The 30 companies among the Dow Jones Industrials are well known as giants of American industry. But as economic activity has grown more global in scope, especially within the upper echelons of the international business community, many of the companies in the Dow have gone well beyond their original U.S. roots to become giant multinationals with customers in hundreds of companies around the world.
As a result of their growing international operations, many Dow companies earn revenue not just in U.S. dollars but also in a wide variety of foreign currencies from around the world. Moreover, currency exchange rates change every day, and over the long run, their fluctuations can add up to have a truly massive impact on a company's sales and net income. In response, top companies have to take steps to avoid being vulnerable to adverse currency moves that can ruin their financial results and spook shareholders. Later, I'll discuss four companies that have particularly high exposure to currencies, but first, let's take a closer look at the issue.
Why currencies are so important
Foreign exchange markets may seem complicated, with dozens of major currencies gaining and losing value against each other. But for businesses, the impact that currencies have is relatively simple.
Consumers in the U.S. are used to seeing prices remain relatively stable for most of the products they buy. With the exception of gas stations, where consumers are used to seeing prices rise and fall dramatically on a regular basis, companies do their best to set pricing levels and keep them relatively constant to avoid customer confusion and uncertainty.
Many U.S. investors don't realize that companies doing business internationally do their best to do the same thing with their foreign sales. By keeping prices in foreign-currency terms stable, companies build customer loyalty and demonstrate their connection to the markets in which they do business.
Keeping prices stable in local-currency terms makes sense from a customer-relations standpoint, but it introduces problems from a financial perspective. When the dollar is strong, the sales and profits that a multinational company earns from its foreign operations are worth less in dollar terms, hurting reported sales figures and reducing overall dollar profits. But when the dollar weakens, the foreign currency those companies bring in is worth more in dollars, boosting sales and profits.
Similarly, the dollar's moves can have a big impact on the costs that companies pay if they rely on foreign markets to get the supplies they need for making products. But here, the effect is the opposite: When the dollar is strong, companies can import supplies more cheaply in dollar terms, cutting their costs and enabling them to enjoy increased margins. A weak dollar makes it more expensive to buy products priced in foreign currencies, squeezing margins.
Which Dow stocks are most affected?
Clearly, companies that have the most foreign exposure have the biggest challenge in dealing with fluctuations. In particular:
- Procter & Gamble has operations in more than 180 countries. With international revenue of more than $54 billion in fiscal 2012 -- almost two-thirds of its overall revenue -- currencies are a key aspect of P&G's results. Earlier this month, the company cut its earnings guidance for the current quarter because Venezuela devalued its currency, causing P&G to project a one-time charge of $200 million to $275 million.
- McDonald's gets almost 70% of its sales from overseas, with Europe representing its biggest geographic segment. Throughout the first half of 2012, a falling euro exacerbated the weak European economy's effect on the company. But since then, the euro has rebounded, helping increase the dollar value of McDonald's European earnings.
- General Electric gets about half its revenue from the U.S., but even more important is that the company has hundreds of billions of dollars' worth of factories and industrial assets scattered around the world. With the need to pay for maintenance and upkeep in local terms, GE has had to pay attention to currency fluctuations on both the income and expense sides of its income statement.
By contrast, oil companies ExxonMobil and Chevron don't have as much currency exposure as you might expect, given their global scope. That's largely because oil is priced in U.S. dollars, with most contracts tied to dollar-based benchmarks even when dealing with international fields. Even so, having to pay for onsite labor and services in local currencies around the world presents the companies with currency risk.
Keep your eye on the dollar
If you invest in stocks, you may see foreign exchange as a whole different market. But currency fluctuations do make a big difference in results, and so it pays to keep your eye on what's happening with the value of the dollar.
Currency headwinds didn't help McDonald's last year, but has the company finally started recovering from bad performance in 2012? In our premium research report on the fast-food giant, our top analyst on the company will tell you whether McDonald's is coming back, and he'll shed light on whether McDonald's is a buy at today's prices. Click here now to read our premium research report on the company.
The article How the Dow Depends on the Dollar originally appeared on Fool.com.Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter: @DanCaplinger. The Motley Fool recommends Chevron, McDonald's, and Procter & Gamble and owns shares of General Electric and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.