The dollar’s value is rising, so stocks of U.S. multinational companies are going down.
Logical? On the surface, it would seem so. If the dollar’s weakness has been a boon for multinationals’ earnings, then it should follow that a stronger dollar would hurt them.
But the 5% to 10% declines in shares of many well-known multinationals in recent weeks may be grossly exaggerating the near-term effects of the dollar’s sudden strength on corporate earnings.
And longer-term, even a sustained rebound in the dollar--if slow and steady--may not be negative enough to outweigh the positive impact of multinational companies’ foreign sales growth, especially in fast-growing developing nations.
Unquestionably, the dollar’s slide against key currencies since 1985 has helped U.S. companies operating abroad. For example, as foreign currencies gain in value, corporate earnings generated in those currencies translate into more dollars when brought home.
At the same time, U.S. exports priced in dollars become cheaper abroad as the dollar withers.
Measured against a basket of 10 major currencies weighted for their importance to U.S. trade, the dollar has lost 42% of its value since 1984, according to the Federal Reserve Board.
But most of that loss of value occurred before 1990. In fact, since then the Fed’s dollar index has actually risen 3.1%--yet U.S. multinational companies’ earnings have exploded anyway in the ‘90s.
Coca-Cola Co., which last year derived 67% of sales and 80% of operating income from abroad, is a case in point.
In 1990, major foreign currencies appreciated more than 12% against the dollar, a seeming bonus for U.S. multinationals. That same year, Coke’s per-share operating earnings rose a healthy 18.6%.
In 1991, however, the dollar strengthened slightly, and for the year the Fed’s basket of foreign currencies lost about 3% against the dollar. Nonetheless, Coke’s operating earnings again rose 18.6%.
In 1992 and 1993 major foreign currencies lost even more ground against the dollar, on the order of 6% a year. But Coke’s operating earnings still grew 18.2% and 17.5%, respectively.
How did Coke produce such steady earnings growth in the face of a gyrating dollar? For one, it’s important to remember that the dollar doesn’t move uniformly against every currency. In any given period, the dollar’s value may be up in some countries and down in others.
So for a giant such as Coke--now operating in 195 nations--currency fluctuations may net out against each other, producing little final effect.
At the same time, many multinational companies use hedges, such as foreign currency option contracts, to reduce their risk of significant losses (or gains, for that matter) because of currency fluctuations. The hedges basically provide an insurance policy.
Finally, currency values can shift dramatically in the space of a few weeks, as global traders pile onto rallies in the hope of making a short-term killing. But that doesn’t necessarily mean that a change in a currency’s direction is sustainable, or sustainable at the same pace.
Thus, whereas traders care a lot about short-term moves in the dollar, corporations generally care much less, because most obviously don’t do international business on the spur of the moment.
“Companies can’t run their businesses based on week-to-week changes in currency values,” notes Parker Hall, president of Chicago-based Lincoln Capital Management, a large investor in multinational growth stocks.
Indeed, it’s important to look at the dollar’s latest rally with some perspective. Although the Fed’s dollar index is up 5.3% since July 1, it still is down 4.1% measured from the end of 1994. So on balance, this is still looking like a favorable year for U.S. multinationals in terms of currency changes.
Even so, it’s true that when the dollar’s trend is up, it is more likely to translate into bad earnings surprises for U.S. multinationals, just as when the trend is down, it is more likely to mean good surprises.
And because the United States, Germany and Japan have been working in concert to pull the dollar back up in recent weeks--through surprisingly well-coordinated dollar-buying by central banks--there is a growing assumption that the greenback’s turn is sustainable.
That is why Wall Street is pushing many multinational stocks lower: Anticipating that the dollar may continue to advance for a while, some money managers figure that the psychology toward the stocks can only get worse in the short term, even if the currency fluctuations have little real effect on earnings at most firms.
Ron Ognar, manager of the Strong Total Return stock fund in Milwaukee, says he has recently trimmed his holdings of Coke, McDonald’s and PepsiCo in part because of the dollar’s rebound.
One of the technical problems such multinational stocks face in times such as this is that they can be used by traders as proxies for the dollar, Ognar says. If a U.S. speculator wants to sell dollar-based assets in favor of yen-based assets--to take advantage of a rally in Japanese stocks, for example--it’s easy to unload such highly liquid stocks as Coke and McDonald’s.
The big blue-chip stocks also are under pressure as some money managers switch into shares of smaller firms, which are viewed as far less dependent on foreign sales and thus relatively invulnerable to currency movements. “A stronger dollar raises the profile of domestic companies,” says A. Morris Williams Jr., co-manager of the MAS Value stock fund in West Conshohocken, Pa.
Not surprisingly, key small-stock indexes hit record highs last week even as multinational issues slumped. While the Russell 2,000 index of small stocks closed at a record 304.30 on Friday, the blue-chip Dow Jones industrial average--at 4,617.60 on Friday--is down 2.5% from its record high.
Yet some Wall Streeters point out that the dollar-fueled rush into smaller stocks is somewhat naive. Many smaller firms, especially in the red-hot technology area, have significant foreign sales. And many that don’t are trying hard to export their products.
Ron Doyle, manager of the Woodward Opportunity stock fund in Detroit, says that of his portfolio of small stocks, “Almost to a company [they tell us] that foreign business is an area of focus going forward.”
Nonetheless, few small companies derive half or more of their sales from overseas business, as many multinationals do. And given that trends in markets are hard to brake once they get some momentum, continued strength in the dollar may mean that the small-stock rally will continue for many months, while blue chips continue to weaken or simply stagnate.
But the cheaper the multinational stocks get, the more appealing many of them ought to become to long-term investors.
The greatest attraction of multinational companies is that they are already established around the planet and thus are supplying products to economies that are growing much faster than the mature U.S. economy. In the long run, minor currency shifts matter far less to the bottom line than the boost a company gets by selling a lot more abroad.
Kevin Parke, co-manager of MFS Funds’ Massachusetts Investors growth-and-income stock fund in Boston, says he has used the dollar’s rebound as opportunity to look more closely at the strength of his multinational companies’ franchises abroad. He especially likes what he sees in the European businesses of Gillette and Johnson & Johnson, Parke says, and in Colgate-Palmolive’s extensive Third World sales.
Investors also should remember that one potential benefit of a stronger dollar could be to re-energize the economies of Japan and Germany by making their exporters more competitive with U.S. exporters. That may crimp some U.S. companies’ earnings growth, but at the same time it could benefit a wide array of American businesses if it contributes to faster global economic growth overall.
As for Coca-Cola, a spokesman in Atlanta said the company’s response to questions about currency fluctuations is simply that “we don’t expect the recent strength in the dollar to have a significant impact on our earnings.”
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Does the Dollar Matter?
The recently rising dollar is supposedly bad news for U.S. multinational companies. But Coca-Cola, which derives 80% of its operating income from overseas operations, has posted remarkably consistent earnings growth since 1988 despite a fluctuating dollar.
Change in Coke’s income from continuing operations, per share
Change in value of key foreign currencies compared to the dollar
Note: Coke’s results are before adjustments for changes in accounting principles. Currency change is measured using Federal Reserve Board’s weighted dollar index.
Sources: Coca-Cola co., Federal Reserve Board
Blue Chips Under Pressure
Here are some major U.S. multinationals, the percentage of their sales derived from overseas operations in 1994, and how the stocks have fared in the recent blue-chip selloff compared with the Standard & Poor’s 500 stock index. *--*
Pct. of sales 1995 Fri. Decline Stock from overseas high-low close from high Colgate-Palmolive 68% $77.38-$58.00 $66.75 -13.7% Eastman Kodak 53% 64.50-47.13 57.75 -10.5% Caterpillar 49% 75.25-48.25 67.75 -10.0% Gillette 70% 46.13-35.38 41.63 -9.8% Procter & Gamble 53% 74.25-60.63 67.13 -9.6% Kellogg 41% 73.88-52.50 67.75 -8.3% AMP 58% 46.25-35.00 42.75 -7.6% Boeing 54% 68.13-44.38 63.25 -7.2% McDonald’s 43% 39.63-28.63 36.88 -6.9% Coca-Cola 67% 67.13-48.25 63.00 -6.2% Johnson & Johnson 49% 71.75-53.63 67.38 -6.1% S&P; 500 index NA 565-457 559.21 -1.1%
NA: not available
Source: Value Line Investment Survey, Times research