There are some aspects of Benjamin Graham’s “enterprising investor” philosophy that have no appeal to me, because they don’t suit my style and also because I don’t believe that I have the skill set to execute in real life—for instance, Graham describes one type of enterprising investor as one who buys in low markets and sells in high markets. The reason that style does not suit my personality is because stock prices tend to track business performance (at least loosely) and the price of a stock is usually at its highest when its business performance is at its best. I’d want to be around reaping the benefit of Nike’s 16% dividend hike or Visa’s string of dividend growth north of 20%, not moving out while you are reaping the most fertile harvests of a company’s business cycle.
The second, and more logistical, reason why I don’t follow Graham’s first definition of an enterprising investor is because selling businesses at highs is much easier said than done. Imagine if a company’s stock performance has been similar to the S&P 500’s since 2009. When did the stock market reach a high: After the 26.46% gain in 2009? The 15.06% gain in 2010? The 2.11% continued inching upward in 2011? The 16.00% gain in 2012? The 32.39% gain in 2013 (seriously, who saw that coming)? The 13.69% gain in 2014? Five out of the past six years have been well above what we should historically expect, and all six years have found an investor richer than before the year began. Timing things correctly is hard; finding excellent businesses at decent or attractive prices is much more doable.
With that in mind, I like to tweak Graham’s definition of a conservative and enterprising investor and combine the two into one: the conservative investor’s insistence on high-quality companies with an enterprising investor’s insistence on bargain stocks. I view the combination as something like this: Let’s find a great company at a moderately discounted price. With that as our objective, I see a lot of appeal in Phillips 66 as a long-term investment.
What I like about Phillips 66 is that the company easily passes my survivability test (e.g. if oil was at $40 per barrel for the next seven years, it would still be a solvent, profitable company) and it also has some interesting business strategies that should bode well for long-term shareholders. First of all, it has a low dividend payout ratio stemming from its artificially low dividend payout at the time it got spunoff from Conoco Phillips in April 2012. In 2012, its first quarterly dividend payment was $0.20. This is a company making over $6 per share in profits even with lower oil profits. The dividend has since gone up to $0.50, or $2 annually, but it’s still only about a third of net profits.
In the broadest sense, this is what Phillips 66 is right now: A downstream and midstream oil and natural gas company that makes $3,700,000,000 in annual profits that mails out $1,036,000,000 of those profits to shareholders as much dividends. They have about $2.7 billion of profits remaining each year from left to make share repurchases and make large capital investments in future refining projects.
The share repurchases do play an important role in insulating shareholders from seeing some of the volatility that we’d expect with oil prices: For instance, each share of Phillips 66 stock made $6.48 each in 2012 profits. In 2014, it made $6.50 per share in profits, even with oil prices down 55% in the last six months of the year. What I find interesting is this: Phillips 66, as a business, actually saw its profits decline from $4.2 billion in 2012 to $3.7 billion in 2014. The decline in oil made the business less profitable for the time being, but because Phillips 66 has been reducing the share count, you’re actually up two cents amidst the oil decline. When oil prices rise, there are fewer shares outstanding to share the profits with, so the profits per share increase by a rate than would otherwise be the case.
Is Phillips 66 as good as Chevron and Exxon? No, if oil went down to $30 or something like that from 2015-2020, I would much prefer to be fully invested in both Chevron and Exxon. But Phillips 66 holds my attention for a few reasons: even with oil down to $50 per barrel, it’s still on pace to make anywhere between $3.0 billion and $4.5 billion in the next year, due to refinery upgrades at its Sweeny facility. It is using actual profits to retire stock and boost the earnings per share, which dampens the sting of short-term declines of profitability and sets you up for added wealth when prices recover.
The risk/reward scenario is highly favorable—the company only has $6 billion in debt while doing $180 billion in annual sales that is the result of refining 2.2 million barrels of oil per day. It will make $3 to $4 billion per year going forward, even with current oil prices. Basically, it has the present profit-generating ability to wipe out all of its debt clean in two years if it so chose (though Phillips 66 wouldn’t actually do so because the debt is locked in at very cheap rates that will only require $300 million in interest payments over the life of the borrowing period).
In other words, my thesis with Phillips 66 amounts to this: It has the demonstrated ability to survive and remain profitable even if oil prices remain, as it makes $3+ billion profits with $50 oil and has a conservatively financed balance sheet. From there, there are attractive qualities like a low dividend payout ratio that paves the way for manageable dividend coverage and share repurchases that allows shareholders to reinvest at these lower prices and then experience more significant profit per share gains when profits do recover. It is this last bit, the snapback in profits both due to refining gains and share repurchases if oil heads north of $90 per barrel, that makes it so attractive because the price of the stock will likely go up much more significantly than Chevron or Exxon when energy prices rise.