Right after ConocoPhillips announced a 66% dividend cut in February 2016, a user with the name “nylitigator” offered this very reasonable sounding comment in response to the suggestion that Conoco was a buy:
“I don’t understand what is attractive about COP after the dividend cut. COP is down 45% or so over the last year (and I understand that one year with any energy company is way too short of a time), but COP is down 27% over the last three years and down about 15% over the last five years (I believe this takes into account the dividends received).
So if you were long COP over the last 5 years you’re still down 15% and now have an approximately 3% dividend to look forward to collecting. I have to believe that there are better places for me to invest my money.”
As a factual matter, that comment was incorrect because it failed to include the 2012 pure stock spin-off of Phillips 66 which has performed well in the interim. If you bought ConocoPhillips in 2011, you’d be up almost 40% on your position today (note: historical investment calculators may misreport this fact because they treat Phillips 66 as a stock dividend for approximating value rather than keeping track of a spun-off security and then plugging it back into the calculation of the former parent even though that would truthfully reflect the situation for a passive holder of the old Conoco since 2011).
But I don’t want to quibble about that because the guy did have a good point–Conoco was down 45% of the past year at that moment, it did slash the dividend to a 3% yield, it was reporting losses in the hundreds of millions, and it didn’t seem particularly enticing with oil in the $30s.
And yet, you know how I feel about cyclical companies (oil stocks in particular) at the moment they announce their dividend cut. If it is not the moment of maximum declines, it is usually near it, as the pessimism about the business model is seemingly validated and the shareholder base shifts from dividend investors to value investors.
The premise of this type of value investing–searching for cheap stocks—almost necessarily implies that the business you are studying has some problems with it. That’s almost the point of it. The theory is that the identification of those problems has led to an overreaction in which the stock gets sold off at a far greater than it deserves.
Four months later, Conoco shareholders now find themselves up 37.5% from that February 9th/10th low at the time of the dividend cut. It’s in the top two tenths of one percent of investments in the U.S. markets that you could have made on that day.
Always remember this: At the time a value stock gets cheap, the market has punished the price of the stock more than the fundamentals of the business deserve. But when the operational outlook for the business improves a moderate bit, you will then reap greater returns than the change in the fundamentals would suggest that you deserve. Capturing the spread between the value at punishment and the deserved value is what the “margin of safety” provides you.
This is why I wrote yesterday’s article about Viacom. Like Conoco, it does have some operational issues. The fundamentals had/have come down over the past five years. There is a lot of pessimism. The issues aren’t precisely the same–the Viacom dividend isn’t in jeopardy and it continues to gush out billion-dollar profits amidst its fall in value, but the long-term concern about ad rates is similar to the long-term concern about the price of oil.
In Viacom’s case, the appeal is that the stock is only trading at 8x earnings. That is crazy cheap–the operational concerns wouldn’t have fairly punished the stock price below $60. Hence, the recovery from $41 to the low $60s represent that spread between the value at punishment and the deserved value which is what the “margin of safety” provides you. It’s the same play as before, just using different actors with each iteration.