One year ago in the September 2012 issue of the Investor Advisory Service, we marveled at the contrast between the stream of perpetually negative world economic news versus the stock market’s consistently strong performance. To bridge that inconsistency, we went looking for silver linings in the economic picture. We found some reasonable ones. In the second fiscal quarter, corporate earnings had advanced 5.5% from the year before. Inflation was almost nonexistent, measuring 0.7% in Q2, down from 2.5% in Q1. Low inflation and lower levels of personal debt helped disposable incomes increase 3.2% in Q2. The U.S. seemed to be doing okay.
Plus there was the housing market. According to Zillow Inc., home prices for the second quarter rose for the first time since 2007, up 0.2%. CoreLogic Inc. reported the year-over-year advance as 2.5%, with 71 of 100 metropolitan areas tracked showing gains. Unlike the stock market, there tends to be a lot of predictable momentum in housing prices. Improvements tend to lead to more improvements, another bit of evidence that things were looking up.
With the prospect of a U.S. led recovery helping worldwide growth improve, we went looking for opportunities in out-of-favor sectors. Emerson Electric (Ticker: EMR) is a global manufacturing company whose customers are mainly big industrial companies. We have a long history with Emerson, having followed the stock in the IAS since 1986. Its biggest markets are fluid handling, electric power, industrial automation, and refrigeration. This is a stock to buy when industrials are out of favor and Emerson’s customers have tightened their belts to the max. The trick is to guess when the pressure is going to reverse. We guessed the worldwide industrial economy would start to improve. Trading at $50.30, with a P/E at the low end of its historical range, Emerson seemed to offer nice upside potential with limited downside.
One nice thing about following Emerson is that management makes it pretty easy for investors to measure the company’s performance in real time. Different companies offer investors different levels of transparency. For a large, diversified company, Emerson is very transparent. The company publishes monthly sales figures, and continuously updates its guidance to reflect changing conditions. Those monthly sales figures were still pretty soft in September 2012. In truth, they really haven’t turned up much since then either, although the stock has done fine. We thought it would be an improving world economy that helped Emerson score gains, but cost cutting, combined with a still-higher stock market, has been sufficient instead.
In its second fiscal quarter of 2012, sales increased just 3%. However, Emerson rode cost cuts and a reduced share count to a 16% increase in quarterly EPS. Q3 brought more of the same. Sales rose 2%, while EPS rose 13%. Although earnings growth was good, investors fixated on the slow sales growth. Shares slightly underperformed the broader stock market through the middle of November 2012, then mounted a rally as investors looked forward to better times to come. Q4 2012 results, which the company reported in February 2013, showed sales up 5%, with EPS up 24%. That was just the kind of improvement investors were hoping for. Shares briefly traded above $58, nicely outpacing the broader market. That positive momentum did not persist, however, as the world industrial economy remained soft in the first half of 2013. Emerson’s sales increased just 1% in Fiscal Q1, with EPS up only 4%. Q2 saw a sales decline of 2%, with EPS hurt by a one-time charge related to a business divestment. Shares treaded water until late July, when investors once again started looking forward to better times to come, pushing shares up above $60. At a recent price of $62.31, plus $1.63 in dividends, Emerson has returned 27% in the past year. The S&P 500 is up almost as much, 25%, during the same period.
Economic conditions really haven’t improved for Emerson in the last twelve months, but more investors seem to have jumped into our boat looking forward to the eventual recovery. Our thesis hasn’t really played out, but the stock pick did okay nonetheless.