Private Equity May Grab Your Future Wealth

After I recently lamented the strong performance of Exxon (XOM) stock despite the price of oil being in the $40 range and the necessity for the oil giant to take large write-downs, I speculated that the rise of indexing strategies in the stock market means that people will be sending through automatic buy orders without much regard for whether the fundamentals of the business deserve increased demand for the stock.

A reader forwarded me an on-point discussion of this topic between a young Bill Ackman and Charlie Munger that took place as part of “The Buffett Essays Symposium” in 1996.

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Procter & Gamble Stock: The Future Won’t Match The Past

Let’s compare snapshots of Procter & Gamble between 2006 and 2016.

In 2006, each share of Procter & Gamble represented $2.64 in net profits. In 2016, each share of Procter & Gamble earned $3.67 in net profits. That seems like a disappointing, though tolerable, ten years of 3.35% annual growth.

The reality is worse, though. Over this time Procter & Gamble added $7 billion in debt and leaned on that financing along with $20 billion in retained profits over the decade to retire 500 million shares of stock.

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Predicting A Bad Investment

You have probably heard ad nauseam about how the low interest rates of the past nine years have caused many investments roughly classified as dividend growth stocks to become overvalued because they have served as substitute investments in place of bonds. My corollary is that the balance sheets of most large businesses are under-scrutinized right now. Cash-rich balance sheets aren’t leading to premium valuations, and excessive debt doesn’t seem to impose a penalty right now.

I had this in mind when I studied the balance sheet of Post Holdings (POST), an acquisition-hungry St. Louis company that owns some familiar brands, including: Power Bar, Shredded Wheat, Fruity Pebbles, Raisin Bran, Grape Nuts, and Honey Bunches of Oats. These brands aren’t strong enough to demonstrate industry-leading pricing power, but they are strong enough to raise prices by a bit more than inflation costs each year. If Post Holdings had a strong balance sheet and traded around 15x earnings, I’d cover it regularly on the site as a “Top 50” investment.

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Dodging Mediocre Retirement Investing

Some general market analysis from Research Affiliates that I completely agree with:

“It doesn’t seem like much to ask for–a 5 percent return. But the odds of making even that on traditional investments in the next 10 years are slim. Research Affiliates looked at the default settings of 11 retirement calculators, robo-advisors, and surveys of institutional investors. Their average annualized long-term expected return? It was 6.2 percent…One message that John West, head of client strategies at Research Affiliates and a co-author of the report, hopes that people will take away is that the high returns of the past came with a price: lower returns in the future.”

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Costco Stock: Long Road To $300

I’ll cut to the chase: It should take ten to fifteen years for Costco stock (CSCO) to reach an earnings level that would justify a price of $300 per share, roughly double the $149 price of Costco stock that existed as of Friday’s close.

Considering that Costco stock only offers a starting dividend yield of around 1%, I assume that most people own Costco stock because they want it to give them strong capital appreciation.

That makes me pose the question: What business results would be necessary for this stock to legitimately double in value?

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