Understanding the Numbers Behind GDP
Tuesday, November 1st, 2016
On Friday, we saw the third quarter release of the Gross Domestic Product report, commonly referred to as GDP.
Gross Domestic Product measures the nation's economic activity as it looks at the value of all goods and services produced within the country for a given period.
It is an important measure that many economists rely on to determine the strength of the economy.
Real GDP for the quarter was reported at a rate of 2.9%, which appears to be a major plus on the surface.
It is important to understand that this is the number reported on a real basis. There are two numbers produced for GDP, the nominal report and the real report.
The nominal report does not account for inflation which in the most recent quarter grew at a rate of 4.4%. The real report is a much stronger indicator of the health of the economy as it accounts for inflation.
To understand what this report means for the strength of the economy it is important to understand the breakdown of the GDP components.
The report is broken down into four components: Consumption, Government Expenditures, Investment, and Net Exports.
Consumption is a crucial component as it measures the strength of the consumer and accounts for approximately 70% of GDP.
Now that we have a better understanding GDP, we can take a closer look at the numbers. The actual real number of 2.9% was above both the prior report of 1.4% and the consensus number of 2.5%.
With the release coming so close to the upcoming election, it was a heavily debated topic by supporters of both parties.
Proponents of the Clinton campaign were praising the strength of the report, while many proponents of Mr. Trump were claiming the report was artificially boosted and the real number is closer to 1.5%.
How can this discrepancy occur?
The Trump proponents backed out numbers which benefited from cyclicality and will not produce reoccurring growth. Business Inventories added 0.6 percentage points to overall GDP growth.
If inventories are not depleted throughout the quarter the inventory change could be a drawdown on the next GDP report.
Net Exports looks at the total exports minus the total imports.
This component added 0.8 percentage points to the report as it was helped by a 10% exports increase. Foods and soybeans added a dramatic boost to exports.
The combination of net exports and business inventories produce a total benefit of 1.4% to GDP. This produces the difference between the previously mentioned growth rates of 2.9% and 1.5%. If these components pull back on the next report, GDP will have a slower growth rate.
Based on our experience it is important to not take the report at face value, but rather dig into the numbers and understand what they are showing us. This leads us to the conclusion that while the 2.9% growth appears strong on the surface, there are the underlying factors that present concern with the report.
Understanding the various reports produced for GDP is also very important. There are three reports produced for each quarter. The one we saw on Friday was the first report and is known as the advance report.
On November 29th, 2016, the preliminary report will be released and then on December 22nd, 2016 the final report will be produced.
It is important to understand there can be large fluctuations produced between the reports even though it is from the same data period. It has caused some to question why they produce the various reports.
This week's company of the week is The Clorox Company (CLX).
The current price is $118.97 and the 52-week range is $117.89-$140.47.
Clorox has many other brands besides its famous bleach as it includes Tilex, Kingsford, Glad, Burt's Bees, Scoop Away, and a few other well-known products.
Sales for the company have increased 1.9% over the last 12 months and EPS has risen by 7.9% over the same time frame.
This compares to an industry average of a 2.1% increase in sales over the last 12 months and an increase in EPS of 6.2% over the same time frame.
The balance sheet raises some major cause for concern. The current ratio of 0.95 is below the comfort zone of 1.0, but the major problem lies within the Debt/Equity.
As of the most recent quarter the Total Debt/Equity is 781.14%, well above the industry average of 102.4%.
This is the equivalent of owning a house worth $1 million and owing $7.8 million on that house. That is a frightening situation to be in.
One other area of concern is the company’s price to tangible book value is not material. This is due to the acquisitions of the many different companies Clorox has acquired, but is still worrisome as the company has no tangible equity.
Looking forward to June 2018, estimated EPS of $5.77 gives us a target sell price of $95.21.
This company appears to have many problems and would not be one that we would recommend to help spruce up your portfolio.
Do you have a question or a company you'd like me to take a look at? Email us at Brent@WilseyAssetManagement.com or Chase@WilseyAssetManagement.com!