High quality US shares deserve a closer look.
Like the UK, the US markets had its own "lost decade" in the Noughties, with the S&P 500 index producing a negative ten-year return for the first time since tracking began in 1927. So could US blue chips be the answer for global investors this coming decade?
As it turns out, maybe so.
In his third-quarter letter, and again in his fourth-quarter letter to investors, GMO Capital's Jeremy Grantham made a case for quality US stocks. In fact, in the more recent letter, he predicts that over the next seven years, "US high quality" stocks will post 6.8% annualised real returns -- two full percentage points over emerging markets.
How is this possible?
One thing favouring S&P 500 firms is they collectively hold $2,180 billion (£1,450 billion) in cash, the highest level in at least nine years. Granted, at least some this cash is to hedge against another economic downturn, but it also puts a number of large American firms in a position to make strategic acquisitions and fund expansion opportunities.
For example, Apple is sitting on a massive $25 billion (£16 billion) cash pile, which CEO Steve Jobs recently told investors he plans to use for opportunistic investments down the road.
The second advantage for American blue chips is that many of them do significant business overseas. While the median S&P firm derives just 25% of its sales overseas, a recent study by Goldman Sachs found the 50 companies with the highest levels of foreign sales outperformed the market nearly two-to-one in 2009.
The shares in this basket include Pfizer, Coca-Cola, and Merck, and as a group generate a median 68% of their sales abroad. If the US dollar weakens further and emerging markets continue to grow rapidly, strong performance from these multinationals will likely continue.
Most importantly, valuations of select US blue chips remain attractive, despite the rally over the past year. To illustrate, Ned Davis Research found that over the past thirty years, the S&P 500's average price-to-book value was 2.41; today it sits at 2.14 (11% lower).
The index average dividend yield of 1.9% may be less than desired, but it's also coming off the worst two year stretch for dividend cuts in generations. The good news is US companies are raising their payouts once again -- Standard & Poors expects 5% dividend growth in 2010 and estimates it will return to pre-crash levels by 2012 or 2013.
Let's name some names
All three of these factors make US blue chips in general worth a closer look, but I want to single out a number of shares that would likely pass Grantham's "high quality" test.
My criteria are:
1. S&P 500 shares only, with
2. Dividend yields over 2%,
3. Return on equity over 15%
4. Long term debt-to-equity ratio below 50%, and
5. At least 50% of sales outside the US.
Here are three of the results:
| Company | Dividend
yield | Return
on equity | Long term
debt-to-equity
ratio | Non-US
sales |
|---|
| Procter & Gamble | 2.8% | 17.6% | 33% | 60% |
| Coca-Cola | 3.3% | 30.1% | 20% | 73% |
| 3M | 2.6% | 28.2% | 41% | 63% |
*All in U.S. dollar terms. Data provided by Capital IQ, a division of Standard & Poors, as of 2 March 2010.
These are all fine companies with solid balance sheets, globally recognised brands, and long histories of increasing dividend payouts. In short, they're worth your time to research.
What this means for UK Fools
It's important to remember that you don't need to invest in emerging market companies to benefit from growth in those economies -- many multinational firms, like Diageo (LSE: DGE), Unilever (LSE: ULVR), and British American Tobacco (LSE: BATS) in the UK and the US firms mentioned above can add to your portfolio's international diversity and provide ample appreciation potential.
With a number of American multinationals poised for consistent growth over the next seven years and beyond, don't be quick to dismiss US shares. While the past decade was surely a bust, the future is indeed looking brighter.
More on the markets:
US Fool analyst Todd Wenning owns shares of Procter & Gamble, but of no other company mentioned.
