Hershey stock has come down 15% since the Christmastime period when I wrote about it being overvalued. The price currently sits at $93 per share (down from the January high of $111). I would classify the current price as high end of fair value. Many people will look to the 2.3% dividend yield and conclude that it is too low to meet their needs.
I certainly get that. If you have a plan to live off dividend income within the next ten years, you are going to receive much higher checks if you buy Chevron at $105 per share, lock in a starting yield of 4%, and reinvest those dividend payments until the time comes when you need the cash.
But, over super long periods of time, companies like Hershey will have the best dividend growth rates of all because people eat chocolate in bad times, ordinary times, and good times, and the dividend payout perpetually marches onward. The company states in their annual reports that the nation is obsessed with the Reese’s Peanut Butter brand, and the volume of Reese’s continues to grow even as they jack up the prices.
If you have paid attention to the price of Reese’s over the past six years, you will have noticed that the price of the peanut butter chocolate has doubled in grocery stores. In 2004 or 2005, you could have seen Reese’s candy bars on sale for $0.40 at Wal-Mart or something. Those days are gone. For most of America, you are going to pay $1.24 at Wal-Mart and you will rarely find Reese’s on sale for $1. But here is the thing: Even as the price has gotten up substantially, the volumes continue to grow between 3% and 5% each year.
For the past ten years, Hershey has been able to do what Procter & Gamble cannot. When P&G raises the price of Gillette razors, the volume shipments decline. When the razors go on sale, the volume gains aren’t enough to offset the amount of the sale price. That’s why Procter & Gamble has seen its dividend payout ratio increase from 40% to 60% as earnings have mostly stagnated since 2007, and there has been a merry-go-round of executive firings at Procter & Gamble as the company looks for leadership that can achieve price increases and volume growth simultaneously.
Hershey, meanwhile, is raising the price of its chocolates and shipping out more chocolates, and that is why most analysts are calling for long-term earnings per share growth between 8% and 12% (and keep in mind for the past century Hershey has achieved 16% annual returns, so this isn’t exactly an unusually great era for the firm’s business. This is what Hershey does. America loves chocolate, and the company is happy to provide it.)
It seems to be going through the same thing Disney did in the 1990s and 2000s—the management team realizes that you can raise the prices by a lot, and the people still come in droves. Analysts will call you brilliant and you’ll be featured in magazines as Businessman or Businesswoman Of The Year even though you know your only great insight was unleashing suppressed value when you took advantage of the untapped energy of your predecessors and tested what the market would bear for your popular product.
Most people look at Hershey’s dividend yield of 2.3% and figure it could never grow into something that would change a life. This kind of thinking ignores what happens when you have a high growth rate that is sustained through all economic cycles. In 1985, Hershey traded at 25x earnings and offered a dividend yield of 1.5%. It didn’t seem like the kind of thing that could be useful to income investors. Yet, by 2015, the $0.06 dividend in 1985 grew to $2.14 per share. If you wanted to generate the average American household’s income of $53,000 per year in 2015 with Hershey dividend, you would have needed to invest $40,000 in 1985. You’d also be sitting on a $2.2 million capital gain.
I have a special fondness for companies that are worth 20x earnings (or maybe a bit more) and also have high natural earnings per share growth rates. Sure, it’s nice that each dollar in profit gain also manifests itself in another $0.40 in dividends for shareholders. But it is nice very beneficial to see each dollar in earnings per share gains correspond to a $20 gain in share price. Hershey is expected to grow its profits per share by $3 in the next six years. If that happens, the price of the stock should fairly go up $60.
I would imagine that paying between $85 and $90 per share would fit the classic definition of buying a wonderful company at a fair price. With the current quotation at $94 per share, we’re getting there. Adding something like Hershey really changes the composition of your portfolio. At the time you buy it, you never really feel like you’re getting a sweet deal. Then, you look back a few years later, and see how important the stock is for adding stability for your portfolio.
The dividend keeps going up. The earnings per share growth is over 10% in good years and mid-single digits in slightly bad years. It tends to become one of the faster growers in a conservative account, and the growth is usually rewarded in the share price as it only takes a nickel in per share growth to justifiably raise the price of the stock $1. The dividend has doubled since 2007. The stock, much like the products, rarely go on sale, and it probably takes a couple years of seeing the dividend and earnings per share growth before you start to feel very fond towards your decision to buy Hershey stock in the first place.