US shares

In January I am able to cash in my dollars. This means two things:

• I am no longer heavily exposed to the US dollar.
• I have a lot of cash available to invest (enough to increase my share portfolio by around 50%).

So the US stock market becomes a viable place to invest. Previously I've limited myself to buying Berkshire Hathaway at the irresistable price of $2380. At $3540 I'm up 50% in $ terms, but in £ I'm only up 25%.

At the moment I'm agnostic as to whether the US market is good enough value to be worth investing in. But rather than decide in January, I think it's worthwhile starting to investigate the possibilities now, and keeping an eye on how things move over the next 6 months.

Dividend tax

I'll be taxed 15% on any dividends paid by US companies. While I live in the UK (and have a wife paying basic rate tax) that's a significant disadvantage over buying UK shares. But once I move to Norway I'll be lumbered with some dividend tax no matter whose name the shares are held in - and the US witholding tax will be offset against the Norwegian liability.

There seems little point targeting high-yielding shares (although I don't rule them out).

S&P fair value

Based on historical earnings and P/E ratios, fair value for the S&P 500 is about 900. It's current trading at about 1000, so is moderately overpriced at the moment. I'm not averse to investing at these sorts of levels, but I will be selective.

Possible candidates

A few different sorts of investment appeal:

• Good quality blue chips beaten down by the market. General Electric springs to mind here, but there are undoubtedly others.
• Large-cap growth shares that are reasonably valued. Buffet-type shares: Johnson & Johnson, Coca-Cola?
• Technology shares, if they are reasonable valued. Google, Microsoft, Amazon?
• Corporate bonds - a decent yield, US$ exposure, and adding some diversity to my portfolio.

One investment I'm definitely excluding: US treasury bonds. An uninspiring yield, and a vast programme of money-printing by the Fed: not a good combination in my view.

Google

Let's take a look at Google first:

Net tangible equity: $22bn

Revenue: ~$22bn

Post-tax earnings: ~$6bn

Dividends: No

Selecting info from their latest 10-Q:

"as of June 30, 2009, our two founders and our CEO, Larry, Sergey, and Eric, owned approximately 90% of our outstanding Class B common stock, representing approximately 68% of the voting power of our outstanding capital stock"

"We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future"

How enduring is Google? I'm sure it will be around in some form in 10 years time, but it relies largely on having a large share of the search market. I think it could be displaced by Microsoft - Microsoft can leverage their dominance of the OS and browser markets to drive search traffic through their own site.

What is a fair value for Google? They dominate a fast-growing highly profitable market, have an impeccable financial strength, a strong history of earnings and revenue growth, wide margins, and a powerful brand.

On the other hand, we should not get too carried away. Google will likely face increased competition in the future; their margins and growth will come under pressure. The future of the internet is inherently unpredictable. They are not run for the benefit of ordinary shareholders. Their earnings could very easily be frittered away on unprofitable acquisitions, or simple hoarded, benefiting shareholders very little.

I think a reasonable P/E ratio is around 20, which equates to a market cap of $120bn vs their current market cap of $144bn (at a shareprice of $457).

So Google is a little overpriced at the moment. I'd say $380 is a fair price.

Microsoft

Net tangible equity: $26bn

Revenue: ~$58bn

Post-tax earnings: ~$15bn

Dividends: 52c per share (yield: 2.2%)

I would say that Microsoft have a more secure revenue stream than Google, but without the same growth potential. They return a large part of their income to shareholders via share repurchases and dividends - in the last year about 1/3 to dividends and 2/3 to buybacks.

I would say a fair P/E ratio for Microsoft is a little lower than that of Google: 18. That is a market cap of $270bn, which is a share price of ~$30. That compares to their current share price of $23.50 - so I'd say MSFT is undervalued.

Amazon

Net tangible equity: $2.2bn

Revenue: ~$19bn

Post-tax earnings: ~$600m

Dividends: No.

So, what is a fair value for Amazon? They dominate a sector of online retail, they have a tremendous growth record and the prospect of continuing it into the near future. Their size gives them strong purchasing power and fantastic economies of scale when it comes to distribution. I'd say a P/E ratio of 20 is reasonable. That's a market cap of $12bn, or around $28 per share.

Their current share price is an astonishing $85. Assuming that eventually their growth rate will moderate to ~10% per year, and at that rate they justify a P/E ratio of 20, that means their current 30% growth rate must continue for another 4.5 years. I reckon I can get a 10% return on plenty of other shares, so applying a 10% discount stretches that required growth period out to about 7 years.

Amazon's net profit is around 3% of revenue. If that continues to hold true, then in year 7 their revenue will have to be $125bn. That compares with:

• Walmart $400bn
• Carrefour $140bn
• Tesco $80bn

So to justify their current share price, we are looking at Amazon leapfrogging Tesco to become the world's 3rd biggest retailer - without selling any consumer staples. Or, alternatively, they may start to achieve a better margin, improving profitability and boosting their share price. That seems more likely - but can they do that and continue to fight off competition?

There is way too much growth factored into Amazon's share price.

General Electric

Net tangible equity: $8bn

Revenue: $183bn

Post-tax earnings: $18bn (allegedly - but they somehow only paid $1bn in tax!)

Dividends: $1.24 (yield: 8.3%)

GE is a behemoth. Their growth in the recent past has been driven by GE Capital Services - the financial crisis has rather put the skids on that one.

Their earnings for the first half of 2009 are down on 2008. This year they might earn ~$12bn. On those reduced earnings I'd be prepared to put a P/E ratio of 15 on them. That's a market cap of $180bn, a share price of $18.

They current trade at $14.70 - they look reasonably cheap.

Johnson & Johnson

Net tangible equity: $15bn

Revenue: $64bn

Post-tax earnings: $13bn

Dividends: $1.795 (yield: 3%)

Johnson & Johnson don't have a great deal of debt: $12bn, easily covered by one year's earnings. About 17% of their earnings come from consumer healthcare; the remainder is split fairly evenly between pharmaceuticals and diagnostic devices.

JNJ's growth comes from (a) R&D, which counts as a cost and therefore reduces profits, and (b) acquisitions, which are paid for out of earnings. Their is a constant rate of attrition as their drugs lose their patent protection and suffer from generic competition.

JNJ increase dividends by around 13% per year. Their dividend cover has remained consistent at around 2.5 times.

Their gross margin is constant at around 70%, so their growth has not come from squeezing margins.

The split of sales between the US and international has remained roughly equal. So the growth is not wholly dependent on rampant US healthcare expenditure.

Long-term debt is constant at around 10% of assets, so growth has not come through leverage.

All of this is quite impressive. A consistent 13% growth rate is not to be sneezed at. It can't be maintained forever (because JNJ would take over the universe) but there seem few signs of it moderating yet.

I'm going to give JNJ a P/E ratio of 16. That puts fair value at $73, or a market cap of $210bn. They current trade at $60, so JNJ are somewhat undervalued, in my opinion.

Coca-Cola

Net tangible equity: $8bn

Revenue: $32bn

Post-tax earnings: $5.8bn ($6.4bn underlying)

Dividends: $1.52 (yield: 3.1%)

What is there to say? Coca-Cola dominates the non-alcoholic beverage market. Most of its revenue now comes from outside the US, primarily from emerging markets. Its tremedous return on equity means that it can grow successfully while distributing most of its earnings as dividends.

I would give Coca-Cola a reasonable P/E ratio of 16. Multiplying by the underlying earnings of $6.4bn that gives a market cap of $102bn. With 2.3bn shares outstanding, that gives a fair price of $44 per share. They currently trade at $49, and therefore I reckon they are slightly overvalued.

McDonalds

Net tangible equity: $12bn

Revenue: $23.5bn

Post-tax earnings: $4.3bn

Dividends: $1.625 (yield: 2.9%)

McDonalds have about $10bn in debt, or about 2.5 years worth of profits. Not too bad.

Like Coca Cola, McDonalds is a very powerful brand with global appeal. They have growth prospects in emerging markets. Like Coca Cola they have spectacular return on equity.

I would give McDonalds the same P/E ratio as Coca Cola: 16. That equates to a market cap of $70bn, or $62 per share. Currently the share price is $55, so McDonalds is slightly undervalued.