By Lance Helfert
SANTA BARBARA, Calif. (MarketWatch) — The U.S. economy is toast and prudent investors should stay away from U.S. stocks.
At least that is the belief espoused by a number of bearish market commentators who see the U.S. budget deficit, troubled housing market, and dependence on consumer spending as reasons that economic malaise will continue for years to come. And what if they are right? What does that mean for a stock market index such as the S&P 500 Index(SPX 1,325, +5.52, +0.42%) going forward? Perhaps not as much as one would think.
The reason is that many companies in the S&P 500 generate a substantial amount of revenue outside the U.S. According to Standard and Poor’s, of the 250 S&P 500 companies that report detailed information on foreign income, 47% of sales were generated outside the U.S. in 2009. This represents a 7% increase from 2006 with growth primarily coming from Asia. Accordingly, most investors have significantly more international exposure than they are aware of. In fact, the S&P 500 is positioned well to benefit from a major international secular trend that is likely to accelerate in the coming decade.
Specifically, the development that will drive spending growth across the world is improved living standards. Residents of the U.S. live in a modern country with seemingly endless amenities and access to a dizzying array of goods and services. As such, it is often easy to forget that developing nations do not necessarily have the same access to the goods that Americans take for granted.
However, as incomes rise and emerging economies become more advanced, citizens of these countries are going to demand the same standard of living enjoyed by their counterparts in developed nations. They will eat more meat, burn more fuel, buy more luxury goods, and desire the most advanced drugs and new technologies.
Populations of countries such as China and India dwarf that of the U.S. Even a small increase in the percentage of people who can afford more goods leads to a huge jump in the number of potential customers available to U.S. companies that have overseas operations.
For example, according to an October 2010 release from China’s Ministry of Security, the total number of automobiles in China is around 85 million. In contrast, according to the U.S.’s Bureau of Transportation Statistics, in 2008 there were approximately 137 million passenger cars in the U.S. This means that there are approximately 0.45 cars per person in the U.S and only 0.065 cars per person in China. If the ratio in China were to reach even one-third of the U.S. ratio, there would be nearly 200 million cars in China. Any material increase in this ratio for China would have a profound impact on energy consumption, global energy prices, and the global economy. Does anyone doubt that this ratio won’t increase?
None of this should come as a surprise to those who follow the global equity markets. Since the U.S. is expected to be stuck in a slow growth environment for a number of years, it is only logical that investors will continue to seek international exposure. But what is the best way to gain such exposure, and is the anticipated growth already reflected in foreign company valuations?
For the average investor, the answer to the first question is not to go directly to the source. While betting directly on emerging markets through their local stock exchanges may sound exciting, there are many risks that have to be taken into consideration. Such risks include lower liquidity and regulation, as well as higher volatility, currency risk, political risk, and risk of fraud. Second, many high-growth companies are already priced to perfection and assume that aggressive growth targets are met.
Despite the fact that the secular growth story in the emerging markets is so well known, many world class companies in the S&P 500 trade at cash flow multiples that do not reflect their significant exposure to these trends.
Take personal and health-care company Kimberly-Clark Corp. (KMB 65.01, -0.06, -0.09%)Aside from a slight blip in 2009, KMB has achieved consistent revenue and earnings growth since 2005. More importantly, revenue in Asia and Latin America increased more than 52%. KMB is an attractive company because of its exposure to international markets and the fact that its products are associated with a better quality of life. Irrespective of those positive aspects, KMB is currently trading at approximately nine times trailing cash flow with a dividend yield of 4.1%. Thus, KMB is precisely the type of company that should be enticing to investors looking for exposure to growth in developing markets.
Bears may be right and the U.S. economy may stagnate for the foreseeable future, but this concern should not cause investors to shy away from select U.S. companies with attractive valuations and international growth prospects.
Lance Helfert is president of West Coast Asset Management , and the co-author of “The Entrepreneurial Investor — The Art, Science and Business of Value Investing.” West Coast Asset Management does own Kimberly-Clark (KMB) in their portfolio. Ben Claremon contributed to this article.
