Just last night, I was reading through the annual report at Waste Management (WM). It is the definition of a stable cash generator. You can lump it alongside utilities and consumer non-cyclicals as “best type of stock to hold during a recession.” I personally like it because trash is a self-evidently unsexy business, and the executive culture at such businesses tends to be light on stock bonuses, general dilution, overhyped acquisitions, and other largesse that tends to attach to billion-dollar enterprises.
Over 25+ year periods of time, you tend to get 3.5% revenue growth and 7.5% earnings growth with a business like this. Throw in a 2.5% dividend, and your results will tend to mirror the S&P 500 over long periods of time.
If you are investing according to Warren Buffett’s “Twenty Punchcards” or trying to put together a career where you beat the S&P 500 by four points annually, Waste Management is not going to be your stock. If you are building a portfolio of 50 common stocks where you want 30 stocks to be recession-proof sources of income during the worst economic conditions you will ever encounter, then Waste Management is something you’ll want to give full due diligence.
But any time you are studying a business that generates single-digit growth over the long haul, you will want to make sure to get the price right.
Normally, businesses like Waste Management are such an afterthought that the price is nearly always fair or better. Heck, even during 2007, Waste Management traded at $32 in relation to $2.07 in per share earnings for a P/E ratio of 15.5.
But when I pulled up a quote, I saw that the stock was at $64! What are these people thinking? The stock’s earnings are only at $2.85 per share for a P/E ratio of 22.5x earnings. Why are you paying 22.5x earnings for literal trash? From 2007 through 2016, earnings only grew at a rate of 3.41% annually ($2.07 to $2.85).
This is a mid-single digit growth business. Heck, you can get Nike stock at 22x normalized earnings, and Nike at least grows its earnings at 13-17% annually over the long haul. Who are these people out there that prefer Waste Management to Nike? Between 2016 and 2036, it wouldn’t surprise me if the cumulative wealth produced by Nike ended up quintupling what you’d get with Waste Management.
And the worst thing is that Waste Management has recently begun depleting its cash position to repurchase shares at a high valuation. Two years ago, it had $1 billion in cash against $9 billion in debt. Now, it has $9.5 billion in debt and only $39 million cash in the bank. It would be difficult for me to name five “ordinary” corporate maneuvers that bother me more than the sacrifice of liquidity for the sake of short-term financial engineering.
My thoughts while I studied Waste Management are similar to how I view the S&P 500 as a whole. There’s just a lot of businesses out there that you’d like to buy at 15x earnings, and there have been a lot of moments in recent history when you could get them at that price, that are now trading in the 21-24x earnings range. When single digit growth stocks trade at 25-33% overvaluation, you are setting yourself up for single digit returns in the decade ahead. The dividends get offset by the P/E compression. It’s nowhere near as bad as the tech indices in 2000, but it is nevertheless frustrating if you’re the type of person who doesn’t like to buy a business knowing that the stock returns will trail the earnings growth.