Every now and then, you stumble across a company that does not show up on the radar of many investors, often due to its size, lack of a dividend, or decidedly unsexy business model that nevertheless ends up producing a whole lot of money for people that start a position in the stock and hold on to it for a few years. One company that falls into that category is Autozone.
What has the car part replacer done over the past ten years? Two things have happened at this business: one, they have rolled out new stores across the United States, increasing the store count from 3400 to a little over 5000. This has enabled the company to grow its profits from $500 million per year to a little over $1 billion per year. Given that there is no dividend, you might imagine that shareholders have doubled their money over the past ten years.
But there is more to the story than that. Way more. Instead of paying out a dividend, the company has had an enduring, unstoppable, relentless—whatever word you want to use—commitment to reducing ownership units of its stock. Ten years ago, the Autozone business was divided up into 79 million pieces. Now, it’s divided into 32 million pieces (and if you want to go back to 1998, the company had 150 million shares outstanding then, meaning about four out of five shares have been retired over the past sixteen years. That’s crazy, crazy good).
So the people who have owned shares of Autozone for a long time have benefited from two nice things coming together over the past decade—growing profits mixed in with free cash flow being used to get rid of other owners that could lay claim to the stock’s profit so that each year the company’s profits have to be split up among fewer owners. I’ll put in the clearest form I can: In 2004, Autozone made $500 million that had to get divided into 79 million pieces, so that buying one share of Autozone stock represented $6.32 in profit. In 2014, Autozone made $1 billion in profit that only gets divided into 32 million pieces, so that each share of Autozone stock that you buy represents $31.25 in profit.
Over the past ten years, the profits per share that Autozone has generated have quintupled, even though the business performance has only doubled. The remaining part of the growth has come courtesy of the stock repurchase program. Companies like Autozone are nice niche investments to have in the taxable account of a portfolio, because they silently compound quickly without drawing any tax consequences because U.S. domestic policy currently taxes dividends in regular brokerage accounts, whereas the capital gain does not get taxed until the time that you elect to sell.
The usefulness of carving out a few spots in a portfolio for the likes of Autozone is that the rapid growth can get converted into higher income at the time you decide you want to actually start collecting and spending dividends.
For example, someone who bought $25,000 worth of Coca-Cola stock twenty years ago would have $131,000 today, generating $3,785 in annual income. Pretty sweet, considering you had to do nothing over the past twenty years except collect the dividends and spend the cash. If, however, you chose to buy Autozone stock twenty years ago, and needed to start generating income today, you would have seen a $25,000 investment in Autozone twenty years ago grow into $531,000 today. If you converted that to Coca-Cola, you would have to pay taxes—say, 23.8%, and have $404,000 working for you in Coca-Cola stock immediately generating $11,675 in annual income.
Investing in a non-income generating stock does have its place, particularly when (1) you are investing in a taxable account, and (2) you have found a company growing profits per share north of 11% or so that is trading at a reasonable valuation, and (3) you do not presently have any purpose for which you would need to generate immediate dividend income. When those conditions come together, it makes sense to add things like Google, Berkshire Hathaway, Autozone, and a few others to your household holdings because they can serve the important purpose of building wealth much faster when economic conditions range from normal to good. And as an added bonus, the specific non-dividend stocks mentioned in this post also kept chugging out reliable profits during the 2008-2009 downturn as well.