Many investors believe that the depreciation of the dollar is a bad thing, but on the other hand, the weakness of the dollar provides several profit opportunities.
The depreciation of the dollar will weaken its international purchasing power, and this will eventually translate to the consumer level. For example, a weaker U.S. dollar will increase the cost of imported oil, leading to higher oil prices. This means that you can buy less gasoline for one dollar, which affects many consumers. Although this situation is unfortunate, investors can retaliate by investing in the stocks of American multinational companies, which make most of their profits overseas.
As more and more emerging markets become interested in American products, these companies will send more products to the world, thereby increasing their profits and perhaps increasing shareholder returns.
How do multinational companies benefit when the dollar falls?
So how do these multinational companies benefit when the dollar depreciates? Suppose an American company has a large amount of business in Europe and the exchange rate of the euro against the dollar strengthens. The company’s profits in Europe will be denominated in euros. When these euros are converted into weak U.S. dollars, the American company has more U.S. dollars, which is a good impact on the bottom line. Higher profit margins usually lead to better results for shareholders.
How to trade a falling U.S. dollar
A typical multinational company and its relationship with the U.S. dollar
The two best examples of American multinational companies are McDonald’s (NYSE: MCD) and Procter & Gamble (NYSE: PG). These two companies are one of the largest companies in the United States and the most well-known companies on the global stage. McDonald’s has unparalleled brand awareness, and millions of families around the world have at least one Procter & Gamble product.
A large part of the annual sales of the two companies comes from the international market, which puts them in a favorable position when the dollar depreciates and can benefit from it. Procter & Gamble particularly benefits when the dollar is weak, because it produces a considerable amount of products in the United States, and its two biggest competitors, Nestlé and Unilever (NYSE: UL), are foreign companies.
Let us take the euro as an example, because Nestlé and Unilever are European companies. A stronger euro may hurt the profits of these companies, while Procter & Gamble uses a weaker dollar to boost profits.
It may be a bit far-fetched to say that executives of American multinational companies spend time cheering for a weaker dollar, but the reality is that their companies have benefited from this situation.
Will shareholders benefit from the weakness of the U.S. dollar?
Empirical evidence supports the view that when the dollar depreciates, shareholders of American multinational corporations will win. Take McDonald’s as an example. Comparing the McDonald’s stock chart with the U.S. dollar index, which tracks the performance of the U.S. dollar against a basket of major currencies, the results are shocking. In countries where the currency is depreciating the dollar, the more Big Macs and French fries are eaten, the more McDonald’s shareholders.
Although investors benefited from the capital appreciation of multinational companies when the dollar was weak, it is difficult to quantify whether the increased profits will translate into higher dividends for shareholders. In other words, McDonald’s and Procter & Gamble had previously increased their dividends during the U.S. dollar plunge, so when the U.S. dollar depreciated to increase investor confidence, this would not harm the opportunity to increase dividends.
When the U.S. dollar is weak, another way that shareholders can benefit is through acquisitions. For foreign companies looking to buy solid American companies at discounted prices, the weak dollar may be irresistible. This is not limited to small American companies, because Anheuser-Busch is a true American multinational company and one of the most respected companies in the country. It was acquired by InBev in 2008, partly because of the strengthening of the euro against the dollar.
Made in the U.S.: U.S. exporters and the U.S. dollar
A weaker U.S. dollar has other benefits for large US exporters. First, they can increase the price of their national currency, which translates into the same price overseas. Higher prices equal higher profits.
If the dollar continues to weaken for a long time, American multinational companies may also be forced to retain more manufacturing and production operations in the United States, because the cost of foreign goods may be higher. There is a trickle-down effect, because more Americans are working, which is good for the US economy as a whole.
Of course, Uncle Sam likes large multinational companies to make more money because it means they will pay more taxes. Although the increased tax burden has never been welcomed by corporate executives, the IRS definitely likes it, and there are few penalties sufficient to have a meaningful impact on stock prices, thereby reducing the burden on shareholders.
The trap of a weak dollar
From a shareholder’s point of view, a weak dollar may be a good thing in a moderate dose, but the long-term depreciation of the dollar also has its drawbacks. Obviously, a weak U.S. dollar will reduce the purchasing power of American consumers, which may lead them to switch to generic brands instead of higher-cost, high-quality products produced by multinational companies.
A weaker U.S. dollar will also affect trade with countries with strong currencies. Some companies build factories or sign multi-year contracts, hoping to have a certain currency exchange rate. A major change may affect the company’s bottom line to continue to convert the weak U.S. dollar into a strong local currency and cause foreign companies to reduce trade with the United States. However, the downfall here is potential unemployment and reduced taxes.
A period of dollar weakness can benefit shareholders of American multinational corporations. Historical trends support this trend, but these impressive returns usually last for several quarters, not years. A depreciation of the U.S. dollar for 5 or 10 years is not good business. It will make US companies and their shareholders vulnerable to acquisitions by foreign competitors. Therefore, if your portfolio has been benefiting from the decline in the U.S. dollar for months, it may be time to break the pom-pom and cheer for the U.S. dollar’s rise.