Since the advent of the Fed’s multiple quantitative easings, I've felt that it was conservative or rational to add something to the 30-year Treasury bond that I use as my risk-free rate for stock valuation purposes. Everybody knows what the game is, and if you are going to play (be long stocks, realizing that the rug might sometime be pulled out from under you quickly, when the Fed lets the bond market seek its own level), you had better add some margin for increased risk. I had used an extra 1% added to the long bond rate, and had been thinking recently about adding another 25-50 basis points.
Obviously the stock market was thinking much more about yield and income, and the consumer staples stocks have really run with basically no change to the longer term outlook, but with the likelihood of less commodity cost pressure from good crop yields this year.
Because the stock market is obviously not using my valuation conservatism, I wondered where it stands on this issue relative to consumer staples overall. Recently I looked at my three-stage EPS discount models for some slow growth staples -- specifically Campbell
(NYSE:CPB), Kraft Foods
(NASDAQ:KRFT), Kimberly Clark
(NYSE:K), General Mills
(NYSE:GIS), and Clorox
(NYSE:CLX) -- where I believe there has been minimal change in the fundamental outlook over the last six months.
I looked at the present valuations first using my 4% risk-free rate (30-Year T-Bond of 3%, plus the 1% I've been adding). That gives me an implied 5-year compound annual growth rate of EPS and an implied terminal growth rate of EPS after 10 years that will justify the present price. Those growth rate were in the 4-6% range, and the terminal growths were 1-2%. Going through the same process with the present 3% T-Bond results in implied growth rates in the 2-3% range, and terminal growth rates 50 to 100 basis points lower.
But I can say that most of these companies had implied 5-year compound average growth rates in the 2-3 range over the past few years (Kraft Foods would have, had it been spun off sooner). Has anything changed fundamentally? The only thing is that we are closer to a harvest in what should be a normal crop year and the attendant lower input cost. Nobody I know can give any reasonable reason why private labels will not continue to erode profitability or volume, especially with the longer term financial pressure on the consumer.
My conclusion is that the Fed has gotten the present group of consumer staple stockowners to believe that the present yield curve is somehow normal and not a product of quantitative easing. Wow! (Readers may now insert comment from P.T. Barnum about who is born every minute.)
No positions in stocks mentioned.
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