The stock market may be more terrifying than campfire ghost stories were when you were 10. Doubts about economic growth litter the ground like beer cups after a NASCAR race.
But the merger-and-acquisition market is hot. Companies spent 20% more money buying other companies in the first quarter of 2011 than in the first quarter of 2010. And the dollar volume of deals is up 40% from the first quarter of 2009, the low for this cycle.
The activity in some sectors is positively frantic. For example, in the chemical industry, 2011 is shaping up as a record year for M&A. The first half of the year saw $60 billion in announced deals, an increase of 41% from the first half of 2010.
It may seem odd that companies are willing to invest billions and millions when you and I are having nightmares about putting our thousands and hundreds to work. And it may seem strange that companies are so willing to buy other businesses when the global economy may be slowing. But it's completely logical.
And that logic suggests a strategy that you and I can use to invest in the currently volatile stock market: Think about what's scarce right now. And what's cheap.
Jim Jubak
Cash is cheap
When so many of the world's developed economies are growing at 2% a year or less -- if they're expanding at all -- top-line growth is scarcer than hen's teeth. And with the cost of raw materials and energy climbing, any squeeze on top-line revenue growth can turn into real pain by the time the money flows through to the bottom earnings line.
But when developed economies cut interest rates to near 0% and then dump additional cash into the global market through policies like the Federal Reserve's programs of quantitative easing, cash becomes cheap. In May, Google (GOOG, news) raised money at a yield of 3.63% for 10-year corporate bonds. Johnson & Johnson (JNJ, news) sold 10-year bonds at 3.68%. Take out the current 3.6% inflation rate, as measured by the Consumer Price Index, and you've got essentially free money.
And, of course, many companies don't need to borrow. At the end of the first quarter, companies were sitting on $1.9 trillion in cash.
This leads to one logical conclusion: Growth is scarce, and money is cheap -- so buy growth.
But isn't this strategy risky if you're a CEO? Here are three reasons it isn't:
- The stock prices of the companies that you're looking to buy aren't at nosebleed levels. The 12-month trailing price-to-earnings ratio on the Standard & Poor's 500 Index ($INX) stocks is just 15.2, well within the range history calls reasonable. The forward P/E ratio -- if analyst earnings estimates are right -- comes to just 13.7, well within the range that history calls cheap. (And in many sectors, private equity companies are looking for exits. The companies they're looking to sell don't always come with a low price, but the other available deals help to keep prices down.)
- It's less expensive to buy growth than to invest to create it. Buy a company doing $500 million in annual sales and you can be reasonably sure that even if the economy grows slowly, most of that growth will still be there next quarter and next year and the year after that. Invest in growth in a slow-growth economy and you risk having the market that you want to capture recede into the future so that your company is spending millions or billions chasing a will-o'-the-wisp. Just ask electric-car battery maker when it will see that market reach significant volumes.
- You aren't investing for tomorrow. Individual investors may get spooked out of a position if growth is slower than expected for a quarter or two or three, but if you run a mining or oil company, for example, you're looking at growth trends for the next decade. Sure, Alcoa (AA, news) will be depressed if demand for aluminum doesn't growth by 12% in 2011. But the really important number is the 6.5% annual growth in demand that the company projects for the next decade. And this kind of long view isn't limited to natural resource companies. The deal to buy a 60% stake in Hsu Fu Chi International, a Chinese snack and candy maker, for $1.7 billion, has the same long horizon. Hsu Fu Chi's revenue in the company's last fiscal year grew three times faster than Nestlé's own worldwide sales. I don't know what's more exciting for Nestlé -- the chance to grow Hsu Fu Chi's sales more rapidly using Nestlé's product development and marketing expertise or the opportunity to expand sales of Nestlé's own brands in China using Hsu Fu Chi's distribution network. But you can be sure that the company didn't make the deal with an eye on next quarter's results.
