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.