This strategy consists of investing in the highest yielding stocks in the Dow Jones Industrial Average at the beginning of each year. At the end of the year an investor would invest in the then current Dow Dogs for the subsequent year. The performance of the Dow Dogs has underperformed the Dow Jones Industrial Average so far this year.

The below table lists the Dow stocks that were a part of the Dow Jones Index at the beginning of 2008. The table does contain the performance of the Dow before the three member changes this year and the performance with the three Dow changes. In both cases, the Dow Dogs are underperforming the Dow Index itself.

(click to enlarge)


Source: Dogs of the Dow

As an investor, yield alone does not ensure a stock's outperformance.

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High ROE Danger

I have written a couple of articles in the past on on the benefits of reviewing a company's ROE or return on equity. One of the benefits of this measure is the resulting ROE calculation provides an investor with insight into managements use of capital. In general, higher ROE's point to better managed companies.

One danger looking solely at ROE is the ability of leverage (debt) to overstate ROE. In 2006, Bear Stearns' ROE was over 19% and this was an increase over the prior years ROE of 16%. What occurs is any debt taken on by a company reduces the equity figure. Since the ROE calculation is essentially net income divided by equity, a higher ROE would result for a company that uses debt versus equity to finance its operations. An example:

If you buy a house for $100,000 and borrow $50,000 to buy it, you have 50 percent debt and 50 percent equity in the home. Say the home is worth $110,000 a year later (this really is a hypothetical situation, isn’t it?). Your ROE is 20 percent: the $10,000 gain is divided by $50,000 in equity.

Now let’s say instead that you borrowed $75,000 to buy the home. The ROE would be 40 percent: $10,000 divided by $25,000 in equity. You’ve taken on more debt, but the results look more impressive.

Additionally, interest on debt (as compared to dividends) receives favorable tax treatment as well. The interest is deducted from a company's income before determining the level of taxes owed. On the other hand, dividends are paid out of net income and a company does not receive a tax deduction for the dividends that are paid. A company can enhance its ROE by using debt so long as the cost of the borrowing is less than the company's ROE.

Another way to calculate ROE is to use the DuPont Model. The DuPont Model formula is:

ROE = Net Profit Margin x Total Asset Turnover x Financial Leverage

• Net Profit Margin = Net Income/Net Sales

• Total Asset Turnover = Net Sales/Total Assets

• Financial Leverage = Total Assets/Total Equity
  

The DuPont formula enables one to see more directly what is driving the increase in ROE.

As an investor analyzes a company and its ROE, it is important to know what is influencing the ratio. A high ROE in and of itself does not necessarily imply a strong management team or ongoing viability of the company.

Source: Checking for Bloated ROE ($)
BetterInvesting Magazine
By: Michael Maiello
January 2009
http://www.betterinvesting.org/Public/Store/Store/Membership/default.htm

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A Look At The Consumer

I deviate from a discussion on strictly dividend/dividend growth stock investments in order to take a look at the largest contributor to GDP growth in the U.S.--the consumer. The consumer accounts for nearly 70% of GDP and so goes the consumer so goes the U.S. economy. A reason for investors to keep tabs on consumer economic data is the data can provide a clue as to a potential turnaround in economic growth.

As the below chart notes, U.S. GDP has grown to over $14 trillion. At the same time, consumer debt has grown to over $14 trillion as well. The average level of consumer debt going back to 1953 is only 53%. The issue here is consumer debt has fueled a large part of the economic growth in the U.S. Since early 2007 though, consumer debt has begun to decline as a percentage of GDP.

(click to enlarge)

Consumers certainly need to live more within their means. However, with consumers finding more difficulty accessing the credit markets and continuing to reduce debt, what does this mean for the economy when it comes out of the recession?

Another economic variable investors can track to gain some perspective on the consumer is the Personal Consumption Index (PCE).

(click to enlarge)

Source: New York Times

The PCE measures the average price change for all domestic personal consumption. Updated data on the PCE Index can be found at the St. Louis Federal Reserve Bank economic data site.

So if consumer spending is potentially constrained in the next economic recovery cycle, it will be important for investors to invest in those firms that demonstrate they have the ability to grow earnings in the future. Evaluating the dividend practices of companies is one way to gain insight into a company's prospective earnings potential.

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Dividend Aristocrats With Dividend Cut

For the most part the Dividend Aristocrats have performed well on a relative basis versus the S&P 500 Index and the Dow Jones Industrial Average. Year to date through November 21, 008, the Aristocrats return equals -29.5% versus -39.3% for the Dow and -45.5% for the S&P 500. From a dividend perspective all the dividend cuts for the Aristocrats have been those companies in the financial sector. Detail on the recent dividend actions for the Aristocrats is contained in the below spreadsheet.

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Source: Standard & Poor's-Issues Indicated Dividend Rate Change

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Don't Overreach For Dividend Yield

The recent decline in equity prices and near record low interest rates, have enticed stock investors to focus on higher yielding dividend paying stocks. One must keep in mind though, a stock's dividend yield is not the same as comparing yields on certificates of deposit.

"After all, if one invests primarily for current income, it might seem logical that stocks with the highest yields would be best. The popularity of the “Dogs of the Dow” approach would seem to support that assumption. However, the Dow Dogs approach is designed to beat major averages through price appreciation; the high yield under that approach is merely an indicator of possible undervaluation."

The stocks that trade at higher yields tend to be the ones that are at the highest risk of a dividend cut. Ideally, stocks with lower yields and the ones that grow the dividend on a regular basis tend to be the type of stock that outperforms the market over the long run.

This year's performance of the high dividend yield approach of the Dogs of the Dow strategy offers some evidence that a high yield approach does not always mean higher total return. The year to date return for the Dow Dogs equals -41.8% versus the return on the Dow Jones Index of -35.9%.

The dividend-discount model is based on the assumption that dividends ultimately drive share price. If a firm doubles its dividend over a certain time, its stock price should also double if interest rates do not change.

Thus, the percentage rate of dividend growth drives and equals the expected rate of increase in share price. From that equivalence, we can derive this formula for expected percentage total return:

Expected Total Return =
Expected Dividend Growth Rate +
Current Dividend Yield

One event that is occurring with companies and the overall economy is the process of deleveraging. In this environment investors should likely look to invest in those firms that have lower debt levels. The risk of only investing in low debt level firms is when the market/economy improves, leverage can actually enhance a company's earnings, resulting in better performance in a somewhat leveraged company. For those interested, this leverage factor enhances ROE through the equity multiplier as detailed in the Dupont Model.

A few financial measures useful for dividend oriented investors to review are:

• Common shareholder’s equity as a percentage of total capital
• Short-term debt as a percentage of total debt (or of total capital)
• Dividend payout ratio
• Dividend growth rate
• Frequency of dividend increases
  
• Price-to-book-value ratio

There is no perfect model to use when evaluating dividend paying firms. However, watching the trend in the above factors, like payout ratio, frequency of dividend increase, etc., can provide clues into when a company might be anticipating earnings weakness in the future. Don't simply get trapped buying the highest yielding stocks, then suffer through a dividend cut. Company's that cut their dividend tend to see a contraction in the company's stock price.

Source:

Equity Income Investing: Beware of Yield Overreaching ($)
AAII Journal
By: Donald Cassidy
May 1999
http://www.aaii.com/includes/DisplayArticle.cfm?Article_Id=822

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Newsletter Recommendations Fall Short Of The Market

Investors obtain investment information from a variety of sources. One source is the advice disseminated from investment newsletters. Mark Hulbert of the Hulbert Financial Digest, tracks the performance of newsletter recommendations. His analysis indicates most newsletter recommendations tend to underperform the market.

The American Association of Individual Investors recently wrote about Hulbert's findings for the period ending June 30, 2008. The analysis covers the 17 newsletters that have been in existence since 1980. A snapshot of the table is detailed below or one can review the full screen here.

• The table shows that just four newsletters (24%) were able to beat the overall stock market on a risk-adjusted basis, where the market is measured by the DJ Wilshire 5000 total-return index.

• This percentage shrinks slightly—to 21%—if we take into account the 12 services that the HFD was tracking in 1980, but which are no longer tracked, two of which were ahead of the DJ Wilshire 5000 index when they dropped off the HFD’s monitored list.

• As low as this market-beating percentage is, it is higher now than it was before the bear market began in 2000. For example, as of June 30, 2000, the point at which the HFD had exactly two decades’ worth of performance data for this group of newsletters, the percentage ahead of the DJ Wilshire 5000 on a risk-adjusted basis was just 8%.

• The reason this market-beating percentage has grown from 8% to 21% is not that the newsletter editors have become better advisers. Instead, the reason has to do with the 2000–2002 bear market, and the associated tendency of advisers to have an easier time beating the market when it is declining compared to when it is rising.

Hulbert concludes that newsletters and advisers (mutual funds) have a difficult time beating the market over long time periods. In the end he recommends indexing. The recent protracted and steep bear market would be a good reason not to simply index. Following a dividend growth type investment strategy would have significantly outperformed an index investment. One key to individual stock investing is to follow a discipline that places the emotional aspect of decision making on the sidelines.

Source:

Long-Term Newsletter Performance: It’s Not Easy to Beat the Market
American Association of Individual Investors
By: Mark Hulbert
2008
http://www.aaii.com/includes/DisplayArticle.cfm?Article_Id=3525&digit=599


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Look Forward Not Back When Formulating Investment Decisions

There is no argument that this is a bear market. During times like this, investors do have a tendency to shape their investment expectations based on historical events. Given the magnitude of the market's decline, it may seem comfortable to remain on the investment sidelines. Historically though, large market advances have occurred in the periods following bear markets.

As the below table outlines, the magnitude of this bear market puts the decline as one of the five worst--declining 43%. However, returns one year following the market trough have averaged 46% over the last 13 bear markets.

(click for larger image)

• Every bear market is different, and the beginning of a new bull market is only known with the benefit of hindsight.

• However, bear markets have inevitably given way to market rebounds.

Source:

Bear Necessities: Down Markets Often Breed Opportunity ($)
Market Analysis, Research & Education
A unit of Fidelity Management & Research Company
October 21, 2008
http://personal.fidelity.com/products/publications/

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Attractive Stock Valuations Being Created In This Bear Market

The market decline this year has been anything but short of amazing. So far in the month of October the market is down 24.72% and down 39.24% year to date through October 24th. It seems as though investors (or maybe forced hedge fund selling) are selling anything that is a stock. Undoubtedly, the economy is going through a significant deleveraging process. However, in this environment, it appears a number of stocks are trading at levels suggesting they are going out of business. Following is a list of some stocks that are trading at single digit P/Es.

Not all of the stocks on the list pay a dividend. Additionally, before purchasing any of the stocks, an investor should evaluate the sustainability of the projected earnings. It is possible that the "E" (earnings) in the P/E ratio is overly optimistic; hence, a downward earnings revision would mean a higher P/E for the company's stock.

(click table for larger image)

Stocks mentioned:

Allegheny Technologies (ATI)
Anglo American (AAUK)
Best Buy (BBY)
Carpenter Technology (CRS)
Cnooc (CEO)
Jacobs Engineering Group (JEC)
Orient-Express Hotels (OEH)
Prudential Plc (PUK)
Rio Tinto (RTP)
Titanium Metals (TIE)
Transocean (RIG)
United States Steel (X)

Source:

Bargain Hunting ($)
Outlook Newsletter-Standard & Poor's
By: Beth Piskora, Managing Editor
October 29, 2008
http://www.outlook.standardandpoors.com/NASApp/NetAdvantage/servlet/login?url=/NASApp/NetAdvantage/index.do


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What Is The VIX Index

One market indicator that has been getting a lot of attention lately is the VIX Index (VIX). The VIX has been in the news lately since the Index has been hitting all time high levels, reaching over 81 on Thursday. The importance of the VIX has to do with the fact it is a measure of investor fear looking forward over the subsequent 30 day period.

(click chart for larger image)

According to the CBOE,

since the VIX Index introduction in 1993, VIX has been considered by many to be the world’s premier barometer of investor sentiment and market volatility. The VIX Index is an implied volatility index that measures the market’s expectation of 30-day S&P 500® volatility implicit in the prices of near-term S&P 500 options. VIX is quoted in percentage points, just like the standard deviation of a rate of return.

Additionally, one of the most interesting features of VIX, and the reason it has been called the “investor fear gauge,” is that, historically, VIX hits its highest levels during times of financial turmoil and investor fear. As markets recover and investor fear subsides, VIX levels tend to drop. This effect can be seen in the below chart in the VIX behavior isolated during the Long Term Capital Management and Russian Debt Crises in 1998.

(click chart for larger image)

An important historical aspect of the VIX is it tends to reach high levels at market bottoms. Could the current high level be signaling a market turning point looking forward. Last week's 4.7% market advance is certainly a start.

Source:

VIX (pdf)
CBOE Volatility Index White Paper
http://www.cboe.com/micro/vix/vixwhite.pdf

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Wow! What A Week It Was

After this past week, many investors are asking themselves what to do now or what is in store going forward. As a follow up to my post last week on evaluating management using ROE, this post will touch on an additional management evaluation tool. Before I do that though, these are extraordinary investment times and many an investor are unsure of what to do next. Many factors will go into that ultimate decision, but I believe Warren Buffett said it best a few weeks ago:

"You know, five years from now, ten years from now, we'll look back on this period and we'll see that you could have made some extraordinary (stock market) buys. That doesn't mean it won't get more extraordinary a week or a month from now. I have no idea what the stock market is going to do next month or six months from now. I do know that the American economy, over a period of time, will do very well, and people who own a piece of it will do well."

A key aspect to the success of a company and its stock price is the strength of the company's management. In fact, if this one element is missing, no matter how good a company or its competitive advantage, the lack of strong management can lead to poor company results.

In addition to evaluating the company's ROE, investors should review the company's shareholder letter that accompanies the firm's annual report. The American Association of Individual Investors recently wrote an article on elements to look for in the letter. The article notes:

The one window into a CEO's perspective and goals is the shareholder letter contained in the annual report. But upon reading one, you might find that you can't understand what the CEO is trying to say. Often, shareholder letters are riddled with jargon and glossy prose that convey no information. Six of the most popular CEO letter clichés:

• Talented people,
• Global presence,
• Market knowledge,
• Financial strength,
• Leverage competitive advantages, and
• Create significant value for our shareholders.

The article indicates investors should read the shareholder letter and circle in red the cliché phrases outlined above. If one sees more red than black, be forewarned. Once the company passes this test, there are seven criteria an investor should score. The AAII article contains more detail on each criteria, but a summary is listed below:

1. CEO Voice—Personal and Authentic: When you finish reading the shareholder letter, do you feel like you had a meeting with the CEO? Do you feel as if the CEO is talking to you?... A CEO's attitude toward shareholders can reveal how he or she runs the business—for long-term profits or short-term gain. You need to read between the lines of the letter to try to figure out what kind of "relationship" a CEO is looking for.

2. Practicing the Financial Golden Rule: Is the CEO giving you information that he would expect to receive if he were the investor?
3. Detailed and Jargon-Free Information: Is the CEO explaining complex topics in simple terms without "dumbing" down this information? Is the letter free of clichés and technical jargon?...

   The best letters provide business details in simple, but never simple-minded, language. And they explain how these investment opportunities will produce profits.
   

4. Consistent and Realistic Information: Has the CEO provided historically consistent information, especially with regard to the company's earnings? Is the CEO explaining the company's goals and how the company intends to meet its goals?...

   A CEO who wants to show that he or she is trying to be accountable to investors and other stakeholders is going to tell you about their corporate goals. Financial goals reveal the financial targets that CEOs want their companies to achieve; operating goals reveal the CEO's aspirations to improve the way the work gets done.
   

5. A Proper Accounting of Earnings: Does the CEO letter reveal an understanding of the difference between the company's cash and accounting earnings? Can you find statements of earnings in the shareholder letter and easily locate this same number on the firm's income statement in the annual report?

   Even when CEOs do report company earnings, it's often hard to figure out what they mean. You can blame part of this problem on accounting.

   Earnings can be reported at different "layers." Many CEOs choose to report their earnings in shareholder letters several layers up, typically at a level that lets them show their company's earnings in the best possible light. This is not illegal. But when companies offer these customized pro forma earnings, you'll want to examine the underlying assumptions the company is using to calculate them.

   To judge management's accounting integrity in the shareholder letter, look for:

   • Clarity in reporting the nature of non-routine write-offs that affect company earnings; and
   • Consistency in the presentation of earnings over time.
6. Balanced Strategic Sense: Does the CEO include a balanced picture of the execution of the company's strategy and its results? Are you learning about the year's business failures as well as the successes?...
   

   The topic that is most frequently cited in a shareholder letter is "corporate strategy." This should be no surprise—when we learn about a company's plans to make money from tangible assets, like plants and equipment, and intangible assets, such as patents, brand recognition and new technology—we get to the heart and soul of financial analysis.

   Many companies describe the corporate strategy as a list of action steps they intend to take. But such a list only tells you what a CEO plans to do. They don't show how these steps are being acted out in real-life situations....
   

7. CEO Values: Is the CEO describing his or her values and are these related to specific events in the company? Do you gain more understanding about how the CEO and his or her company practice these values in relation to their corporate stakeholders: employees, customers, investors, suppliers and others?

A key investor takeaway from reading the letter is whether or not you feel comfortable entrusting your investment dollars to a company's particular management. So when you receive an annual report, read the shareholder letter first.

Source:

Shareholder Letter Revelations: Can You Trust the Leadership?
American Association of Individual Investors
AAII Journal
2008
http://www.aaii.com/includes/DisplayArticle.cfm?Article_Id=2310&digit=524

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Evaluating Management Using ROE

Few factors are more critical in determining the potential success of a company than the quality of a firm's management. During economic and financial times like these, a quality management team can make the difference between success and failure. Certainly a company's dividend practice provides insight into management's anticipated view of future business prospects. Another variable that provides a clue to a company's anticipated prospects is return on equity (ROE) trends.

Return on equity provides information on how well management has invested the capital supplied by its shareholders. ROE is calculated by dividend earnings per share by book value per share than multiplying by 100 to convert to a percentage. In a recent article in BetterInvesting Magazine, it is noted adjustments may need to be made to equity to get an accurate measure of book value.

A company’s book value is determined by subtracting long- and short-term debt from the company’s total assets. It represents what a shareholder would get if the company and its assets were sold at cost. A note of caution about book values: If you’re dealing with a company that has most of its assets related to intellectual property or brands, the figure might be more art than science. The book value of drug patents, factory equipment and vehicle fleets are easily quantified. The book value of a brand isn’t so firm (though it would be foolish to say that brands such as Coca-Cola and McDonald’s don’t have value).

When companies use debt to finance growth, the debt level can inflate the ROE number due to the equity number in the denominator being smaller. Consequently, for firms that carry high debt levels, the resulting higher ROE may not be an effective gauge of management effectiveness. When evaluating the ROE, the return figure should be evaluated on a trend basis as well as compared with its peers.

In general, a higher ROE means the company is generating capital with its existing assets. This ability to generate capital internally means the company is less likely to issue more equity (dilutive) or take on more debt. The additional capital that is generated can then be used for business expansion, stock buybacks and/or dividend increases.

Source:

Measuring Management by Return on Equity ($)
BetterInvesting
By: Michael Maiello
September 2007
http://www.betterinvesting.org/Public/default

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Dividend Aristocrats Continue To Perform Well In Volatile Market

One thing is certain, Standard & Poor's Dividend Aristocrats are holding their own in this difficult market environment. Year to date through September 27, 2008, the Aristocrat's total return equals -4.9% versus the S&P 500 Index return of -17.4%. The below spreadsheet details specific information for each Aristocrat. The entire Aristocrat 9.27.2008 spreadsheet is available at this link.

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Should You Stick With Stocks

This will be a somewhat shorter post as we have been without electricity since last Sunday. However, given the volatility seen in the market this week, many investors are wondering what to do with their stock investments. Warren Buffet's thoughts regarding the market can be summed up in one of his famous quotations:

"I will tell you how to become rich. … Be fearful when others are greedy. Be greedy when others are fearful."-- Warren Buffett

Along these same lines, in a recent interview by Jeremy Siegel, he notes:

As some say, it's too late to sell. One thing that I think is also important is again, this is a bear market, but not a huge one. You know we had a 50% bear market from March of 2000 up to October of 2002. This is 20% to 25%. Some people think that it is getting worse and I don't. Listen, it's part of the 200-year history of the U.S. Stock Market. And, if you go back 200 years, has it been right to sell in the bear markets? The answer is no. You take the pain, you hold your position, and you will be rewarded in the future. (emphasis added)

The entire interview, Rough Going for Now, but Stocks Still a Good Bet, is a worthwhile read during this volatile market period.


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Stock And Economic Data Sites Across The Web

Committing dollars to a particular stock is often the last decision made by an investor. The first steps often include a review of company financial data and a review of economic data. There are a number of resources across the internet available to investors to assist in this evaluation. Following are some sites that may be of interest to investors as the work through the review process.

Economic Data

• Federal Reserve Bank of St. Louis-FRED Database
• Federal Reserve Bank
• Federal Reserve Bank of San Francisco. The site has a Fed Webring enabling an investor to search all Federal Reserve databases.
• Bureau of Economic Analysis
• Economy.com. Free registration required.

Stock Data

• Guaging Corporate Financial Results
• Sector Data from Standard & Poor's.
• AOL Money & Finance
• MSN Money
• Reuters
• Zacks
• REIT.com
• REITcafe

International Stock Data

• ADR.com
• BNY Mellon
• Euroland
• CIAWorld Factbook.This publication provides data on foreign countries.

Portfolio Tracking

• Portfolio management tools and tax lot accounting at GainsKeeper.

I was introduced to some of the above sites in the recent issue of AAII Journal from the American Association of Individual Investors. The September issue of the magazine contains a much more comprehensive listing of investment websites for those that have an interest.

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Dividend Investment Possibilities

The September issue of Argus Research's Argus Update newsletter provides a list of stocks the firm titles as Dialing for Dividends. The screen is based on the following criteria:

• A market value of at least $1 billion

• A dividend yield of at least 3%, but less than 6%

• A dividend payout ratio of less than 50%

• Dividend growth of at least 8% per year over five years

• A forward P/E of less than 15

(click on table for larger image)

As is always the case, the list is only a starting point for investors. If any of the stocks on the list are being considered for inclusion in ones portfolio, additional research should be performed.

Source:

Dialing for Dividends: Stocks for Income & Safety ($)
Argus Update
September 2008
http://www.argusresearch.com/

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Test Your Investment Strategies First

For some investors using a dividend growth investment approach to select equity investments may represent a new type of stock selection process. It is important for investors to test their investment strategies by constructing phantom stock portfolios before investing real dollars based on these new strategies.
A free website is available, Stocks Quest, where one can test investment strategies. The site is essentially set up like a stock market game. The only requirement for a user is he/she must register with an email address. Once a user is registered, the site provides an investor with $100,000 in fantasy cash. The user can then implement buy and sell transactions and track the performance of their phantom portfolio.

Using a site like Stock Quest site is a good way for an investor to determine how effective their investment strategy performs.

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Dividend Aristocrats Outperform S&P 500 Index Year To Date

It is expected that in downward trending markets that S&P's Dividend Aristocrats would perform well relative to the S&P 500 Index. In fact, on a year to date basis through August 22, 2008, the Aristocrats are outperforming the major domestic indexes.

As noted in the table below, the Dividend Aristocrats have generated a year to date market cap weighted return of -4.3% versus the S&P 500 return of -12.0%. One short term risk for the Aristocrats is they tend to lag markets that move higher quickly. The Aristocrats are underperforming the Nasdaq Index over the past four weeks.

The table below contains some detail on the Aristocrats. The full Aristocrats spreadsheet can be viewed by clicking this Aristocrats link.

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Media And The Market Often Disconnected

I recently read an article by Dick Davis of the famed Dick Davis Digest titled, The Stock Market and the Media: Turn It on, But Tune It Out, that essentially highlights the fact the news media tends to be out of sync with future market action. Dick Davis is also the author of The Dick Davis Dividend. My take on his media article is the news media tends to focus on short term news information that sometimes tends to impact a stock's price. However, the long run direction of a stock's price is going to be impacted by long term trends impacting a company's business.

Dick Davis makes the point that:

Part of the problem is that, while some news does involve sharp and sudden stock reactions (only when it involves surprise), most of the never-ending flood of daily news is routine, insignificant and meaningless in terms of durable impact. It is important to PR firms, journalists, TV reporters and traders because it gives them a means of making a living. But to the long-term investor, it is little more than filler and noise.

...The truth is that, except in cases of obvious causality (when the news triggers an immediate and decisive reaction), we never know for sure why the market or a stock does what it does. Since a stock is bought and sold by thousands of individuals every day, it’s reasonable to assume there is more than one reason causing its behavior. In fact, there can be a myriad of reasons, some knowable, others not knowable. Buy and sell decisions are often motivated by a host of non-news-related, silent triggers that are rarely cited by the media.

The article notes six points that should be alluded to in news reports trying to explain the gyrations in the market:

1. The stock market itself is the all-powerful final arbiter. The day, hour, or minute it feels the rubber band has been stretched too far, it’ll do something about it, not before.

2. Human emotions, responding to the markets’ gyrations and triggered by fear and greed, likely play a key role.

3. Worries over a wide range of overlapping factors, both fundamental and technical, may or may not be additional influences. (Future market historians may well cite long-standing housing and credit worries as major factors in shaping the market’s trend. The significance of their role on the particular day of July 26, however, is unknowable.)

4. A market that acts randomly and irrationally cannot be explained logically.

5. Except in cases of surprise, most news is irrelevant in explaining the market’s action on a particular day. The stock market leads; the news follows.

6. The answer to the question, “Why today?,” is: “I don’t know—nor does anyone else.” The markets are complex and perverse. They defy definitive answers.

As an investor then, remember the news media is most often reporting on events that are of a short term consequence and have occurred in the past. Certainly this is not the case with all news reports, but I do believe it is the case with most. An example of this might be the cover article I read on oil that appeared in a BusinessWeek magazine a few months ago. The word "Oil" took up a large portion of the cover. Well, the bubble in oil seems to be popping.

Source:

The Stock Market and the Media: Turn It on, But Tune It Out
The American Association of Individual Investors
By: Dick Davis
2008
http://www.aaii.com/includes/DisplayArticle.cfm?Article_Id=3516&digit=103

This article was written by Disciplined Approach to Investing. You can email questions or comments to me by clicking here.

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The Dollar, Oil and Equity Prices

Many critical factors are having dramatic moves of late that could impact the future direction of stock prices. In this article I will address factors an investor should consider as a result of declining oil prices and a strengthening dollar. Last week I did post an article on my blog dealing with the potential currency impact for international investments titled, Be Aware Of Currency Impact With International Investments. Below I will look at factors that will impact U.S. firms.

The price of a barrel of oil reached nearly $150 in early July. Fast forward to today and the barrel price of oil is around $115. This represents a 23% decline in per barrel oil prices in just one month. From my perspective, one does not see price moves of this magnitude unless speculative investing was a part of the recent rise in oil prices. With respect to the dollar, a peak in dollar weakness seemed to be reached in early July when one Euro was equal to 1.59 U.S. Dollars. Over the course of the last month the Dollar has experienced significant strengthening closing at 1.50 dollars per Euro on Friday. Why does all of this matter?

As one evaluates the attractiveness of potential investments, attempting to understand the impact macroeconomic factors such as changes in commodity (oil) prices and currency are important. Unfortunately, the outcomes are not black and white.

As the below chart details, oil and the S&P 500 Index seemed to be highly correlated from early 2007 through August of 2007. However, from late 2007 through July 2008, oil and the S&P 500 Index seemed to have a high negative correlation.

(click on chart for larger image)

Is it possible that oil was at such an extreme over valuation that its negative impact to company input cost caught some firms unprepared. If so, the reduced level of oil and related energy inputs could have a strong positive impact to future earnings growth. This would be a positive for multinational firms that could be facing a headwind due to increasing strength in the U.S. Dollar.

As noted earlier, the dollar has strengthened against the Euro over the course of the past month. As the below chart portrays, a weak dollar (upward sloping red line) and a rising S&P 500 Index seem to go hand in hand. What could be partially at play here is the fact companies in the S&P 500 Index generate a large portion of their earnings (over 40%) from international sources and this has been growing. A weak dollar provides a positive earnings boost to U.S. companies as they convert foreign earnings back into the U.S. Dollar.

(click on chart for larger image)

If a weak dollar is good for U.S. stocks, then the recent U.S. Dollar strength will likely serve as a headwind for U.S. multinational firms. The offset though, and I think this could be a stronger influence, is the reduction in oil and other commodity costs. Reduced commodity inflation will benefit company earnings via reduced cost of sales. Also, lower commodity prices will take the pressure off of inflation and stimulate more positive consumer sentiment.

Undoubtedly, there are many more factors that will impact stock prices, interest rates, the real estate market, etc.; however, getting a handle on the oil and currency impact to company earnings will go a long way in accurately forecasting future earnings growth. Keep in mind though, some companies have aggressive currency and oil hedges in place in an attempt to mitigate the volatility these price swings have on corporate financial results. Reading company 10-Qs and 10-Ks will provide more insight into some of these factors.

Source:

The Dollar-Euro Exchange Rate and U.S. Stocks
CXO Advisory Group
October 17, 2007
http://www.cxoadvisory.com/blog/internal/blog10-17-07/

This article was written by Disciplined Approach to Investing. You can email questions or comments to me by clicking here.

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