Whirlpool Corp. signage
In this good earnings report season, excellent growth insight is in the Whirlpool Corp. results explanation. (See The Wall Street Journal article, “Whirlpool Profits from Higher Prices.”) The insight is that the effect of tariffs and lower economic growth levels cannot be taken at face value. Quality companies with effective management can find ways to create earnings growth.
Disclosure: Author does not hold Whirlpool securities
Whirlpool, benefitting from tariffs on imported washing machines, faced rising costs from tariffs on imported steel and aluminum. Analysts anticipated that raising prices to cover costs would dampen sales, thereby decreasing earnings. Management decided to push the price component further, accepting a 3.8% drop in North American unit sales (with revenues below analyst estimates). The payoff was that profit came in at $4.91 per share, 3.4% above the $4.75 earned the year before and 15% above the downbeat $4.27 analyst projection.
As CFO Jim Peters said, “Demand was down slightly, but it was right where we expected.” In other words, the results represent management in action, taking the current situation’s benefits and drawbacks as both a challenge and an opportunity.
Now, about those high stock prices we keep reading about
Let’s start with Whirlpool. Analysts forecast that management will successfully continue its strategy. Revenue growth expectations are low: (0.6)% in 2020 and 2.1% in 2021. However, earnings growth expectations are good: 3.2% in 2020 and 9.4% in 2021. So, what does this quality company’s favorable growth outlook sell for? A current P/E ratio of only 9.1x and a forward (2020) P/E ratio of a low 8.9x (an earnings yield of 11.3%). Moreover, its current $4.80 dividend is a 3.3% yield. (Plus, the company has raised the dividend at its mid-April declaration in each of the past seven years.)
Important point: “Growth” comes in different forms
Form #1 is rapid growth visions – Say, “growth stock,” to someone and they will likely think of companies like Tesla – big ideas, big objectives and big price. Investors who pursue such stocks know that today’s high prices can look cheap in a year or two if things work out. They also know that if things go awry, the stock can plummet. The measures need not be earnings – product development, customer growth and sales growth can serve as growth metrics in a company’s early growth stages.
Form #2 is high, proven growth – Many investors prefer not to roll the dice on the next big thing. They seek proven growth situations with a bright outlook. Valuations, while higher than average, are supported by both current earnings and expected growth.
Form #3 is well-priced growth – Investors who want growth and value, too, seek well-priced growth companies (often labeled, “growth at the right price” or GARP). Dividend yield can be important as both a positive return and a support level in weak markets.
Form #4 is dividend growth – Dividend income investors often want to see their dividends grow. Naturally, dividends reflect earnings, so dividend growth means earnings growth, too. A popular goal is to have dividends grow by at least the rate of inflation each year.
One company can take on different growth forms over time
A natural progression is down from Form #1 to #4 as a company matures. However, companies can also change, up or down, as their industry, products, costs, popularity and management shift. Spotting such a shift can be valuable because valuations can rise or fall.
Whirlpool offers a good example
Whirlpool’s 3.3% yield, 9.1x P/E ratio, and relatively low 3.2% expected earnings growth in 2020 appear to put its stock in that last category: Dividend growth. However, looking ahead to the higher growth potential in 2021 means it could shift to the next, higher category: Well-priced growth.
That situation means that, if the company’s 2021 outlook holds, dividend growth investors will be thrilled and GARP investors will become interested. The added demand would push the price up to a higher valuation level, thereby creating added return from that shift.
The bottom line
Growth, even only 2% real (above inflation) GDP growth, can make stocks rewarding. Coronavirus notwithstanding, the growth outlook for well-managed companies is very good. And that doesn’t apply to just the popular, high-end names. Desirable company growth is possible in many industries and companies.
The different forms of growth highlight the importance of not lumping investors into one pot, nor viewing investing as one approach: Index ownership. Growth is management dependent, so analyzing and selecting among companies can both improve return and reduce risk.
A characteristic of growth: Active management usurps passive indexation
Actively managed growth funds will become popular. Why? For four reasons:
First, identifying growth means analysis of future possibilities. Even though there are growth stock indexes, they all necessarily rely on what happened already, with no consideration of what could be coming
Second, growth potential changes over time. Stock holding turnover in growth portfolios can occur at any time. Index fund holdings are fairly static, and changes are based neither on growth potential nor risk concerns
Third, fund risk can vary widely. Active manager allocations only partially reflect company size. Virtually all the index funds are simply market capitalization-weighted (the Dow Jones Industrial Average is price-weighted)
Fourth, performance can be enticing. The three items, above, mean active management performance can vary widely from a stock market index. When growth is in, that difference can be large, positive and appealing