Many investors are programmed to believe that a decline in the value of the U.S. dollar is a bad thing. But what's interesting about a weak dollar is the profit opportunities it presents investors with. A falling dollar diminishes its purchasing power internationally, and that eventually translates to the consumer level. For example, a weak dollar increases the cost to import oil, causing oil prices to rise. This means a dollar buys less gas and that pinches many consumers. (Learn more in What do the terms weak dollar and strong dollar mean?)
While that scenario is unfortunate, investors can have their revenge, so to speak, by investing in the stocks of U.S. multinational corporations. Oftentimes, these are companies that investors are already familiar with. They are among the biggest companies not only in the States, but in the world, and earn a significant portion of their profits overseas.
How Do Multinationals Benefit When the Dollar Falls?
The answer is pretty simple. Let's say a U.S. company does a lot of business in Europe and the euro is strong against the dollar. The company's profits from Europe will be denominated in euros and when all those euros are converted against a weak dollar, that means more dollars for the American company and a nice jolt to the bottom line. Better profit margins usually translate to better results for shareholders. (Learn how to examine a company's profitability with the help of profit-margin ratios, see The Bottom Line On Margins.)
The Quintessential Multinational
Two of the best example of U.S. multinationals are McDonald's (NYSE:MCD) and Procter & Gamble (NYSE:PG). Not only are these two companies among the biggest in the U.S., they are among the most recognizable on the global stage. McDonald's has unrivaled brand recognition and nearly every home in the world has at least one Procter & Gamble product in it.
Both companies derive substantial chunks of their annual sales from international markets, putting them in a prime position to benefit when the dollar slumps. Procter & Gamble in particular benefits when the dollar is weak because it manufactures a fair amount of its products in the United States. And two of its biggest rivals, Nestle and Unilever (NYSE:UN), are foreign firms.
Using the example of the euro, since Nestle and Unilever are European companies, a strong euro can hurt the bottom line at these companies, while P&G bolsters its profits by way of a weak dollar.
It's probably a stretch to say the executives of U.S. multinationals spend their time cheering for weaker dollar, but the reality is their companies benefit from the scenario. (The spot, futures and option currency markets can be traded together for maximum downside protection and profit; read Combining Forex Spot And Futures Transactions.)
Do Shareholders Benefit?
The simple answer is yes, they do. Empirical evidence exists to support the fact that shareholders in U.S. multinationals win when the dollar loses. Look no further than McDonald's. Compare a chart of McDonald's shares to the U.S. Dollar Index, which tracks the performance of the dollar against a basket of major currencies. The results are startling. The more Big Macs and fries that are gobbled up by diners in countries with currencies that are beating the dollar, the more McDonald's shareholders benefit.
While investors benefit from the capital appreciation in multinationals when the dollar is weak, it's hard to quantify whether the added profits translate into higher dividends for shareholders. That said, McDonald's and P&G have raised their dividends during dollar slumps, so it doesn't hurt the chances for a dividend hike when the dollar is declining. This is especially true when you look at companies as solid as these.
Another way shareholders can benefit when the dollar is weak is through acquisitions. A weak dollar can prove intoxicating for foreign companies looking to acquire solid U.S. companies on the cheap. And this isn't limited to small U.S. companies. Anheuser-Busch, a true American multinational and one of the country's most venerable corporations, was acquired by InBev(OTCBB:AHBIF) in 2008 due in part to the euro's strength against the greenback. (Learn more in our Acquisitions Tutorial.)
Made in America
There are other benefits to a weaker dollar for large U.S. exporters. For starters, they can raise their domestic currency prices, which translate to the same price overseas. Higher prices equal higher profits.
If the dollar stays consistently weak for extended periods of time, U.S. multinationals may also be compelled to keep more manufacturing and production operations in the U.S., because the cost of foreign goods can be higher. The trickle-down effect here is that more Americans are working and that benefits the U.S. economy at large.
And of course Uncle Sam likes it when giant multinationals make more money because that means they'll be paying more in taxes. While the increased tax burden is never welcomed by company executives, the IRS sure loves it and it is rarely punitive enough to meaningfully impact the stock price, so shareholders needn't be too concerned about the higher taxes a U.S. multinational pays. (Understanding the relationship between these markets can help you spot profitable stocks, read Currency Moves Highlight Equity Opportunities.)
From the shareholder's perspective, a weak dollar can be a good thing in moderate doses, but there are pitfalls to a prolonged dollar slide. Obviously, a weak dollar reduces purchasing power for American consumers, and this may send them over to generic brands rather than higher-cost premium offerings made by multinationals.
A weak dollar can also impact trade with nations with strong currencies. Some companies build plants or sign multiyear contracts expecting a certain currency conversion rate. A major change can really weigh on a company's bottom line to keep converting a weak buck into a strong local currency and it could lead foreign companies to reduce trade with the U.S. The downfall here is the potential for lost jobs and lower tax revenues.
The Bottom Line
At the end of the day, periods of dollar weakness can benefit shareholders in U.S. multinationals. Historical trends prove that, but those tidy returns usually come over periods of several quarters, not years. A dollar slump that extends into five or 10 years is not good business and makes U.S. companies and their shareholders vulnerable to acquisitions by foreign rivals. So if your portfolio has benefited from the dollar's slide for a few months, it might be time to break out the pom-poms and cheer for the greenback to rise. (For more, see What is political risk and what can a multinational company do to minimize exposure? and Play Foreign Currencies Against The U.S. Dollar - And Win.)