Valuations are stretched
in consumer staples and discretionaries. I have good knowledge of the large caps and most mid caps, and I cannot find one that would meet the 20% undervaluation hurdle that is desired at many mutual funds. Finding one with 10% plus valuation seems almost impossible as well.
This morning, I pulled my earnings discount models for about 20 stocks, wondering what is required to make them buys. Anybody who reads my articles
knows that I add up to 1% to the interest rate on the long Treasury bond to get to a decent risk-free rate to counter some of the Fed's quantitative easing. Since the run-up in interest rates to 3.6% on the 30-year bond, I have added only .6%. I went through my 20 stocks and eliminated that .6%. The result was that the net present valuations of the stocks I was looking at were raised by 7-12%, depending on the levels of their expected earnings growth. But none of them became outright buys, reaching 20% undervaluation. For these stocks, 10-15% undervaluation was the best
that I could get to.
VF Corp (NYSE:VFC) at $197, discounting a 13% growth rate, greater than an 11% sell side estimate. Even using a 3.6% long bond results in only 8% undervaluation.
McCormick & Company (NYSE: MKC) at $72, discounting a 9% growth rate the same as the sell side average, while only being 9% undervalued if the present 30-year long bond is used.
PetSmart (NASDAQ:PETM), at $72, discounts a 12% growth rate, which I think is probably high and close to the 15% wisdom from the sell side. Use a 3.6% long bond as the risk-free rate and the deserved evaluation only goes up 10%.
Ross Stores (NASDAQ:ROST) at $67 already discounts a 15% growth rate vs. a 12% sell side average growth rate. Cut the risk-free rate from my 4.2% to 3.6% and the supposed fair valuation only increases 7%. I should also say that these are just some examples from the random stocks I looked at and are not a catalog of the most overvalued.
So buying into the Fed's Kool-Aid does not justify valuations.
Therefore, the only thing that can justify consumer stock valuations is a faster longer-term rate of GDP growth in the US. Here I did some extremely crude seat-of-my-pants thinking about five-year growth rates of EPS. My thinking is that 3% GDP growth gets us to Fed tapering or tightening and my .6% addition to the long bond is appropriate. But I still cannot get to a much higher EPS growth for my companies (2-3% real GDP growth is sort of a normal base for their growth rate calculations now). Therefore, I estimate that three to four years of 4% plus real GDP growth is required to make some of my stocks outright buys.
Ascribing that sort of thinking to the market for consumer stocks, at least, has seemed like a real stretch.
Within the past week, I have seen that June CPI data show that car parts are down 1.5% for six straight months of decline versus their 3-4% average increases in the last few years. Additionally, restaurant sales have weakened noticeably in June. And the National Retail Federation just predicted that back-to-school spending will decrease
12%. The last time the National Retail Federation predicted a decline was in 2009. The implication is a not-so-merry Christmas.
As I look at Consumerland, 1% GDP growth for at least a few quarters is a better bet than the 4% that would justify the present valuations -- and which is still huge stretch.
Long Bunge, Lowe's, and Archer Daniels Midland.
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