If you’re familiar with the writings of Peter Lynch, one of his observations that you will encounter is the notion that when companies report great earnings, the price of the stock will tend to overshoot and make the company a little bit more expensive than what it should fairly be. This happens on the way down, too—when a company reports disappointing results, the price of the stock tends to get cheaper than deserved (and becomes the interest of value investors). In reaction to this typical phenomenon, Wall Street analysts have the annoying tendency to downgrade and recommend selling stocks that deliver earnings growth that is better than anticipated.
At the time I am writing, Chevron stock crossed below the $100 per share threshold (in fact, the company hit a low price of $98.88 today). The current yield of the stock is around 4.3%. That starting base is particularly exceptional when you factor into account how quickly it tends to grow. For every share of Chevron that you owned in 1998, you got to collect $1.22 in dividends. Now, you get to collect $4.29 per share. The long-term dividend growth rate, while sporadic on a year-to-year basis, has a tendency to converge around the high single-digit rate: over the past five years, Chevron has raised its dividend at 9.5% annually. Over the past ten years, the rate is 9.0% annually. And over the past twenty, a little over 8.5% annually.
I was going through some old notes taken by investors that had visited California for Charlie Munger’s old meetings with WESCO shareholders that he would host annually before Berkshire Hathaway fully took it over, and one of my favorite back-and-forth exchanges occurred when an investor asked Munger why the philosophy of Benjamin Graham—namely, buying mediocre companies selling at deep discounts—never caught fire with him.
In his reply, Munger said it would quickly grow tiring “dealing in crap” and it would be much more fun owning something with a strong franchise value that retains profits and has the ability to permanently charge premium prices. This part is the critical reason why Coca-Cola, Colgate-Palmolive, Clorox, Hershey, Heinz, and PepsiCo shareholders have made so much money consistently over the years. They make people rich not just because there is the standard gap between what it costs to produce the goods and the price at which they sell them, but there is a premium price above that standard retail price as well. That extra bit of cost in each soda, mac and cheese, or oatmeal, is insignificant on an individual basis until you start to multiply it across billions of goods mixed with shares bought, held, and reinvested over the decades.
In 1972, the Morgan Guaranty Trust (in conjunction with a few other investment advisory companies) launched an advertisement push called the “Nifty Fifty” that proclaimed certain American companies were so dominant, they should be purchased and never sold. The intuitive appeal of this argument was obvious—people will always need food, beverages, medicine, and so on—and the companies included on the list all had excellent records of making shareholders rich, with the popular terminology at the time calling them “blue-chip stocks” rather than “dividend growth stocks.”
One of the reasons why tobacco stocks had historically been successful long-term investments is because tobacco stocks were cheap, the dividend was high, the dividend increased over time, and these three factors interacted quite well for that that chose to reinvest in companies like the old Philip Morris. But when you look at where Altria is at right now, in terms of valuation, it is as if investors have discounted the incredible risks that come with the territory of investing in a highly regulated, declining industry.
The terms of Philip Morris International’s spinoff from Altria in 2008 made it a company with characteristics that are, to my knowledge, unmatched by any other large-cap stock. And it is that Philip Morris International is a company that sells essentially the same cigarette brands that Altria sells to investors in the United States, except 0% of Philip Morris International’s revenues are generated by selling cigarettes to American investors. It’s all overseas money, except Philip Morris International keeps its headquarters on Park Avenue in New York and reports all of its profits, volumes, and balance sheet considerations in numbers that are converted to U.S. dollars.
One of the Warren Buffett quotes that gets repeated time and time again is that it’s better to buy a wonderful company at a fair price than a fair company at a wonderful price. It’s a useful piece of wisdom, but often gets used by investors to justify whatever it is they want to buy at a moment (using the adage as mere lip service to valuation). Buying Hershey at $109, Brown-Forman at $90, Colgate-Palmolive at $69, or Realty Income at $52 is NOT an example of buying a wonderful company at a fair price. Those are examples of buying excellent companies at 15-25% premiums to what they are worth.
From the end of 1998 until the summer of 2008, ExxonMobil reported annual earnings per share growth of 21%. Chevron reported earnings per share growth of 26%. When oil prices rose substantially, the profits of the two American supermajors grew at a pace we typically associate with a tech startup—not a stodgy oil company that is supposed to be all about the dividends and moderate profit growth. And of course, both Exxon and Chevron were delightful investments over this time frame. Exxon returned 14% annually from the start of 1998 until the peak of oil prices in 2008, and Chevron returned 12.5% over that same time frame.
In the field of finance and behavioral counseling, there is an oft-repeated hypothetical presented to professionals in the industry that call for them to recognize that people have different priorities when it comes to reaching goals. Often called the “Rich Grandparent”, “Rich Uncle”, “Rich Aunt” or merely “Rich Relative” hypothetical, the problem goes like this:
Your rich relative dies and leaves a will making you one of several beneficiaries—the gift you are set to receive is $20,000 in cash. However, a will contest has been filed by other relatives not mentioned in the will and the case is due for trial in two years. If the will contest is successful, you will get $0 (there is a second, earlier will that will be introduced at trial in which you are not included).