28 Feb 2011 | World

Star Spangled Union - Investing in the USA 

America’s altered states continue to create excellent growth prospects for investors argues William Kay

British investors can be forgiven for shying away from the corporate sector in the formerly all-powerful United States economy. While it has been facing increasingly aggressive competition from the surging Asian countries, America has had to cope with the rampant prices of imported oil and other key commodities, the collapse of much of its financial services and housing sectors, and a consequent wobble in confidence.

At the same time, President Barack Obama has spent considerable political capital piloting heavily diluted health care legislation through Congress, in the teeth of a Republican opposition out to avenge its 2008 poll defeat, making it hard for the government to try to pull the economy round.

Nevertheless, the US economy still accounts for about a quarter of world GDP and, despite some savage fluctuations along the way, US share prices are worth about a third more than they were the day Obama was elected. Plenty of investors, especially Americans, think that the mighty US machine is past the worst. That is certainly the view at Baillie Gifford, which sports a healthy sprinkling of stars and stripes in portfolios.

“One feature of the recent recession was the commendable response of the US corporate sector,” said Mick Brewis, Head of the North American Equities Department. “Companies cut costs decisively, controlled working capital and took a disciplined approach to capital spending, all of which contributed to a strong recovery in profitability and cash generation.”

COMPETITIVENESS HELPS RECOVERY

This decisive action continued a drive for efficiency evident in the healthy growth in US labour productivity over the last decade. Many US industrial companies are keen proponents of continuous improvement philosophies and the lean manufacturing techniques that began in Japan. One company held in Baillie Gifford portfolios is Danaher, an industrial conglomerate that specialises in acquiring companies that have leading market positions in growth industries, but which are under-managed. It turns them around using lean techniques and devotion to continuous improvement.

From its head office, within walking distance of the White House in Washington DC, Danaher has bought international companies that make a range of instrumentation including test and measurement equipment, microscopes and dental equipment. The high value-added nature of these products, the company’s emphasis on research and development (R&D), and efficiency improvements have made Danaher’s businesses globally competitive. It is no coincidence that Danaher’s water quality testers have been selling well in China, Brazil and India,and a fifth of total sales are shipped to emerging markets.

“Company managements have started to reinvest their cash as their confidence has risen, benefiting industrial and information technology companies in particular,” said Brewis. “We expect the US consumer to do better in 2011, but the housing sector is still bumping along the bottom. It could be that the recovery in capital expenditure proves more important.”

WORLD LEADERS

Concentrating on high value-added products and prioritising R&D enables American companies to combat the low-cost threat from Asia. Rockwell Automation – another Baillie Gifford holding – began as the Compression Rheostat Company more than a century ago, making electricity regulators. Over the years it has moved into ever more sophisticated products, now concentrating on Logix, the world’s leading plant-wide control platform, and intelligent motor control gadgets.

According to Brewis, “Innovation in the information technology sector primarily on the west coast of the US is as impressive as ever, with Apple, Google and Amazon.com leading the way. The clearest way to benefit from the tremendous growth that is likely over the next few years in the mobile internet, cloud computing, (which allows access of data and applications) and internet data traffic is through the American companies that are the chief architects of the disruptive technologies that are driving change.

The analogue semiconductor maker Linear Technology is less well known, but many of the most advanced communication devices, networking products and medical instruments only work because of its innovative high performance integrated circuits. Some of the best analogue engineers in the world work at Linear, enabling the company to retain its edge over Asian competitors.”

World leading technology and competitive positions characterise US companies in industries such as health care, oil service and agriculture. Intuitive Surgical’s robot assisted, minimally invasive surgical system is well ahead of any competition, and the market opportunity is substantial, primarily because the products are better for the patient and should be cheaper for the health care system.

Extracting oil from deep sea locations or difficult geologies will be increasingly necessary if global oil supply is to meet growing demand, and US oil service companies Schlumberger and National Oilwell Varco, both world leaders in their fields, are providing advanced technologies and equipment to do this. Both companies are helping with the exploitation of gas, and more recently oil shales in the US using techniques such as horizontal drilling and multiple rock fractures. As a result, the US is now oversupplied with natural gas, a relatively clean source of energy.

Monsanto (genetically modified seeds) and Deere (agricultural equipment) are probably the two strongest global franchises in the agricultural sector. The Chinese have so far struggled to replicate Monsanto’s ability to insert genetic traits into seeds. Monsanto leads a young industry whose products will be much needed if global food supply is to meet long-term demand.

INDIVIDUAL STRENGTHS

However, it is one thing to see the potential in a new technological development but investors reap their reward only if they identify managements capable of turning that potential into reality. So while the broad trends give vital pointers as to whether any particular shares might be undervalued, Baillie Gifford takes a bottom-up, stockpicking approach, which focuses on backing individual companies and management teams.

“We look for companies that have a strong culture, with a loyal and well motivated workforce, where everyone is pulling in the same direction,” said Brewis.

One company that certainly has a unique culture is Berkshire Hathaway, the conglomerate run by the legendary US billionaire, Warren Buffett. The interesting feature about Berkshire Hathaway’s corporate culture is its sheer lack of head office commands. Buffett boasts that the group is unusually decentralized with minimal involvement of corporate headquarters in the day-to-day business activities of the operating businesses.

But Buffett and his handpicked central team transmit their cultural messages loudly enough, by deciding where to allocate capital – and by picking the operational chief executives. Brewis added: “America is still a great place for bottom-up growth stock investors because of the wide choice of companies, enough of which are world class, with managements who run their businesses for the long-term benefit of shareholders.”

Certain branded consumer goods companies qualify here with their strong global franchises. Some leap off the page, like McDonald’s, Johnson & Johnson and eBay. Others are less obvious, such as Brown-Forman, which owns Jack Daniel’s whiskey. Some of these brands are so well established that consumers will for many years be willing to pay more for their products and services than those of newer, non-US rivals that are inevitably forced to rely on lower prices to drive sales.

Eventually, as Japan’s Toyota, Nissan and Honda have shown, foreign competitors can build brands, in certain sectors, to gain footholds in the US and other markets where they come up against American equivalents. But it is a long haul, and in the meantime investors can reap healthy rewards from many US shares.

Please remember that ongoing stock market conditions and currency exchange rates will affect the value of investments and any income from them. Investors may not get back the amount invested.

William Kay
Won the Association of British Insurers' Lifetime Achievement Award in 2005. He was Money Editor for The Sunday Times Money and Personal Finance Editor for The Independent. His books include Pasadena Parade, a novel, Lord of the Dance: the story of Gerry Robinson and The Bosses.