Is European Exposure A Good Filter For Stock Selection?

by: MyPlanIQ

Europe is a flashing red blip on everybody's RADAR screens. Brian Stoffel of the Motley Fool highlights European exposure of major companies who are likely to be responsible for a great deal of the dividends on which many will rely over the next few quarters. Brian started by selecting the Dow dividend stocks that could weather a eurozone meltdown. We reviewed this in a previous article.

He started with strong dividend payers and then started to weed out those with too much European exposure.

He did this by eliminating from consideration any company that didn't at least offer its shareholders a 2.5% yield. In addition, he checked out the company's dividend payout ratio and eliminated all companies with payout ratios above 80%. Then he looked at European contribution to 2010 revenue.

Company Payout Ratio Dividend Yield % of European Revenue 2010
Home Depot (NYSE:HD) 3.20% 43% 0%
Chevron (NYSE:CVX) 3.50% 22% 7%
Boeing (NYSE:BA) 2.70% 33% 12%
Intel (INTC) 3.70% 32% 13%
Coca-Cola (NYSE:KO) 2.90% 34% 15%
ExxonMobil (NYSE:XOM) 2.50% 22% 21%
General Electric (NYSE:GE) 4.10% 48% 21%
3M (NYSE:MMM) 2.90% 37% 23%
Kraft (KFT) 3.40% 64% 24%
United Technologies (NYSE:UTX) 2.70% 34% 25%
DuPont (NYSE:DD) 3.70% 45% 26%
Johnson & Johnson (NYSE:JNJ) 3.70% 54% 26%
JPMorgan Chase (NYSE:JPM) 3.50% 13% 28%
Pfizer (NYSE:PFE) 4.30% 54% 28%
Procter & Gamble (NYSE:PG) 3.40% 51% 34%
McDonald's (NYSE:MCD) 3% 48% 40%
Microsoft (NASDAQ:MSFT) 3.30% 23% Unknown
Wal-Mart (NYSE:WMT) 2.60% 30% Unknown
Travelers (NYSE:TRV) 3.10% 41% Unknown

Source: Yahoo! Finance.

This is an interesting filter but what impact does the European metldown have on these companies?

We started by comparing the whole set of 19 stocks with our reference benchmark. We saw that the solid Dow dividends portfolio sits right in the middle of the returns bracket -- which is a good result. We now move to refining this further.

I want to create a blind filter that scores the companies in terms of European exposure. I created a score that was the Payout Ratio/Dividend Yield multiplied by (1-European contribution to revenue).

Dividing the payout ratio by the dividend yield gave me the choice of the best and most stable payouts and I then used the European exposure to derate the performance. This is not the basis of any research but an intuitive approach that I used to create a scoring to rank the companies. The outcome is shown in the table below.

Company Payout Ratio Dividend Yield % of European Revenue 2010 Score
JPMorgan Chase (JPM) 3.50% 13% 28% 19%
Chevron (CVX) 3.50% 22% 7% 15%
Intel (Nasdaq: INTC) 3.70% 32% 13% 10%
ExxonMobil (XOM) 2.50% 22% 21% 9%
Home Depot (HD) 3.20% 43% 0% 7%
Coca-Cola (KO) 2.90% 34% 15% 7%
Boeing (BA) 2.70% 33% 12% 7%
Microsoft (MSFT) 3.30% 23% 50% 7%
General Electric (GE) 4.10% 48% 21% 7%
DuPont (DD) 3.70% 45% 26% 6%
3M (MMM) 2.90% 37% 23% 6%
United Technologies (UTX) 2.70% 34% 25% 6%
Pfizer (PFE) 4.30% 54% 28% 6%
Johnson & Johnson (JNJ) 3.70% 54% 26% 5%
Procter & Gamble (PG) 3.40% 51% 34% 4%
Wal-Mart (WMT) 2.60% 30% 50% 4%
Kraft (KFT) 3.40% 64% 24% 4%
Travelers (TRV) 3.10% 41% 50% 4%
McDonald's (MCD) 3% 48% 40% 4%

Those with a score of 7% and above went into one group and 6% and below went into another. Again, the split was arbitrary and the purpose is to measure whether the selections perform differently.

We kept our reference ETF dividend portfolio.

Asset Fund in this portfolio
REAL ESTATE ICF (iShares Cohen & Steers Realty Majors)
FIXED INCOME TIP (iShares Barclays TIPS Bond)
Emerging Market VWO (Vanguard Emerging Markets Stock ETF)
US EQUITY DVY (iShares Dow Jones Select Dividend Index)
US EQUITY VIG (Vanguard Dividend Appreciation ETF)
INTERNATIONAL EQUITY IDV (iShares Dow Jones Intl Select Div Idx)
High Yield Bond HYG (iShares iBoxx $ High Yield Corporate Bd)
INTERNATIONAL BONDS EMB (iShares JPMorgan USD Emerg Markets Bond)

Portfolio Performance Comparison

Portfolio/Fund Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Retirement Income ETFs Tactical Asset Allocation Moderate 1% 7% 10% 76% 8% 54%
Solid Dow Dividends With Highest European Exposure 11% 52% 17% 70% 7% 27%
Solid Dow Dividends 11% 40% 16% 53% 5% 13%
Retirement Income ETFs Strategic Asset Allocation Moderate 0% 0% 15% 87% 2% 6%
Solid Dow Dividends With Least European Exposure 11% 34% 15% 38% 2% 2%

We can see from the table that the best returns both in absolute terms and also based on the risk adjusted returns comes from the equities that have the highest European exposure. To be fair, it could be that my method of ranking the companies does not work and there may be a better way of doing that.

However, I would like to give the benefit of the doubt to the management of each of these companies. They know that markets go up and down and they are able to shift resources and budgets to batten down the hatches when needed. I also think that those with the broadest worldwide exposures will do best as this gives the best diversification and we know that emerging markets will make an increasing contribution to company revenues.

Three Month Chart
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One Year Chart
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Three Year Chart
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.