Image Source: General Motors
GM’s dividend yield and valuation opportunity are incredible, while Microsoft’s free cash flow generation and solid net cash position speak to tremendous dividend strength. We liked what we saw out of Union Pacific during the first quarter, and you have to be aware of Big Oil’s bloated balance sheets. All of this and more included in this piece.
By Brian Nelson, CFA
It’s puzzling to think about, but with the first-quarter 2017 US GDP print today, April 28, coming in at just 0.7%, below expectations, one wouldn’t think the stock market is near all-time highs. Interestingly, in the report, too, the weakest area came from real consumer spending, which registered a pace of growth as poor as that of 2009, near the depths of the Financial Crisis. Yet I repeat: the stock market is sitting at all-time highs–almost as though the US economy is chugging along at a high-single-digit pace of economic growth as perhaps that of China (FXI, MCHI), for example. We still think, of course, the US economy is healthy, but we do find that the first full quarter under a Trump Presidency wasn’t as robust as many had forecast. We’re looking for first-quarter GDP numbers to be revised up meaningfully, however, as the process may arguably become more politicized.
But even still, upwardly-revised first-quarter numbers may not matter much. New investors sometimes believe that there is a one-to-one link between economic activity and the stock market; this is just not the case. Stock prices are a leading indicator of economic activity (see the Conference Board’s list below), not a coincident or lagging indicator. This concept–that reported economic activity tells us little about the direction of future stock prices–is very important for investors to understand. Most historical economic data is/should be reflected in stock prices, and the same goes for most historical stock data (it’s already in there!). It is expectations about the future that count. If only all investors knew this very important concept, they wouldn’t pay so much attention to the past, which is probably more accurately described as “rear-view mirror investing” (it is quite dangerous, much like looking at only the rear-view mirror while driving a car). I’ll never understand why investors pay so much for economically-oriented newsletters.
The ten components of The Conference Board Leading Economic Index® for the U.S. include:
Average weekly hours, manufacturing
Average weekly initial claims for unemployment insurance
Manufacturers’ new orders, consumer goods and materials
ISM® Index of New Orders
Manufacturers’ new orders, nondefense capital goods excluding aircraft orders
Building permits, new private housing units
Stock prices, 500 common stocks
Leading Credit Index™
Interest rate spread, 10-year Treasury bonds less federal funds
Average consumer expectations for business conditions
Let’s cover some more earnings. We tackled a whole host of first-quarter 2017 earnings reports thus far in our April 26 note and April 27 note, but let’s highlight a few others starting with the major US automakers. General Motors (GM), with its near-5% dividend yield and very attractive valuation, put up better-than-expected first-quarter results, released April 28. We’re still concerned about the subprime lending environment for autos, and we do believe that there may be some “plateauing” as it relates to US auto sales in 2017, but GM has its financial house in order, and mid-cycle expectations still put its valuation in very attractive territory. The company’s record first-quarter earnings thanks to strong sales of full-size trucks and crossovers in the US keep us very interested in shares. EBIT-adjusted of $3.4 billion rose nearly 28% on a year-over-year basis in the first quarter, too. We think investors may be having a hard time forgetting about GM’s problems during the Financial Crisis, but that just doesn’t make much sense. Look at the airlines, which have been in and out of bankruptcy for years, for example. Even Warren Buffett has jumped back into the commercial carriers.
It has always been difficult for us to choose between Ford (F) and GM as it relates to a newsletter portfolio holding in the auto sector (Tesla has never been a consideration), but we like GM’s dividend yield and valuation opportunity much better than Ford’s at the moment. Even though GM is included in both the Best Ideas Newsletter portfolio and Dividend Growth Newsletter portfolio, that doesn’t mean we dislike Ford or even really any other automaker, for that matter. It just means that we don’t prefer exposure to two automakers at any one time, nor do we think we need it. Ford’s first-quarter report, released April 27, was solid, too, with both the top and bottom line coming in better-than-expected. Unlike GM, however, Ford’s profits faced some pressure during the first quarter as higher costs, volume deleveraging, and negative exchange rates took a toll. We don’t think it’s much to worry about for Ford shareholders, but GM is doing much better than its Detroit brother, in our view. Importantly, however, even if GM wasn’t doing as well, its dividend and valuation may still be too hard to overlook.
Let’s have a look at a few of the oil and gas bellwethers. We still believe Exxon Mobil’s (XOM) dividend is one of the strongest in all of the land of “Oil & Gas,” and while, in the past, we’ve dabbled in Chevron’s (CVX) dividend in the Dividend Growth Newsletter and called the dividend cut at ConocoPhillips (COP), among many others, thanks to the Dividend Cushion ratio, we’re still not comfortable saying any dividend that is tied to a commodity producer is completely safe. One doesn’t have to look at how the oil and gas space had to drastically change their capital-spending profiles and take on a tremendous amount of debt to make it to the other side of the energy-price slide that defined much of late-2015/early 2016—and that was only to survive a few short months at suppressed energy-resource prices. What happens if the next time the fallout is more prolonged? Yikes. That’s why we love paying attention to free cash flow (as defined by cash flow from operations less all capital spending) and net cash (total cash less total debt). These two core items of the Dividend Cushion ratio tell us how much free cash the company generates after reinvesting in the business and what cash it holds on the books, less debt, to handle any adverse shocks to operations. The Dividend Cushion ratio is quite-the-intuitive metric, and it’s found in all of our Dividend reports. Pay attention though–there are two variants to the ratio, an adjusted one and unadjusted one.
At Exxon Mobil, we simply loved that “cash flow from operating activities ($8.9 billion) more than covered first-quart