Many investors believe that a decline in the value of the U.S. dollar is a bad thing, but the other side of the equation is that a weak dollar presents several profit opportunities.
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. (To learn more about the impact of monetary fluctuations, see "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, which earn a significant portion of their profits overseas.
How Do Multinationals Benefit When the Dollar Falls?
So how do these multinational companies benefit when the dollar falls? 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 those euros are converted against a weak dollar, there are 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 in "The Bottom Line on Margins.")
How To Trade The Falling Dollar
Quintessential Multinationals and Their Relationship to the Dollar
Two of the best examples of U.S. multinationals are McDonald's (NYSE: MCD) and Procter & Gamble (NYSE: PG). These two companies are among the biggest in the U.S. and the most recognizable on the global stage. McDonald's has unrivaled brand recognition and millions of homes across the world have at least one Procter & Gamble product.
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 U.S. Two of its biggest rivals, Nestle and Unilever (NYSE: UN), are foreign firms.
Let's use 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 that the executives of U.S. multinationals spend their time cheering for a weaker dollar, but the reality is that their companies benefit from the scenario. (To gain a better understanding on how 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 from a Weakened Dollar?
Empirical evidence supports the notion that shareholders in U.S. multinationals win when the dollar loses. Look no further than McDonald's as an example. 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 and the results are startling. The more Big Macs and fries that are gobbled up 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 previously raised their dividends during dollar slumps, so it doesn't hurt the chances for a dividend hike when the dollar is declining to increase investor confidence.
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 for a discount. This isn't limited to small U.S. companies, as 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. (To learn more about the climate for acquisitions, see our Acquisitions Tutorial.)
Made in America: U.S. Exporters and the Dollar
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. There is a trickle-down effect in that more Americans are working, which benefits the U.S. economy at large.
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, to the relief of shareholders. (To learn more about the relationship between currencies and stocks, read "Currency Moves Highlight Equity Opportunities.")
Pitfalls of a Weak Dollar
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 produced 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 weigh on a company's bottom line to keep converting a weak dollar into a strong local currency and lead foreign companies to reduce trade with the U.S. However, the downfall here is the potential for lost jobs and lower tax revenues.
The Bottom Line
Periods of dollar weakness can benefit shareholders in U.S. multinationals. Historical trends have supported that trend, 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. Therefore, 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 further reading, see "What Can a Multinational Company Do to Minimize Exposure to Political Risk?" and "Play Foreign Currencies Against the U.S. Dollar and Win."