Building Wealth, Going Nowhere

A sign of a high-quality business is not that adversity never occurs, but rather, that the core engine still remains strong even when adversity does strike. It is something that comes to mind when I study the recent performance of GlaxoSmithKline. It has been an unpopular stock for quite a few years now. It has dealt with top-level executives accused of bribery, important drugs going off patent, and a lack of clearly identifiable sources of long-term profit growth. Yet, it still has a portfolio consisting of thousands of brands that cumulatively generate 28% profit margins.

Last July, news hit that the company was dealing with bribery accusations while missing its target of expected earnings to boot. If you are someone looking for good news, GlaxoSmithKline has not been your guy. But if it is receiving profits that you are after, the story has been quite different.

Since missing its earnings projections last summer, GlaxoSmithKline has paid out: $0.648 in August 2014, $0.613 in November 2014, $0.695 in February 2015, $0.576 in May 2015, and $0.592 in August 2015. That $3.12 amounted to an extra 7 shares for every 100 shares of GSK owned over the past year, as investors got to accumulate shares in the low $40s.

Something peculiar happens when cash continues to get pounded out when a stock gets cheap and expectations get low. Someone looking at a price chart over the past year would see the $44 per share price and conclude that the stock has done nothing for investors over the past year. But that is a shortsighted, superficial way to think. With reinvestment, you have 107 shares of GlaxoSmithKline in August 2015 compared to 100 shares of GlaxoSmithKline in August 2014. You turned $4,400 into $4,708. You’ve been grinding, clawing, even marching your way forward over the past year with this stock even though the business performance has been below historical expectations and it has generally been a bad news environment for the stock.

The 2016 dividend expectation for the stock is $2.70 per share. You will collect another dividend in November, and your share count should be around 108.5 by the time you collect that $2.70 per share dividend. Whatever amount you invested in 2014, you will stand to collect $292.25 in 2016. We are talking a 6.6% annual yield from a stock that does nothing; by 2017, an investor that dutifully reinvests the dividends should be crossing the 7%. That is sound blue-chip investing: Collecting 7% on your initial investment amounts within three years from a diversified healthcare conglomerate that still throws off $6 billion in annual profits even during a difficult part of its economic cycle.

All the articles about “waiting it out” and “being patient” with GlaxoSmithKline are somewhat overwrought. I hope every “bad investment” works out for you the way GlaxoSmithKline has worked out for shareholders. It is the Facebooks and Amazons that get all the attention because they deliver quick, instant gratification in terms of rising stock prices, but that won’t be taking care of you twenty years from now because bad things happen when you buy 80x or 500x earnings for a stock. If you learn nothing else from value investing, it should be that dangerous long-term results accompany companies that trade at P/E ratios that are disconnected from basic fundamentals.

There are a lot of companies out there that remind me of Dell in 1999. Back then, Dell was trading at 80x earnings, and people will talking about expected laptop market size, revenue projections, and the unstoppable tech economy. They were talking about everything exception the connection between current and medium-term earnings per share figures and the valuation of the stock. Then, the stock did nothing for a decade, and people were distressed that their retirement goals were not being met.

It wasn’t Dell that betrayed you; it was ignoring valuation that got you into trouble.

I don’t think I’ll ever get over my fondness for companies that make real things, sell them at a profit in all economic cycles, and always find a way to get something to shareholders in the form of a dividend. It is such a time-tested formula for success that it amazes me how often it gets overlooked.

The connection between the dividend income that GlaxoSmithKline will pay out to shareholders over the long term and the relatively small amount that shareholders need to invest to generate that high income should be the source of meaningful income for people planning to retire ten to fifteen years from now.

The company is a beast at rapidly growing the share count through dividend reinvestment because the payout has been generally stable while the valuation has been low. This rising share count, mixed with moderate growth, creates enough beneficial effect when the shares created from the high dividend payouts then begin to generate high income because, well, the payout is well. It’s the same story with how AT&T and Philip Morris shareholders keep seeing their share count climb into the sky over the decades.

GlaxoSmithKline sells vaccines. It sells drugs. It sells healthcare machinery. It sells consumer safety products. These are products that tend to get more sophisticated as technology develops, and though individual components in the portfolio may succumb to technology obsolescence, the portfolio of cash generators that make up the GlaxoSmithKline operating businesses are largely immune to technology obsolescence over the long haul.

Almost all of the cash is currently being returned to shareholders, and that is why GlaxoSmithKline has been similar to oil companies of late in giving investors that stick with it an opportunity grow the share count in a hurry. Better days will inevitably come ahead, and those reinvested dividends at low prices will get a bump when not only the initial investment at $44 grows to $65 per share (or whatever), but each dividend reinvested in the $40s gets dragged up to that price range as well.

It is yet another example of dividend stocks building wealth even while the perception exists that shareholders are getting nowhere. No, these are not the glory days of GlaxoSmithKline. But the current performance, with dividends reinvested, is a heck of a consolation prize. Investors should root for the earnings per share and revenues to start increasing sooner rather than later, but should enjoy the valuation in the $40s for as long as possible because it is this low valuation mixed with reinvestment that will give you an impressive yield-on-cost ten to fifteen years from now. It is like a tree that doesn’t naturally grow very fast, but keeps receiving hefty dollops of MiracleGro four times per year to create an end result that creates far more wealth than you’d intuitively be inclined to expect.

Source: GlaxoSmithKline Dividend History