The Difference Between a Bull Market and a BULL Market

Imagine if apparel maker Hanesbrands (HBI) still relied on the spinning jenny. Or if software giant IBM (IBM) hadn't updated its servers since the 1980s.

We'd be paying more for scratchy underwear. And an IBM "desktop" computer would be a desk.

More likely, of course, Hanesbrands and IBM would simply disappear. Companies can't possibly compete without updates.

And in finance, that comes down to one key factor. You can find it on the balance sheet under the "Property, Plant, and Equipment" (PP&E) category.

Without investment in PP&E, manufacturing companies couldn't manufacture. Retail companies wouldn't be able to manage their inventory. And technology companies would be unable to design, produce, and distribute their products.

PP&E represents all long-term tangible assets a company uses to run its business. That includes office space, factories, production machinery, and vehicles.

All of these assets have a useful life before they become obsolete, break down, or otherwise need to be replaced. So companies depreciate the value of their PP&E to reflect the "aging" of their assets.

Most investors ignore PP&E when they buy a business. And often, that means they pay "new" prices for "used" quality.

But you can also use this measure to look at the broad market. And as I'll show you, that's actually a great way to gauge what's in store for today's bull market – if you're using the right numbers...

You can get a sense of how old a company's assets are if you compare the value of a company's PP&E when management purchased it (gross value) to the current, post-depreciation amount (net value).

Looking at net/gross PP&E ratios over time tells us when companies need to spend more money to support their operations. Looking at this ratio for entire industries – or countries – can tell a story about larger investment trends.

At least, it should be able to. In reality, it takes some digging to figure out the real numbers, because generally accepted accounting principles ("GAAP") numbers distort reality.

There are a lot of problems with the GAAP accounting for PP&E. These include issues around acquisitions, companies artificially writing down their assets, and bankruptcy-related accounting noise, to name a few.

At Altimetry, my team and I specialize in Uniform Accounting – a more reliable way of looking at companies than GAAP and International Financial Reporting Standards ("IFRS") accounting policies that distort the way we think about factors like trends in investment.

Using Uniform Accounting, we remove the noise that GAAP creates. This lets us gain better insights on how capital expenditure ("capex") cycles can impact the market.

As companies begin growing their cash flows and see growth opportunities on the horizon, they have more incentive to invest in their PP&E.

With the right numbers, this is easy to see. The chart below highlights the net/gross PP&E ratio for the S&P 1500 (1,500 of the largest public U.S. companies) since midway through 2001...

When this ratio rises dramatically – as it did in 2005, and again at the beginning of this year – management teams around the country are aggressively investing in their assets to drive growth.

Rising investment generally leads to revenue and earnings growth. That's especially important now, after the declines we've seen in recent years...

Once the Great Recession began in 2008, management teams stopped investing. They wanted to conserve cash flows during a time of uncertainty.

After the recession, net/gross PP&E bottomed out at 56%. Then in 2010, companies began reinvesting to make up for lost productivity.

Over the long term, net/gross PP&E across corporate America averages 57% and higher. Companies tend to feel the pressure on their production when their ratio falls below this amount.

Companies continued investing until they reached 57% levels midway through 2013. Then, in 2015, as the energy crisis began to grow, many companies that were aggressively investing in capex – especially in the energy space – stopped investing.

Since then, companies across all sectors have limited further investment. And ratios hit multidecade lows in the first half of 2018.

At current levels, it is imperative that management teams begin putting capital toward new investments. If their assets continue aging, it could lead to constraints on capacity and production levels. These companies could turn into Hanesbrands forced to use a spinning jenny.

Management teams appear to be realizing this need for capex. Since net/gross PP&E reached multidecade lows in the second quarter of 2018, we have begun to see an uptick in net investment... a possible signal that management teams have returned to a growth mindset.

If so, this is extremely positive for upcoming economic growth and for the market. Continued asset growth has three bullish signals embedded within...

First, it confirms management teams are anticipating future growth opportunities.

Second, it indicates that quality investment opportunities exist for future growth.

Third, and most important, it signals that corporations are profitable enough to support investment activity and management teams are not hoarding cash to prepare for economic turbulence. It means earnings growth is coming.

Strong earnings growth is what turns a positive market into a capital-letter BULL market.

That can't happen without strong investment trends... And now, we're starting to see them.

As they say, you need to spend money to make money.

Regards,

Joel Litman

Editor's note: Joel has a way to see what's really happening throughout the entire market... using his investment "Truth Detector." He built this tool to help investors uncover the "hidden" earnings of almost any stock – weeks or even months before the mass public catches on. If you missed his demonstration last week, don't worry. You can still learn how his system works... And get the name of Joel's favorite stock today. Watch the replay right here.

Further Reading

"Accounting is incredibly important for investors," Mike DiBiase writes. "You'll never be a great investor without at least a basic understanding of it." Get his breakdown of financial statements – and how he would "fix" accounting rules – right here.

"Reported financial statements and Wall Street research cannot be trusted," Joel says. "Worse, most of the investment world does not recognize this at all." Learn how to turn this widespread problem to your advantage here: This Secret Could Have Made You 15 Times Your Money.

Market Notes
A PHARMACEUTICAL GIANT MAKES QUICK DOUBLE-DIGIT GAINS

Today’s company is part of the bull market in health care…

Our colleague Dr. David Eifrig has been tracking a massive tailwind for health care stocks. You see, America’s Baby Boomer population is getting older… with more health care needs. Of course, folks of every age need asthma care, flu shots, and relief from headaches and heartburn. Today’s company serves them all…

GlaxoSmithKline (GSK) is a $108 billion pharmaceutical giant with a broad product portfolio. While you’re probably most familiar with its consumer brands like Excedrin and Tums, the company makes more of its money from cutting-edge prescription drugs. It’s also the world’s largest vaccine company, providing 2 million doses every day. GlaxoSmithKline earned roughly $1.3 billion in the most recent quarter, more than twice what it earned this time last year.

GSK shares are up 15% so far this year, and they just hit new multiyear highs. Shareholders are also enjoying a 4% dividend yield. As an aging population continues to provide a tailwind for health care stocks, we expect more gains ahead…