Did someone hear the Euro Drop?

A few months ago, all you heard about was how weak the dollar was and how Government borrowing was causing all Americans to lose wealth. Now it's the Euro's turn as they have weakness in many of the poorer nations. So while the US Economy slowly recovers and the Asian story remains unchanged, the fear that the Europeans will derail the whole thing has given us a correction.

The real question you have to consider is whether the recovery is going to be derailed. Ultimately, the value of a company is based on its profitability. Now past profitability has little relevance, so what you consider is the ability of a company to continue to be profitable and hopefully that it will increase its profitability.

Currently, most American companies are profitable and while many are still cautious, they see profitability continuing as long as the recovery continues, even at a tepid rate. So take a company like AT&T which has solid earnings, is expected to have earnings increase and is trading at about 12 times earnings and also pays a significant dividend. You can get almost 7% holding that stock. Yet it has fallen from its high of over $28 to around $24. In fact with the drop in value, it is closer to 10 times earnings than 12. Is it expected that the cell phone market is about to dry up? Not by anyone I know. The only factor that seems somewhat negative for AT&T (as well as Verizon and others) is that consumers are not as willing to sign multi-year contracts in exchange for a big phone discount.

Now, this could impact the profitability somewhat, but remember the company already has a huge subscription base among consumer and corporate customers and it reported that the I Phone is making inroads with business users.

So, the how do you account for the drop in the stock price? I mean, while admittedly there should be a premium for taking common stock risk versus buying a treasury bond, T gives you almost double the 10 year rate, doesn't tie up your money and has essentially no negative indicators of any substance. In fact by my rather simple calculations, the company is simply undervalued by the market by 15%.

Oddly, this is approximately about the percentage decline in the Euro vs. the Dollar over the last few months. So let's think about what this might mean. Suppose you think in Euros. AT&T was selling at 20 Euros a share when it was at $28 and the exchange rate was at 1.4 dollars per euro. 20 Euros will only get you $24 at an exchange rate of 1.2. So if you simply think of T in Euro terms, the price hasn't changed much at all.