At 4:10 pm, on October 10, 2022, Legget & Platt Inc [LEG] issued a press release announcing a reduction in their estimate of earnings for 2022 and some business acquisitions. I only noticed this after-market news release because there was an inconsistency between my spreadsheet, that uses the day’s closing price, and a certain exhibit of TD Ameritrade’s website that displays where prices have landed after all post-close trading is complete.
In just 10 minutes, LEG’s share price fell from the day’s close of $34.68 to $31.10, or -10.3%.
We’re in a bear market and an economic recession. The market has lost a quarter of the value it has built up in over a century in just three quarters of a year. But 10% in 10 minutes for a single company? I was intrigued.
A Quick Reaction
Society is all about sound bites and blurbs. Here are the two bullets from the press release that would have triggered the quick sell-off:
- Sales guidance now $5.1 to $5.2 billion (vs prior $5.2–$5.4 billion)
- EPS guidance now $2.30 to $2.45 (vs prior $2.65–$2.80)
From midpoint to midpoint, the sales guidance was reduced -2.8% and earnings per share was lowered -13.2%. Lately, the market has been hypersensitive to any less-than-spectacular news, so I was actually a little surprised to see that the price hadn’t fallen more than the earnings revision. But being born a pessimist, I assumed Mr. Market would get there in the morning and I wasn’t disappointed.
It continued to drop and hit $30.50 before it bounced back up. That’s -12.1% from the previous day’s close. That’s close enough. After all, there is a lot of noise in a trading day, no impact is ever perfectly reflected.
I felt better. I felt better knowing there are businesses and people out there so incensed and disappointed by this tragic news, they were willing to dump their shares for a much lower price than just minutes before. Further, it is fantastic to know that this collective of investors are such robots, taking the mathematical reduction in the earnings guidance and applying it directly to the share price. There is a certain pleasure to be had in seeing my expectations play out, even if there’s a cost to the amusement in the form of an unrealized loss.
Introducing Mr. Market
There are all sorts of owners out there. There are the big industrial money managers and financiers, the so-called ‘smart money’. We can certainly debate their intelligence. Still others, are just like you and I, folks trying to provide for their economic needs, now and in retirement. All of us find our way out to the yard for a brief time each day. And we trade. For all but a select few on literal Wall Street, we have no idea who we’re trading with. The father of value investing, Benjamin Graham, tells us just exactly who we’re dealing with by way of a parable on pages 204-5 of The Intelligent Investor.
Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.
If you are a prudent investor or a sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of a $1,000 interest in the enterprise?
Graham, Benjamin. The Intelligent Investor: A Book of Practical Counsel (Revised Edition). Harper Business, 2006.
Back to Business
Leggett & Platt Inc obviously wanted to get this news out in advance of what will be a ‘disappointing’ earnings announcement in a couple of weeks. The press release also announced three acquisitions that fall very nicely into their existing business:
In late August, Leggett & Platt acquired a leading global manufacturer of hydraulic cylinders for heavy construction machinery. The company has manufacturing facilities in Eschwege, Germany and Ningbo, China and a distribution facility in Halifax, Pennsylvania with combined 2021 sales of approximately $65 million. Also, in late August, the Company acquired a converter of construction fabrics for the furniture and bedding industries located in Shannon, Mississippi. On October 3, Leggett & Platt acquired a distributor of geo components located in Ottawa, Canada. Each of these Textiles businesses have annual sales under $10 million.
Oh, and there was this little nugget under the EPS guidance:
- Expect sequential improvement from 3Q to 4Q
It is not difficult to read the full press release and gain an understanding as to why a company that supplies components of innumerable items, the greater portion of which are considered consumer discretionary in nature, might expect their sales to fall during a time of worldwide inflation. That should not surprise anyone. What is of more interest to me as an owner of the company is knowing that management is working through it. They’re making some appropriate acquisitions, they’re reducing inventories, and tempering expectations.
Dealing with Mr. Market
One way to view a company’s share price is via the Dividend Discount Model. Though it be deeply flawed, impractical, and impossible to apply to some companies, it does have a sound, theoretical premise. It assumes that a company’s stock price is equal to the present value of its future dividends. Intuitively, this should make sense for a shareholder of a company that pays dividends.
When Mr. Market responds to a Dividend King’s news release that it is expecting 13% less in earnings for CY 2022 than it expected a quarter ago, by immediately reducing his price by the same percentage, he is saying that shareholders should expect 13% fewer dividends in the future.
Though it is an estimate of the future, LEG believes that Q4 will be better than Q3. In other words, earnings aren’t strictly monotonic – for any company. They fluctuate, sometimes wildly, sometimes unexpectedly. This does not have to be the case with dividends. Leggett & Platt Inc has been around for 139 years, and they’ve put together a streak of 51 years of increasing their dividend annually. There is nothing in the press release suggesting that this streak won’t continue indefinitely.
This is why I say Mr. Market is rash. He immediately took what was mathematically tractable and made a hasty decision to devalue a company that has been in business for a near infinitude of time and has one of the strongest dividend histories in the world. Did he spend a moment considering the value of these acquisitions, the management adjustments to inventories, and capital allocations? Did he consider the possibility that inflation could be significantly lower 5 years from now? Any consideration at all for the vicissitudes of business? Economic cycles? No? So, because a couple of quarters are going to be lower than expected, we need to believe all future quarters have to be just as low? Hell to the no.
Here is how Benjamin Graham answered his question posed earlier.
If you are a prudent investor or a sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.
The true investor is in that very position when he owns a listed common stock. He can take advantage of the daily market price or leave it alone, as dictated by his own judgment and inclination. He must take cognizance of important price movements, for otherwise his judgment will have nothing to work on. Conceivably they may give him a warning signal which he will do well to heed—this in plain English means that he is to sell his shares because the price has gone down, foreboding worse things to come. In our view such signals are misleading at least as often as they are helpful.
Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.
Graham, Benjamin. The Intelligent Investor: A Book of Practical Counsel (Revised Edition). Harper Business, 2006.
I wouldn’t be surprised if LEG is up for reinvestment on Monday.