Since 1900, there have been two sets of conditions in which it has been extraordinarily difficult to be a long-term, buy-and-hold investor. Those were the Great Depression conditions that surrounded 1973 (no duh), and the 1973 bear market in which the earnings of even great non-cyclical companies (think Pfizer, Johnson & Johnson, PepsiCo, Coca-Cola, Procter & Gamble) collapsed. 2008 is an honorable mention if you were an investor in the financial sector.
With many blue-chip stocks cutting their dividends in half and earnings falling by at least that much (and prices falling by 75% or more), you couldn’t assess the present fundamentals of the company and see that the prices were irrationally cheap—maybe in the narrow sense that you saw that the prices plummeted more than profits, but it had to be weird to see AT&T go from earning $4.88 per share to $2.8 per share, Procter & Gamble go from earning $3.25 per share to $1.79 per share, and so on. If that’s what the dominant firms were doing, you can guess how the rest of a stock portfolio might have fared.
One thing I wanted to do this afternoon is talk about the rare class of company—ExxonMobil, Wal-Mart, and IBM come to mind—that has no choice but to repurchase shares of the company’s stock. If you read much investment commentary on the company, you will walk away with the impression that IBM has no plans for growth or moat-building and is surviving slowly on the use of existing cash flow to retire stock to create an illusion of progress.
To understand why IBM makes the capital allocation decisions that it does, I find it wise to keep IBM’s size in mind. IBM is one of those two or three dozen firms in the world that when you buy an ownership stake, you are really buying into something that is the size of a small country. For instance, the company is going to generate about $97 billion in revenue or so this year, conditional upon the next quarter’s report. As a point of reference, the entire country of Libya produces $95 billion worth of goods and services in a year. The entire country of Morocco produces $95 billion worth of goods and services each year. The entire country of Puerto Rico produces $105 billion worth of goods and services per year. So when we talk about IBM, we’re talking about something that has an output roughly the size of Libya, Morocco, or Puerto Rico.
Over the past ten years, Coca-Cola has increased its profits from $5.0 billion to $9.2 billion. The profits per share have increased by a little more than that (from $1.03 to $2.10) due to a stock repurchase program that has reduced the number of ownership units you have to share the profits with from 4.8 billion to 4.3 billion. The company has increased its cash on hand over the past two years from $13 billion to $18 billion. The soda giant’s sales have gone up from $21 billion to over $46 billion during the 2004-2014 stretch. And plus, you collected a rising cash payment during each of those years we’re examining (and it’s a streak that now goes back more than half-a-century in total).
Generally speaking, it is wise to hold investments that pay out high streams of dividend income inside the confines of an IRA, so you can avoid those frictional taxes that take a tax bite out of each dividend payment and limits your compounding engine (though there is also wisdom in owning something like Starbucks in an IRA because IRAs have contribution limits and getting large capital gains inside the account can be useful, too).
Usually, the blue-chip stocks that are candidates for consideration are things like tobacco (Philip Morris International), telecom (AT&T), and oil (Royal Dutch Shell, BP, and sometimes Conoco). You don’t get an opportunity to diversify into the health-care field all that often, if you’re looking strictly for high income candidates: Johnson & Johnson has a present dividend yield of 2.77%, Abbvie yields 2.97%, Abbott Labs yields 2.08%, and Pfizer is a bit better with a 3.66% yield. But GlaxoSmithKline is a notable exception.
One of the obstacles that prevents people from being successful investors is that buying stocks tends to lack the tangibility that owning a small business (like a storage unit or cash wash in your community) or real estate can provide for an investor.
When it comes to stocks, it’s an acquired taste to reach the point where you think in terms like these, “Each share of McDonald’s earned $3.67 in 2008, $3.98 in 2009, $4.60 in 2010, $5.27 in 2011, $5.36 in 2012, and $5.55 in 2013, while returning between 47% and 56% of those profits to shareholders in the form of cash dividends over that time frame.” Instead, the initial impulse is to think, “Oh no, the stock fell from the $60s to the $40s in 2008, better sell because this isn’t working.”
Some perspective on IBM: For the June 30th through September 30th 2013 period, IBM reported a profit of $3.68 per share. For the June 30th through September 30th 2014 period, IBM reported a profit of $3.68 per share. Each share of third-quarter profit is the same year-over-year. And, though, nobody is talking about it now, IBM is still expected to earn $16.04 in annual profit for 2014, compared to $14.94 last year. Though it has gone completely undiscussed in the past several days, IBM is still on target to post profit per share growth of 7% when you compare 2014 against 2013.
I was reading an investor forum recently where a commenter said that he was contemplating a purchase of shares in Vanguard’s legendary Wellington Fund that has a track record of delivering 8.5% annual returns to investors dating back to 1929, making it one of, if not the, oldest balanced fund in the nation.
He said that he wasn’t going to buy shares because it had trailed the S&P 500 over the past three and five years. For reference, the Vanguard Wellington Fund has returned 12.32% over the past three years and 13.95% annually over the past five, while the S&P 500 has returned 16.58% and 18.83% over those same time periods, respectively.
While I am flattered—and I mean this sincerely but I’m not a good enough internet writer to make the depth of my appreciation jump off the screen—that some of you have written to me asking that I manage some of your money, sadly, that is not something I can nor want to do.
First of all, I mean that literally: I don’t have the proper licensing to start taking on investors.
And secondly, even though I understand that the management of other’s assets “is where the money is” when it comes to the financial services industry, it’s not something I’ve had much of an inclination to do because most people are interested in twelve to twenty-four month returns, and I have little desire to spend my life defensively explaining to others why stock selections aren’t performing better than the S&P 500 Index over the past six months, year, three years, and you get the picture. If I wanted to beat the market over the next ten years or so by owning high-quality blue chips, it could be done: it would be a portfolio loaded with Visa, Becton Dickinson, Disney, and the like, but I’d have no ability to tell you whether those stocks will be winners in 2015, 2016, or 2015 through part of 2016. Being right over a fifteen year period isn’t something that would be enough for most people; they want to see that they are right at every annual benchmark along the way. I couldn’t do that, and I wouldn’t want the hassle.
In the 2013 letter to shareholders of Berkshire Hathaway, Warren Buffett noted this: “It is important for you to realize that Bank of America is, in effect, our fifth largest equity investment and one we value highly…We can buy 700 million shares of Bank of America at any time prior to September 2021…We are likely to purchase the shares just before expiration of our option.” Even though Buffett’s terms on the deal are much, much better than what any investor could get by going online, typing in the ticker symbol BAC, and clicking the purchase button, the fact that Buffett values the position highly and will likely make Bank of America such a meaningful portion of the Berkshire Hathaway investment portfolio seven years from now indicates positive sentiment about the long-term future of the bank.