These Stocks Have Dangerous Exposure

"Europe hasn't been steamrolled like this since the U.S. Dream Team ran their basketball teams off the court in the 1992 Olympics."

That's the hilarious and oh-so-accurate line my Global Gains co-advisor Nathan Parmelee tossed out to describe the carnage we've seen on the continent over the past few months since the Greece debt crisis dropped.

Yet Europe's problems didn't start with Greece, and won't stop there. Debt and deficit issues plague many of Europe's countries, including Italy, Spain, Ireland, and Portugal.

Furthermore, it's not clear that the joint EU/IMF near-$1 trillion bailout will be enough to help these countries get through this crisis, or if Europe's governing financial bodies have enough autonomy to continue to implement decisive action plans.

All of this has caused investors to sour on Europe, its businesses, its growth potential, and its currency. A single euro now fetches just $1.22. That's a 15% drop since the beginning of the year, as well as a low not seen since 2006.

With analysts expecting the euro to fall further, the question is: Are you inadvertently exposed?

What, you worry?
Even if you don't own European stocks, the euro contagion has the potential to spread into your portfolio. Many blue-chip U.S. businesses derive a significant amount of business from Europe. As the euro continues to weaken, these sales will be worth less in dollar terms, and profit margins will narrow. And while many European stocks have already dropped to reflect this risk, many U.S. stocks with the same magnitude of euro exposure have not.

Consider, for example, the following list of U.S. companies. All are up since the euro started plummeting some three months ago, despite their significant euro exposure.

Company

Revenue Exposure to Europe

Trailing 3-month return

Rofin-Sinar (Nasdaq: RSTI  )

70%

11%

Paccar (Nasdaq: PCAR  )

35%

12%

EMC (NYSE: EMC  )

31%

9%

McDonald's (NYSE: MCD  )

41%

8%

Autodesk (Nasdaq: ADSK  )

39%

5%

Data from Capital IQ and Morningstar.

If you own any of these stocks, you may now be worried about the euro exposure that has crept into your portfolio. But what can you do about it?

Don't sell...hedge
One approach would just be to sell. However, the downward pressure on the euro is a temporary phenomenon, and a company like McDonald's has significant future opportunities to grow operations in other markets around the world. If you sell now, you may never get back in.

Another option is to hold and ignore the volatility. While this is a reasonable approach, many investors don't have the stomach to watch stock prices swing wildly. That tends to be most true of investors near or in retirement.

So if you don't want to sell, and you don't want to hold, your other option is to hedge. That means buying protection against the euro exposure, so that if the decline in the euro causes these stocks to drop, your loss would be balanced out by gains in your protective vehicle.

Here's a hedge that worked
Back on April 1, worried about the future of the euro, I recommended that investors buy Philip Morris International (NYSE: PM  ) , a good company with strong cash flows and growing emerging-markets exposure that had been sold off because of its 46% revenue exposure to Europe.

Yet even though I thought the stock was cheap, I thought it might sell off more if the euro continued to drop. As a result, I recommended that investors also hedge that position in Philip Morris International buy buying $1 worth of ProShares UltraShort Euro (NYSE: EUO  ) , an exchange-traded fund that rises as the euro falls, for every $2 worth of Philip Morris International. Here's how that trade has worked out thus far:

Position

Return since April 1

Philip Morris International

-14%

ProShares UltraShort Euro

+22%

Total Hedged Position

-2%

Although Philip Morris stock has declined, the hedge has worked to protect our principal. And while I expect to maintain the euro short for the time being, given the problems in Europe, as the pressure on the euro alleviates in the future, we can roll our gains on our euro short into Philip Morris at an even more attractive price. Again, this is a strategy anyone who owns the five stocks listed above should consider.

That just happened
This is just one example of how trading strategies such as hedging can help you protect against downside in the stock market, while preserving your opportunity to bank profits for the long-term.

Further, it's the secret to how our portfolio management team at Motley Fool Pro expects to make money in all types of market environments. By hedging and judiciously employing tools such as currency and commodity ETFs and options, investors can avoid volatility and profit regardless whether the market is down, flat, or up.

If that's an approach you'd like to learn more about (and who wouldn't in these volatile times), simply provide your email address in the box below.

Tim Hanson owns shares of Philip Morris International. Rofin-Sinar Technologies is a Motley Fool Hidden Gems selection. PACCAR is a Stock Advisor pick. Philip Morris International is a Global Gains recommendation. The Fool owns shares of and has written covered calls on Autodesk. The Motley Fool has a disclosure policy.


Read/Post Comments (22) | Recommend This Article (37)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 04, 2010, at 1:38 PM, Bman409 wrote:

    Thanks for this article. This reminds me of an article I read a year ago, or so, which stated that McDonald's had to withdraw all of its restaurants from Iceland, due to the currency (Krona) crashing.

    The reason is that McDonald's buys its ingredients globally, but sells them locally. So, if the a hamburger sells for 5 euros, but the ingredients cost 6 euros, because the euros isn't worth anything.... well you get the idea.. Anyway, the same dynamic that drove McDonald's out of Iceland could hurt them in Europe.

  • Report this Comment On June 04, 2010, at 3:14 PM, plange01 wrote:

    europe is fine it just caught a dose of the depression the US has been in for the last year and a half.the US is the problem collapsing deeper into a depression and there is no president to make decisions...

  • Report this Comment On June 04, 2010, at 3:15 PM, TMFMmbop wrote:

    Real time update: Today's drop in the euro has put the hedged position into the green.

  • Report this Comment On June 04, 2010, at 4:42 PM, longtermgrowth09 wrote:

    Tim maybe i feel better waiting for the euro to fall around a dollar to then buy PM on cheaper prices because the etf has very high expense ratios and could be more dangerous than wait and see. I feel currency movements are unpredictable in the short term also. euro can rebound short term and the etf position can collapse. thank for the advice. do you think that if i have to choose just one stock to allocate 100% of my money i have to choose PM because of its quality given the dubious foreign numbers of smaller companies and unproven managements?

  • Report this Comment On June 04, 2010, at 4:47 PM, longtermgrowth09 wrote:

    I read all your articles and i came to a conclusion that if you allocate 5% of total portfolio in 5 chinese companies you are assuming a couple will fail another couple will have good returns and just 1 will gain huge but its just 1% of the portfolio and the commision costs increse with the basquet , why not allocate all the money into Phillip Morris given quality and management, lower comission costs and lower risks with a growing divi over time? it will be unbeatable i think. i dont know i was planning to do that. i like your insight also. i will appreciate your comment.

  • Report this Comment On June 04, 2010, at 5:12 PM, TMFMmbop wrote:

    Why not do both? PM has its own risks (litigation, for example) and portfolios will benefit from diversification.

  • Report this Comment On June 04, 2010, at 9:28 PM, xetn wrote:

    Why not buy puts on say, MCD to hedge rather that hedging against the Euro?

  • Report this Comment On June 04, 2010, at 9:52 PM, longtermgrowth09 wrote:

    Yes i know that in theory diversification matters but i have the inclination to bet in big on specific names. only an style. thanks. China Marine Food also sports good valuation but its pretty suspicious why so cheap? i think its a good stock because you said you can trust management but remember that they only show you what they like during the trips. remember FUQI and im more inclined to buy growth elsewhere.

  • Report this Comment On June 04, 2010, at 9:52 PM, longtermgrowth09 wrote:

    thansks.

  • Report this Comment On June 04, 2010, at 9:54 PM, longtermgrowth09 wrote:

    FUQI is a scam. i cant trust managers lying about numbers. scary.

  • Report this Comment On June 04, 2010, at 10:16 PM, longtermgrowth09 wrote:

    tim, how many chinese companies did you know that have problems with governance and numbers? many? a handfull? 2? 20?

  • Report this Comment On June 04, 2010, at 11:22 PM, longtermgrowth09 wrote:

    One final though: if you can retire on the dividends of PM why risk the capital on smaller ventures ? it doesnt make sense to me in that case. any thoughs? Tim? The cost of living in south america is too cheap to ignore this fact im telling you. im living in south america.

  • Report this Comment On June 04, 2010, at 11:23 PM, longtermgrowth09 wrote:

    h

  • Report this Comment On June 04, 2010, at 11:29 PM, longtermgrowth09 wrote:

    I will share with you my best ideas so you can tell me what do you think if you like it.

    Domestic : Hansen Natural.

    International: Phillip Morris.

    China Marine Food,

    China Green Agriculture.

  • Report this Comment On June 04, 2010, at 11:29 PM, longtermgrowth09 wrote:

    k

  • Report this Comment On June 04, 2010, at 11:36 PM, longtermgrowth09 wrote:

    They all sport good valuations and good growth. Second , when you are betting on the US, except count exceptions like HANS its very difficult to come up with a monster gainer because the market is already saturated and its rare to see hansens very often . the best is to invest in them after they prove they can growth(mid cap status) this for domestic securities because its dominated by big names like coke in beverages and so on. this is why hansen is speccial cause the first beverage to be profitable since decades. repetitive business that can last.

    no crocs. no overvalued tech garbage. im referring to real business.

    International it only make sense to go with a strong multinational like PM or with small chinese securities because the market offer more oportunities for growth cause of the fragmented industries.(agriculture)-

  • Report this Comment On June 04, 2010, at 11:36 PM, longtermgrowth09 wrote:

    l

  • Report this Comment On June 05, 2010, at 11:58 AM, jrj90620 wrote:

    Just read a good article yesterday about how Europe is better off than the U.S. The article states that Europe,due to protectionist policies,has a larger manufacturing base than the U.S. and that with a lower Euro it will be able to export more.Also,every report I read says Europe's students are much better educated than Americans.Another thing is that Europe isn't wasting $Billions(maybe $Trillions) on military adventures around the world.I wouldn't be so fast to dis Europe when the U.S. is such a mess.

  • Report this Comment On June 06, 2010, at 12:11 PM, plange01 wrote:

    europe has merely caught a dose of the growing depression in the US. as this gets worse all stocks are in trouble...

  • Report this Comment On June 08, 2010, at 7:26 PM, sagitarius84 wrote:

    MCD should do fine over time - they have China

    http://bit.ly/9DtcyL

    Enjoy!

  • Report this Comment On June 09, 2010, at 5:59 PM, gimponthego wrote:

    I'm rather new to the market. I have 8 stocks and a question for you. Among my holdings are many shares of BRKB. Someone told me the other day that particular stock "is like a mini-hedge fund."

    Is that a viable way to look at it and why?

    Thanks,

    Johnny / San Antonio

  • Report this Comment On June 15, 2010, at 7:06 PM, philkek wrote:

    M.F. Thanks for this public exposure to many fool opinions. Good read. I've bet on the bull and the bear. Bet on different parts of the world. Sometimes I win. Sometimes I lose. I'm still learning. Someday I hope to learn enough to NEVER lose in any market. haha. Dream on, fool. Meantime, I enjoy and LEARN things I never knew before. Some suggestions are very rewarding as I have owned PM on M.F. advice. MCD sounds good to me. M.F. teaches better understanding of FUNDAMENTALS. 4 & 5 STAR stocks are good starting points for more homework. Fool on for honest gains.

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