In Grinding It Out, the story of McDonald’s, Ray Kroc explained the financial engineering that drove the company to prosperity in its early days: “The formation of Franchise Realty Corporation, was to my mind, a stroke of financial genius. Franchise Realty was the supreme example of a guy putting his money where his mouth is. We started Franchise Realty Corporation with $1,000 paid-in capital, and Harry parlayed that cash investment into something like $170 million worth of real estate. His idea, simply put, was that we would induce a property owner to lease us his land on a subordinated basis. That is, he would take back a second mortgage so that we could go to a lending institution (in the early days it was a bank) and arrange a first mortgage on the building; the landlord would subordinate his land to the building. I must admit that I was a bit skeptical: Why would a landlord want to do that?
In a sign of the times, a few readers have contacted me over the past months asking what you’re supposed to do when your brokerage account balance exceeds $500,000 and the amount of your account is no longer covered by SIPC insurance.
As many of you know, the federal government is the first backstop against institutional failure. You got $75,000 in a bank account, and the bank goes under? No problem. You’re covered up to at least $250,000. Got $125,000 sitting in a credit union somewhere? No problem. NCUA insurance has you covered for at least $250,000. And because credit unions have no shareholders, the risk of institutional failure is minimal because the credit union is run to benefit the lives of depositors and other customers whereas banks have to charge higher fees to make a profit for shareholders. Plus, there is the prospect of demutualization. Every now and then, a credit union decides to convert into a publicly traded company, and when it happens, the depositors become the public shareholders.
Between 2011 and 2015, Procter & Gamble raised its dividend from $1.97 per share to $2.65 per share. During these four years, each share of P&G that got purchased at $60 in 2011 paid out $11.50 in cumulative dividends if you forward count the September and December payments. At an average reinvestment price of $68.23 over the past four years, and assuming the final two payments get reinvested at the current market prices, an investor would have created 0.168 shares of Procter & Gamble over the past four years just by making a singular decision in 2011 and checking off the reinvest box.
Every now and then, a reader will want to know what kind of formula can be easily plugged in to figure out what stocks to buy. I can think of useful approximations to get the process started. If a newbie investor only considers companies that have been raising dividends for 20+ years with earnings per share growth of at least 5% annually over the past ten and then selectively removes the financial and tech companies from the list, he will put together a pretty darn good portfolio. It’s not a perfect test—companies like Dr. Pepper and Hershey would be great lifelong holds even though they don’t have the dividend history due to buyouts and a two-year dividend freeze. And I would much rather own those companies than something like Vectren that has been raising its dividend every year for decades.
In 1988, the private equity firm of Kohlberg Kravis Roberts was on the prowl to take over a company after making hundreds of millions of post-tax dollars quickly from the leveraged buyout of Reynolds Tobacco. It wanted to buy The Kroger Company, a large American grocer that looked small enough to be taken over by activist investors. Because KKR wanted to oust the then-existing management at Kroger, the management team sought a creative strategy to keep out KKR so that they could keep their jobs. At the time, KKR did not engage in the golden-parachute strategy of paying off executives handsomely to relinquish control of the company and go away.