by Jason Jenkins, Investment U Research
Thursday, January 5, 2012
You may wonder, with all that’s going on in the world in regards to political and economic woes, how could any stock index actually be up for 2011. But, through the market’s December 31 close, the Dow was up 640.05 points in 2011. Here’s why:
The Price-Weighted Index
The first part of the answer lies in its structure. Unlike many other stock indices, the Dow Jones industrial average is price-weighted. This means that the most expensive stocks have the biggest impact on the Dow’s movement. Other indices such as the S&P 500 and Nasdaq are weighted by each stock’s market cap.
Last week, Nicholas Colas, Chief Market Strategist at ConvergEx, a software provider for brokerage and investment technology firms, stated in a note just how much of a factor each Dow stock was in its advance. He also stated that big gains from two specific high priced companies had the biggest impact – IBM (NYSE: IBM) and McDonald’s (NYSE: MCD)
Colas found that nearly half of that advance came from these two giants – both of which accounted for more than 100 points.
He went on to say that the confidence investors have in the business models of companies viewed as industry leaders “may have something to do with the remarkably sanguine perspective the sell-side has on the earnings predictability” of Dow components. Even the most pessimistic analysts, he found, only differ about 9% from the consensus forecast for 2012 profits.
In English Please?
Basically, there are just some brands out there we trust no matter what. And apparently, IBM and McDonald’s are two of those brands, and with good reason.
The last time I wrote about McDonald’s, The Big Mac – Recession Proof, it was right after they released their third-quarter numbers. They were impressive. But what was more impressive was Micky D’s future direction. Here were the highlights:
McDonalds has adjusted its food selections to match the trend toward healthier eating choices, and added such options as fruit, oatmeal and smoothies to its menu.
- The burger giant also launched the McCafe concept, complete with free Wi-Fi and fancy coffee drinks, to compete with other popular coffee shops like Starbucks.
- It has remodeled restaurants and converted more locations to 24-hour operations.
- In China, McDonald’s increased its restaurant locations from about 1,200 to 1,400 over the past year.
- Revenue in Europe climbed 16%, and revenue in Asia/Pacific, the Middle East and Africa climbed 20%.
- And of course, McDonald’s belongs to an elite cadre of companies that have raised dividends for 25 consecutive years.
Since my last article, McDonald’s reported a larger-than-expected rise in November same-store sales. Comp-sales rose 7.4% globally. Analysts were anticipating a rise of 4.6%.
As economic troubles persist, McDonald’s may continue to beat market expectations. With the low rates and headline risk out there, more investors will probably head to this type of safer play.
What About IBM?
International Business Machines Corporation (IBM) creates business value for clients and solves business problems through integrated solutions that leverage information technology and deep knowledge of business processes. IBM solutions typically create value by reducing a client’s operational costs or by enabling new capabilities that generate revenue. These solutions are drawn from an industry-leading portfolio of consulting, delivery and implementation services, enterprise software, systems and financing.
This isn’t your father’s IBM that just produced and innovated through hardware. Clearly the focus is now on client services, emerging markets and research.
So What Was Warren Buffet Thinking?
Early in November, Warren Buffett bought about $10.7 billion worth of IBM stock. “I felt that IBM had a very good business,” said Buffett. Many commentators expressed surprise at this development, as Buffett has traditionally chosen to avoid technology stocks.
Mr. Buffett said he invested in IBM after reading its most recent annual report and was taken with IBM’s entrenched position providing technology services to businesses. That is a characteristic he has long sought in investments, which he calls a “moat” against competition.
In an interview with The Wall Street Journal, Buffett said IBM “fits all my principles… it’s something we expect to own indefinitely.”
Three Reasons IBM Could Reach $200
1. In the last 10 years, IBM has grown EPS from $4.35 in 2001 to $11.52 in 2010. Including in the 2008 to 2009 crisis period, IBM was able to grow EPS. For 2011, IBM should earn more than $12 per share.
2. Huge amounts of cash have been returned to shareholders in the last 10 years. On average, $10 billion annually has flown back to shareholders through stock buybacks and dividends. This is more than 85% of the free cash flow generated during this period.
3. IBM’s 5,896 patents in 2010 were the most U.S. patents ever awarded to one company in a single year. Over 70% of the patents issued in 2010 were for software and services. The company’s investments in R&D also result in intellectual property income of approximately $1 billion annually.
There’s no telling what 2012 will bring to the markets. But these two companies have certainly gained some nice momentum going into a new year.