Fool's Eye View

[ March 8, 2000 ]

Ahh...tishoo!! How P&G Gave the Market a Cold

By Alan Oscroft (TMFAlan)

Liverpool -- Isn't it strange the way that if one company sneezes, an entire stock market can catch a cold? It is most illogical and simply an emotional response, but it happened yesterday in the USA. Sitting back and pondering such reactions to news sometimes makes me wonder how our species ever made it out of the trees in the first place.

The American company that sneezed yesterday was consumer products giant Procter & Gamble (NYSE: PG), and the stock market that scurried off on search of hankies and aspirin was the New York Stock Exchange. In fact, the sneeze was so hard that a few virus particles wafted all the way across the Atlantic and got up the nose of the London Stock Exchange too.

But what was the nature of the sneeze? After several years of reasonable increases in earnings per share (though based on slower growth in revenues), Procter & Gamble yesterday issued a surprise profits warning, and a mad panic ensued. The share price fell over 30% to $60, and the Dow Jones Industrial Average followed suit, falling 374.47 points on the day to end on 9796.03.

"But what's unreasonable about that?" you might ask. It might be fair enough for the P&G share price to fall so far, after the announcement that third quarter earnings are expected to fall by around 10%, with earnings per share for the full year to June 2000 expected to grow by 7% rather than the previously forecast 13%. In fact, a trailing price to earnings ratio (P/E) of 23, after yesterday's fall, might be a perfectly reasonable multiple for a large consumer products group, whose earnings growth is expected to be in single digits, to be trading on, mightn't it?

And it's a big company, with a market capitalisation of $76 billion, so a fall in its valuation should be expected to cause a fall in the Dow, shouldn't it?

If it was just the fall in the P&G share price that hit the Dow, then the reaction might have been rational. But for some reason, investors seemed to think that because P&G's management is struggling to grow its sales revenues without it having a detrimental effect on the bottom line earnings per share figure, then the whole world must be about to cut down on its consumption of ice-cream, soap, breakfast cereals, and all the other thousands of other consumer products that P&G and its worldwide rivals manufacture.

At least, that's what it looks like, because rival consumer companies saw their share prices fall too. The shares of Colgate Palmolive (NYSE: CL), for example have fallen by nearly 15% since the P&G announcement. Similarly, Kimberly-Clark (NYSE: KMB) shares are about 7.5% down. Both companies, by the way, were quick to rush out statements denying that they are having any problems themselves, and stating that their earnings for this year are still on track.

So why did so many investors dump shares in two perfectly reasonable companies, when they had no evidence at all that either is in trouble? It couldn't be because some of them are basing their investment decisions around that millennia-old bugbear of the hairless ape, irrational fear, could it? Methinks it could.

And over in good old Blighty, even long-suffering Unilever (LSE: ULVR) has taken a 15% fall too.

And this all makes me think back to the good old Efficient Markets Theory, as taught by academics everywhere, and adhered to by a surprisingly large number of investors today (well, it surprises me, anyway). The Efficient Markets Theory claims that all information about all companies in a stock market is so rapidly distributed that no individual can gain access to it quicker than the rest. In such circumstances, claim the theory's proponents, everyone will digest the information at the same time and reach the same conclusion about its implications. Thus it is impossible to ever get ahead of the market.

The big flaw in this theory, though, is that it assumes that everyone will draw the same conclusions from the same information, as it becomes available. Every one of us can work out, from our own personal experiences, that that is not the case. We all know someone who believes fervently that the share prices of Internet companies will only ever go up, don't we? And we can also think of someone who is convinced it will all collapse in a messy heap tomorrow too, can we not?

But putting anecdotal evidence aside, the only way a theory that requires everyone to make the same deductions from the same evidence can stand up is if every one of those deductions is made rationally, not emotionally.

And we can see from the Procter & Gamble fallout that not everyone behaves rationally when valuing company shares. In fact, investors have behaved irrationally to the tune of 15% falls in a couple of cases here.

Got any good reasons why the world's consumers might be about turn their backs on, erm, consumer products? Or any other reasons to explain this consumer company contamination? Let's hear them on the Fool's Eye View discussion board then, please.

Related Links
• Fool's Eye View discussion board
• The Qualiport on Unilever's predictable earnings