The Magic of Phantom Growth. Bonus Round: Still 'Cheap' After Nearly Doubling? And the Trap Door Under the Market's False Floor.
If this quarter is flashing one big warning, for some companies it’s the illusion of growth.
Better yet, organic growth – or as my friends Bill Whiteside and Jeff Middleswart call it in their newsletter, Peek Behind the Numbers: “The organic growth illusion.” (They also run the independent long/short institutional research firm, Behind the Numbers.)
Here we have company after company reporting better organic growth, but... is it really?
As Jeff and Bill explained – and this was before the latest earnings deluge...
Investors must always remember that organic growth is a function of volume growth plus price increase.
And in many cases, they point out, “all of the recently reported organic growth” comes from price increases while volume has evaporated.
They cite such examples Conagra (CAG), the protective product segment of Sealed Air (SEE) and the tools unit of Stanley Black & Decker (SWK.)
This quarter the trend hasn’t just continued, but just eyeballing it, has accelerated…
Just look at a few reports from earlier this week...
Kimberly Clark (KMB): Organic sales rose 5 percent, driven by a 10 percent increase in price and favorable product mix while volume fell by 5%.
Procter & Gamble (PG): Organic sales up more than 7%, aided by a 10-point boost from pricing, while volume slipped by 3 points.
Coca-Cola (KO): Organic revenues rose by 12%, mostly the result of pricing; volume rose a mere 3%.
Pepsi (PEP): Organic growth rose 12%, mostly the result of pricing, while volumes slipped 2%.
Here’s the thing...
If you go through call after call, while there clearly are exceptions, you’ll notice something…
Quite a few of these companies are saying they’re done or nearly done with price increases. (At least for now.)
Either they’re like Pepsi, which said they’re already enough this year to cover higher costs. Or McDonald’s (MCD), which said customers are balking, or in the words of CEO Chris Kempczinski…
The customer is certainly feeling, I think, some of the stress and pressures on that.
More importantly, he said…
So things like did someone add fries to their order, how many items are they buying per order, we're seeing that go down in most of our markets around the world slightly, but it's still going down.
All of which means short of a sudden surge in demand, organic growth might start to sputter.
Other companies, like Chipotle (CMG), claim they have more pricing power than others, but even Chipotle said it plans, for now, to pause increases.
If the trend continues, something’s got to give, like operating leverage, which can quickly shift into reverse, taking margins along for the ride..
And I’m not even going to get into the more difficult comps a year out. Or the falling dominoes, as Bill and Jeff lay out so well in their newsletter, from rising inventories as orders started to fall.
As one friend mused, “people forget how ugly things can get.” Not to mention how fast it can happen.
Moving on… I’m a sucker for boring companies…
One reason is that their executives often spend more time running their businesses than their mouths.
Like Bel Fuse (BELFB), which makes electronic connector. Or as my pal Bob Marcin of Marcin Asset Management said said roughly a year ago, when I first quoted him on the company, in an Empire Financial Daily headlined, “Revenge of the Real Companies.”.
“NOTHING,” he said, “has been more boring than that for the last 20 years.”
How boring? The below is from the front of its website…
Not exactly the kind of stuff that makes headlines.
When Bob first told me about it, I paused. With $150 million market cap at the time, and so thin it generally trades by appointment, it was almost too risky to write about.
The stock was just under $16, but Bob insisted that even after it already had lifted 25% in the span of a few months, it was still cheap, in part based on what he thought was “considerable” margin upside.
He also likes that the company's fairly new CFO "is a former investment banker from this industry who knows all the right ratios and companies from which to model Bel Fuse's price and cost structure."
With 10% organic sales growth, the company seemed to be benefitting from the electrification of everything.
As it turns out, after a few good quarters, the company went on to more than double earlier this year. Even after pulling back, it’s more than doubled.
Now, after yet another good quarter yesterday, shares up another 20% today, Bob – who tends not to mince words – tweeted...
A real beat and raise, with 26% sales growth and 150% surge in EBITDA. This is not that META…beat with a 0% sandbag guide that turns into a 3% sale growth "blowout" ...
Bel is a big beneficiary of secular trend towards Electrification of Everything, EV's, IoT, and Data Center buildout for AI. All at 4x's EBITDA run rate. That valuation is crazy cheap if numbers continue to grow. Sell Meta and swap into Bel, the Fuse has been lit!
Still a micro cap. Still thin. Still potentially too volatile. But while everybody else is firing, Bel Fuse has been hiring. That’s because unlike so many speculative ideas these days, it’s a real business with real products and what seemingly looks to be a real turnaround.
Best part, it has nothing to do with artificial intelligence, generative or otherwise.
Finally, in my recent “The World is Broken, Part 1” I noted that while the world is getting more volatile, the market certainly isn’t.
The question was… why? Classically, the answer might be hiding in plain sight....
Maybe it has to do with nothing more than a market that has been dominated by ETFs and other large “passive” investors, which were flooded with regular inflows of cash from 401Ks.
That money, in turn, poured into the market, indiscriminately, month in, month out... but in the process creating a false floor.
There was a point, when I was doing short research, that we skirted companies whose holdings were dominated by big ETF investors for the simple reason that no matter how bad the numbers were, or the model was, the only thing that would happen is that the stock would go higher.
That may be changing, as Mike Green writes in his “Yes, I Give a Fig” newsletter....
Equity markets are largely incapable of looking forward due to the constant flows into passive funds from 401K contributions — this flow is starting to falter with layoffs in the high-wage technology sector lowering contributions...
Just remember, if there’s a false floor, beware of the trap door.
Ideas? Tips? Thoughts? I can be reached at firstname.lastname@example.org.
(I also write two investment newsletters for Empire Financial Research, Empire Real Wealth and Herb Greenberg’s Quant-X System. For more information, click here and here.)
Thanks for reading On the Street! Subscribe for free to receive new posts and support my work.