Streetwise for Sunday May 18, 2008

Streetwise

Lauren Rudd

Sunday, May 18, 2008

The Magicians At The Labor Department

It is amazing the way Washington’s number crunchers portray economic data. You might think they received their training on Madison Avenue and their rose colored glasses from Congress. Paraphrasing the Labor Department’s latest report on the consumer price index, inflation eased last month with the 0.2 percent increase in the CPI reflecting a flat reading on energy prices and a 2.0 percent decline in the price of gasoline, all of which helped offset the 0.9 percent increase in food costs.

Flat reading on energy prices, 2 percent decline in gas prices, how is that possible? Easy...all you have to do is apply a little seasonal magic and presto a 5.6 percent increase turns into a 2 percent decline. Here you thought the magicians in Las Vegas were great illusionists. They have nothing on the folks at the Labor Department.

And food prices, they do not really count because they are simply “seasonal” increases. Anybody in Washington happen to notice the seasonal trend of food prices over the past two years? Of course, since Government transfer payments, such as Social Security, deficit financing expenses, such as Treasury inflation protected securities, and many other payment programs, both government and private, are all indexed to the CPI...no, certainly not.

Want a solution? Investment opportunities that can help ease the burden of inflation continue in abundance. However, seizing the moment requires a willingness to make your own decisions with confidence and purpose; to stay the course despite the admonition of others. Quoting from Rudyard Kipling’s famous words, “You need to keep your head when all around you are losing theirs.”

To that end, you want to select from a pool of candidates whose fundamentals demonstrate the potential to generate value going forward. Yet, there is a caveat. You must avoid the pitfall of portfolio turnover.

Wall Street’s brokerage community is famous for helping you “rebalance” your portfolio to take advantage of market fluctuations. In actuality, the only thing they are taking advantage of is you and your checkbook. Long-term value, not rebalancing, determines investment success. Furthermore, value is often packaged in those not-so-sexy companies that produce products designed for everyday consumption.

An excellent example is Church & Dwight, the company famous for ARM & HAMMER baking soda. A year ago I forecasted Church & Dwight would earn $2.39 per share in 2007. The company’s earnings came in at $2.46, while the return on the stock over the past 12 months was 10.86 percent.

For the first quarter 2008, the company earned $0.81 per share, an increase of 23 percent over last year's $0.66 per share. Net sales for the quarter increased approximately 7.5 percent to $552.9 million. The company’s gross margin increased to 40.5 percent as compared 38.9 percent a year ago. Selling, general and administrative expense (SG&A) as a percentage of net sales was 14.1 percent for the quarter, consistent with last year's first quarter.

Church & Dwight generated approximately $56.4 million in free cash flow during the first quarter of this year, as compared to $18.3 million a year ago. The increase was primarily related to higher net income and improved working capital management. Finally, the company recently announced its 429th regular consecutive quarterly dividend.

The intrinsic value of the shares using a discounted earnings approach is $72, while the intrinsic value using a free cash flow to the firm approach is $83 per share.