We’re in the early stages of a secular bull market in stocks.
Such an idea probably sounds implausible to most observers, given the vast and multiple problems burdening the world economy. Not only is a secular bull market in stocks unlikely, most investors would agree, it’s even hard to imagine.
So, imagine it.
It’s worth the effort, if only because the stakes are so high. If you get this cycle wrong, there’s no Plan B. You could have completely missed the 1982 to 2000 secular bull market in stocks (15% average annual returns) and still made piles of money investing in bonds, which enjoyed the biggest rally since the 1830’s. You could have even parked cash in money market funds during the 1982 to 2000 cycle, and you would’ve come out the other side just fine, earning 6.5% compounded, thank you very much.
But if you bypass the current secular bull move in stocks, you’re going to be left high and dry. Cash yields are so tiny you need a microscope to see them. Yields on bonds are not much better, and bonds face the additional prospect of material capital losses if and when interest rates rise.
Unlike the 1982-2000 iteration, this secular bull market in stocks won’t have the tailwind of falling interest rates. Not to worry. There are two much more powerful tailwinds in place:
(1) The Technology Revolution
Computers already fly planes, drive cars, manufacture product (with the help of robotics), and make medical diagnoses. It’s just the beginning. Look out five, ten, and twenty years, and the change to lifestyle and business is mind-boggling to contemplate.
Of course, I’m telling you something you already know. But this isn’t about telling you something new; rather, it’s about the appropriate weighting to be given to the technology variable. The appropriate weighting is, in a word: More. Most investors, it seems to me, don’t fully appreciate what’s around the corner for technology and it’s impact on wealth-building and stocks.
Wealth-building is a direct result of increases in productivity and efficiency. While technology didn’t have an appreciable effect on operational efficiency in the 90’s (cost roughly approximated benefit), that has changed in recent years. Capital efficiency has increased markedly, and the phenomenon appears to be accelerating. To gain from this secular trend, investors only need to tie what they already know (about technology) to this wealth-building principle: The more efficient an income-producing asset (business) is, the more valuable it is.
(2) The World is Open for Business
What a difference a generation makes: The U.S. economy used to be largely limited to the North American continent, with it’s international agenda focused on limiting communist expansion. Now it’s a worldwide economy, and the impetus for growth no longer rests squarely on the shoulders of U.S. consumers. Emerging economies are catalyzing growth, led by massive infrastructure buildout. The modernization of emerging economies is still in its early stages, and will provide a tailwind for the worldwide growth for many years to come.
The two new additions to my Top Ten list, below, are U.S. companies that stand to benefit in an outsized way from the infrastructure buildout theme. Note that the picks below are in addition to my first pick, General Electric, from last week’s column.
Buy: Terex (TEX)
Terex is a worldwide leader in infrastructure, the #1 or #2 player in a number of categories, from aerial work platforms to materials processing equipment to cranes and port equipment, among other things. The stock sells at about $16 per share, and the company is expected to earn $1.63 next year.
Of course, next year’s earnings are not the reason to buy this stock. As I said in my last column, the most important question investors can ask during turbulent market conditions is this: What is normal? To answer the question with respect to Terex - or any other company - requires a detailed study of the earnings history (at least ten years) of both the target company (Terex) as well as all of their major competitors. There are easy adjustments to make (e.g., for outlier years), and there are some more complex fine-tuning, like adjustments for capital flows and supply/demand imbalances (a key variable in calculating margins).
While I’m impressed that Terex earned $5.83 in 2007 (and I’m especially impressed by their $96 stock price), it was an outlier year, not indicative of normalized performance. And the same is true for the subnormal performance of Terex during the credit crisis.
By my calculations, in a normal environment – which we’re tantalizingly close to, perhaps beginning by the end of next year - Terex will be closing in on an annualized earnings rate of $4.50 or so per share. It suggests a stock price in the $50’s over the next couple of years, or about three times the current quote.
Buy: MANITOWOC (MTW)
Manitowoc is comprised of two distinct businesses, of roughly equal size: Food service equipment and cranes. The stock is trading at about $11, down from $51 in 2007 when it enjoyed peak net profit margins of 8.5% - 2007 is a prime example of a peak, outlier year that should be given little weight. On the other hand, the performance of Manitowoc during the credit crisis – it generated a profit, but not much – has to be discounted as well. So, what is normal for Manitowoc?
Net profit margins, according to my estimates, will soon be 5.5 to 6%, suggesting an earnings stream of $2.30 or so in a couple of years. I’m not sure what multiple the market will assign to this earnings stream, but 12 to 14 is probably a conservative guess, given that the long-term growth prospects for this company are quite impressive. That equates to a stock price of $27 to $32.
More Top Ten picks coming
Look for my next column, when I’ll detail more picks for 2012, as well as reasons why the best days for business are ahead of us.
Other articles in this series: