If I had to make a list of the obstacles that can prevent people from successfully applying some of the sound investing principles found in Benjamin Graham’s early writing, one of the spots would be reserved for lack of patience—stocks that are unpopular can sometimes remain unpopular and underpriced for a long period of time, and it can become tempting to sell a stock simply because the price of the company isn’t moving forward as fast as you’d like (by the way, a lack of patience can also be a problem with companies that move upwards too fast—Exxon Mobil turned $100,000 into $1,800,000 over the past twenty-five years, and I’m sure a quick gain from $100,000 to $130,000 in 1989 or 1990 brought some investors out of the stock).
But it is selling stock before they get a chance to deliver returns for investors in line with actual business performance that causes the most obvious problems for long-term investors. The story of Abbott Labs from 2003 through 2011 is the most notable recent example of this trend, as far as companies in that bluest of the blueblood class go. I’ve always paid special attention to large healthcare stocks because they have been the best performing stocks in the S&P 500 since its formation with virtually no bankruptcies among the class. When you include Abbott’s 50+ year of dividend raises, I get very interested.
And yet, despite Abbott’s excellent track record, the company’s share price stagnated for many years even while the dividends piled up and the earnings continued to expand. In 2003, Abbott Laboratories made $2.21 while paying out 44% of its profits to shareholders ($0.98). At some point in the year, you could have paid $47 to start your ownership position in the stock.
Fast forward to 2011, and the business of Abbott Labs was in a much better place: earnings per share has grown to $4.66, and the dividend had grown to $1.88 (consuming only 40% of profits). During that time frame, the business doubled its profits for shareholders, and the dividend almost doubled as well. Yet, the price of the stock itself traded for $47 at some point in 2011. Eight years of more than satisfactory performance, and at that moment in time, the only thing that a 2003 investor in Abbott Labs had to show for the investment was the dividends received.
And it’s not like Abbott Labs was crazy overvalued or anything in 2003—it traded in the range of 20-22x profits, which was well below its historical range and in line with the earnings per share growth that it came to deliver within the next years. Rather, what happened is that the stock of Abbott Labs became unseasonably cheap, hitting a low point of 10-11x profits in 2011 as investors grew concerned about Abbott’s future growth potential (this is something that regularly affects even the most well-run healthcare companies that regularly deal with intellectual property going off patent, as investors tend to exaggerate the long-term effects of the expiration and drive the stock price down to something cheaper than it would deserve).
This story of Abbott Labs is something I find it important because it is a reminder that even the most well-run companies can go through a very long period of underperformance—heck, Abbott Labs was the company that Benjamin Graham himself used as the textbook example of a buy-and-hold stock in the 1920s. For those familiar with the performance of the S&P 500 since 1957, you already know that large healthcare stocks are the best performers (in aggregate) in the entire index. Abbott hadn’t failed to raise its dividend for more than five decades. The earnings per share grew just about every year—there’s not a whole lot more you can ask, and yet it remained undervalued.
That’s one of the main reasons why I thought that Windsor Fund manager John Neff was on to something when he described dividends as hors d’oeuvres that allow you to snack while waiting for the main meal to arrive (this was Neff’s simile to describe the act of receiving cash as an important way to receive bits of wealth even when a stock fails to trade at a price that it deserves).
That’s why I consider companies like McDonalds and IBM, which are working through some problems growing revenues, as great ways to engage in value investing because you receive a decent present stream of cash right now that ought to keep rising each year even as it may take a few years for the business to wow investors and drive the valuation upward. In hindsight, those long-term profitable companies that share cash with their owners during times when the stock is cheap end up creating more wealth anyway as those reinvested dividends create new shares that pay dividends in their own right that get to experience the inevitable P/E expansion. Considering that a company of Abbott Labs’ caliber could spend eight years trading well below its worth (and even getting cheaper!), a company that grows its dividends while cheap will give you a significant advantage over those that don’t because (1) of the turbo-charged wealth effect just stated, and (2) as a matter of behavioral psychology, it’s a lot easier to sit tight and be patient when you’re collecting growing distributions of cash each year while you wait.