"Advertising is totally unnecessary. Unless you hope to make money."
- Jef I. Richards
What's true for companies is also true for investors. Advertising spending can be a leading indicator, one that provides valuable information on future stock-market leaders and laggards.
Professor Richards' quote acknowledges the power of advertising, which can put companies in a position to connect with their customers, bring in more revenue and reap higher profits.
But a number of companies, in these challenging times, are cutting back on their advertising budgets. This could trigger a downward spiral, leading some companies to even lower revenue as fewer customers are exposed to their products.
To profit from this, all investors have to do is follow the money -- the advertising money. And for that, data from the media information company Nielsen is a great place to start.
Nielsen says advertising spending was down -15.4% in the first half of the year, which should come as no real surprise in this tight economy. Even less surprising was the drop in advertising spending by both auto manufacturers and car dealerships, which trimmed their ad spending by -31.4% and -26.2%, respectively.
The Nielsen report also contained a few surprises. The pharmaceutical sector is traditionally a stalwart during economic downturns. From the market's perspective that has held true. The Dow Jones U.S. Pharmaceutical Index has eked out a +0.5% gain In the past 12 months versus the S&P 500's -14.3% loss. But when it comes to ad spending, drug makers started tightening their belts, cutting back on ad spending by -11.3%.
Once ad spending falls, more cutbacks generally follow. For instance, Eli Lilly (NYSE: LLY) trimmed its advertising in the second quarter. This week it said it was cutting -13.6% of its work force. Advertising also may have been the tip of the cost-cutting iceberg for Pfizer (NYSE: PFE), which is ratcheting back on just about everything as it prepares to pay for its $6.8 billion acquisition of Wyeth (NYSE: WYE).
Not every sector is hunkering down. One product group, in fact, more than doubled its ad spending in the first half of the year: Smartphone companies increased their ad spending by +104%. The devices, which can access the Internet, play video and support a myriad of applications, are selling strong in this otherwise cautious economy.
The biggest beneficiaries of the smart phone advertising may not be limited to the phone manufacturers. Manufacturers, after all, just sell the phone. It's wireless providers that sign up smartphone users and generate multi-year revenue streams. Companies like Verizon (NYSE: VZ), Vodafone (NYSE: VOD), and AT&T (NYSE: T) stand to gain, piggybacking off the burgeoning manufacturers' ad budgets.
As an investor, you want a company to believe in its ability to grow profits. While almost every company will talk the growth talk, advertising spending is a good indicator that a company is walking the growth walk.