Streetwise for Sunday June 8, 2008

Streetwise

Lauren Rudd

Sunday, June 8, 2008

This Investment Thing Is Not Difficult

Yes, I know the financial markets have been trying of late. Nonetheless, if you can invest in companies with excellent track records, using a discount brokerage house where you pay a one-time commission per trade of less than $10, and hold those investments undisturbed for a year or more and chalk up annual returns in excess of what the major indexes do, why do so many of you want to make this investing thing so difficult?

Notice that I said nothing about trading stocks, or buying mutual funds, or receiving “help” from your friendly stock broker, or tips from Uncle Joe. You simply pick out companies that you know and understand, that have a track record of earnings and whose future you, yourself, can foresee.

Understand that the emphasis is on you, not what someone else says might or might not happen. You want to train yourself to stay focused on finding companies that are outgunning their competition because they are hard at work at improving their positions in the marketplace.

Does that mean that every company you select is going to turn in an outstanding performance, year after year? No, of course not, especially if you only take into consideration a single one-year period. However, if you are careful in your selection you are likely to outperform the vast majority of all mutual funds and the major indexes during any 3-to-5 year period. That conclusion is based on more than four decades (Ouch!) of Wall Street experience.

So by now you are probably asking yourself why I don’t provide you with an example of just such a company.  Great idea and I cannot think of a better example than Kellogg.

To start with, Kellogg has achieved a distinguished level of honesty and ethical behavior, a real treat these days. In recognition of that, Ethisphere recently named Kellogg to its Most Ethical Companies list.

"Kellogg has developed impressive and meaningful ethical business practices, making them true standouts within their industry," said Alexander Brigham, executive director of Ethisphere Institute, a think tank dedicated to the subject.

Meanwhile, food is an excellent example of a sector with total inelasticity. That means there is no substitute product should food prices rise. You still have to eat. Furthermore, while you may cut back on the quantity purchased, if you have been an on-going consumer of Kellogg’s products then it is highly probable that you will continue in that vein despite price increases. All of which is a long winded way of saying that Kellogg is a relatively recession proof company.

For the first quarter of this year, Kellogg reported net earnings of $0.81 per share as compared to last year's $0.80 per share. However, the 2007 results included a tax benefit resulting in an effective tax rate of 24 percent as compared to this quarter's 30 percent. Revenue growth for the quarter was 10 percent, but you need to realize that the weak dollar was a major contributor.

At the same time, operating earnings for the first quarter increased 9.2 percent. Although the company exceeded a Street consensus of $0.76 per share and increased its dividend 10 percent, the share price remained downtrodden. Part of the reason for the moribund share price is that Kellogg reiterated its prior guidance for the year of $2.92 to $2.97 per share and the Street wanted an increase. Yet, Kellogg is known for being extremely conservative in its guidance.

Looking at the intrinsic value of the shares, a discounted earnings approach yields a value of $61 per share, while the free cash flow to the firm model produces an intrinsic value of $66 per share. Both models are using an earnings growth rate of 9.5 percent.