Playing the Weak Dollar Is Harder Than You Think - TheStreet

The drop in the dollar has boosted exporters in a big way this year. But jumping blindly into companies that do business abroad could be a mistake, say some analysts.

So far this year, the top 10 companies in the

S&P 500

with the heaviest foreign exposure are up 45% on average, in line with the

Nasdaq's

performance. That's not too surprising given that four of the names on the list are technology-related.

The dollar has fallen about 8% against the yen and 10% vs. the euro since the start of the year, as the U.S. government has backed away from its strong dollar policy, and as the Group of Seven industrialized nations have tacitly encouraged Japan and China to let market forces determine their exchange rates.

Japan has been intervening to weaken its currency in an effort to protect its exports, which account for about 10% of the country's gross domestic product. Meanwhile, many believe that China is keeping its currency, the yuan, artificially low by pegging it to the dollar.

Although some worry that a weaker dollar will prompt foreigners to take money out of dollar-denominated assets, it can also be a boon to corporate earnings. Domestic firms that sell products overseas benefit from more favorable currency translations and from greater demand.

According to data from Merrill Lynch,

Freeport McMoran Copper & Gold

(FCX) - Get Report

is currently the most exposed to foreign markets, deriving about 93% of its sales from abroad. The stock is up 124% this year.

Texas Instruments

(TXN) - Get Report

,

National Semiconductor

(NSM)

and utility outfit

AES Corp.

(AES) - Get Report

, which all get more than 75% of their sales from abroad, have also done very well, rising 70%, 155% and 168%, respectively.

Still, Merrill Lynch global strategist David Bowers points out that correlation does not necessarily imply causality. Just because these stocks have performed solidly this year doesn't mean that's a direct result of weakness in the dollar. Nor does it imply that these stocks will continue to do well in the future. "There may not be a link," Bowers said. "And I don't think it's satisfactory to say overseas sales are high, therefore it's

a good

stock to own in this environment."

The extent to which a company benefits from its international operations depends on a number of factors, Bowers said. If a firm is producing goods in America and shipping them overseas, that would enhance its competitiveness abroad. But if much of the production is based overseas, as is the case with

Tupperware

(TUP) - Get Report

, the only effect of a weaker dollar would be from better currency translations. Tupperware receives almost 85% of its sales from countries other than the U.S. but is up just 2% for the year.

Other firms have the opposite problem.

Intel

(INTC) - Get Report

and

Nobel Corp.

(NE) - Get Report

, for example, sell almost all of their products abroad in U.S. dollars, not in local currency. So while it's cheaper for foreigners to buy their goods, there's no immediate boost to earnings from currency translations. Both Intel and Nobel derive about 68% of their sales from abroad.

"Looking for companies that benefit from the simple translation of earnings attributable to the weaker dollar might prove more beneficial than looking for companies that might have increased competitiveness," said Richard Berner, chief quantitative strategist at Merrill. "A weaker dollar is indeed good for U.S. earnings. However, a key point may be the unanticipated sensitivity of non-U.S. economies to the strengthening of their own currencies. Weak non-U.S. growth might simply get weaker."

Another consideration is the effect of hedging. Freeport, Texas Instruments,

Applied Materials

(AMAT) - Get Report

and others all hedge against currency fluctuations, meaning that big swings in the value of the dollar don't have as much impact on their earnings. Only a few names like

Nvidia

(NVDA) - Get Report

are completely unhedged. Nvidia gets slightly more than 68% of its sales from abroad, according to Merrill.

Despite these caveats, analysts say it's important to consider the effect that currency fluctuations can have on companies. Bowers noted that some stocks have historically fared poorly during periods of dollar weakness.

Specifically, he said

State Street

(STT) - Get Report

,

Northern Trust

(NTRS) - Get Report

and

Citigroup

(C) - Get Report

all underperformed a global benchmark when the euro appreciated vs. the U.S. dollar.

Banc of America

(BAC) - Get Report

,

Sovereign Banc

(SOV)

and

M&T Bank

(MTB) - Get Report

were losers when the yen strengthened against the dollar. Bowers said financials fare poorly because a weaker dollar implies that rates will go higher to attract foreign capital and financial stocks are more sensitive to rate hikes than other sectors of the market.

"You've got to be aware that historically there has been an association which may impact these stocks going forward," he said. "But I think it's dangerous just to

make decisions on currency forecasts

alone. You've got to use this as one of a number of tools."