Streetwise

Lauren Rudd

Sunday, May 15, 2011

Why Make Investing Difficult

Why do so many of you want to make this investing thing so difficult? Forget about daily stock trading, or buying mutual funds. Forget about receiving “help” from your friendly stock broker, or tips from Uncle Joe.

Instead, opt for investment candidates selected from a universe of companies whose products you know and understand, companies that have both with a track record of positive earnings growth and a future that is aligned with the economy. In doing so, you are likely to outperform the vast majority of mutual funds. That statement is based on about four decades of Wall Street experience.

Understand that the emphasis is on you and what you believe and identify with, not what someone else says. However, also understand that in today’s environment you simply cannot invest and then forget. Keep an eye on your investments; make sure the companies are doing what they said they would do.

So by now you are probably thinking that I should provide you with an example of a potential investment. Great idea and I cannot think of a better example than Kellogg, the company I still associate with the characters Snap, Crackle and Pop.

To start, Kellogg has achieved a distinguished level of honesty and ethical behavior, a real treat these days. In fact, Kellogg has been called out in the past as being one of the country’s most ethical corporations.

Furthermore, food is an excellent example of a sector with virtually complete inelasticity. In general that means there is no substitute product should food prices rise. You still have to eat. And, while you may cut back on the quantity purchased, or switch to a lower priced but comparable item, 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.

When I last discussed the Company a year ago, my earnings estimate for 2010 was $3.60 with a 12 month price target of $62 per share. So how well did the Company perform? Earnings for 2010 came in at $3.30 per share, while the shares recently closed at $57, both numbers well shy of my estimates, although the capital gain for the year was 3.8 percent, with a dividend yield of 2.8 percent, for a total of 6.6 percent. The question of course is why the under performance and what does the future hold.

The first part of the answer is that Kellogg came under severe pressure from continually rising commodity costs, which in turn dented first-quarter profits. Nonetheless, sales were higher than expected. Moreover, my opinion is that Kellogg will likely be able to leverage moderate sales growth going forward into increased profit expansion. At the same time, the dividend yield will mean the overall return to shareholders will continue to achieve a desirable level. To see why, we need to look at the company’s latest quarterly numbers.

Net sales increased 5 percent to $3.5 billion. Operating profit was $572 million, a decline of 10 percent. The decline is attributed to increased raw material costs and a double-digit increase in brand building as the Company reinvested it operating profits in order to increase sales momentum.

Keep in mind that the benefit from recent price increases was not fully reflected in first quarter results. In addition, the year-over-year comparison is with first quarter 2010 profit growth rate of 17 percent.

Earnings for the quarter came in at $1.00 per share, a decline of 8 percent from a year ago. Cash flow, defined as cash from operating activities less capital expenditures, was $207 million for the quarter, compared to $190 million in the first quarter of 2010. The Company’s 2011 guidance is for sales growth of approximately 4 percent with earnings of between $3.33 and $3.40 per share.