Don't Sell these Companies on FX
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Both Procter & Gamble (NYSE: PG) and Philip Morris International (NYSE: PM) lowered their earnings forecasts, citing unfavorable foreign exchange rates caused by the strong dollar. Because both companies derive large portions of their sales overseas (PMI derives all of their sales internationally), a strong dollar hurts the companies as they make sales in foreign currencies and must then trade those currencies back into dollars. However, despite theses stocks' declines, foreign exchange risk is not a reason for long-term investors to dump companies. In fact, foreign exchange related selloffs provide good entry points if the underlying company is strong.
Markets are Smart
Selling a stock after a foreign exchange related earnings revision is a major mistake. Foreign exchange rates are not secret; neither is the list of companies that derive large portions of their sales overseas. If the dollar is strong for an extended period of time, market participants will sell or sell short companies with negative exposure. For example, Citi released a note two days before PMI’s announcement, lowering earnings estimates because of exchange rates. Since market participants do not wait until the news is announced to sell, more often than not, they use the announcement as an opportunity to buy back what they sold or cover their short. Panicked “dumb money” provide ample liquidity for "smart money" to exit.
Secondly, foreign exchange risk is a diversifiable risk. That is, if you own a diversified group of stocks, currency fluctuations should not bother you. The strong dollar may hurt multinational consumer goods names, but it should benefit the names in your portfolio with commodity exposure (stronger dollar correlates with lower oil and commodity prices). Similarly, when the dollar weakens, the multinational names in your portfolio will benefit as other names are hurt. Sure, you can attempt to game such fluctuations, but over time, all you need is a diversified portfolio to eliminate the majority of foreign exchange risk.
Look Past the FX
With both PMI and P&G getting hit on their earnings revisions, the question becomes: are the companies worth buying here? The answer for PMI is yes. PMI shows solid organic growth with revenues and earnings growing at a compound annual growth rate around 6.25% and 14% since 2008, respectively. Moreover, PMI continues to invest in new products. Most notably, the company is developing multiple products to reduce smokers’ exposure to carcinogens by heating rather than burning the tobacco in its cigarettes. Lastly, PMI is committed to returning capital to shareholders through its ever-increasing dividend and stock repurchases (recently, PMI announced plans to buy back $18 billion of shares over the next three years).
P&G is not a buy on the foreign exchange dip. P&G has grown revenues just 1.37% and earnings 4.95% on a compound annual basis since 2008. Moreover, innovation at the company appears to have slowed. P&G’s most recent major innovations were for Febreze, Dryel, and Swiffer in 1998 and Crest Whitestrips in 2001. Since 2001, the company has acquired growth (Iams, PUR, and Gillette) and sold peripheral business (prescription drugs and food). So while P&G has been a treasure for investment bankers over the last few years, its investors would hardly agree. With innovation at the company absent and demand for existing products in developed markets slowing, the company has announced a plan to cut costs by eliminating 5,700 non-manufacturing jobs. With slow growth, little innovation, and restructuring on the horizon, P&G is a company to avoid independent of foreign exchange issues.
dtlly has no positions in the stocks mentioned above. The Motley Fool owns shares of The Procter & Gamble Company. Motley Fool newsletter services recommend Philip Morris International and The Procter & Gamble Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.