There was a moment in 2016 when Hershey stock was trading at $82 per share while earning $4.41 per share in profits for a valuation of 18.5x earnings. It was something that struck me as an example of “buying a wonderful company at a fair price”, and I purchased shares. The stock briefly rose to $113 per share for a rapid 37.8% increase. By June 2018, Hershey was down to $92, for a 12.2% gain.
Did that bother me in the slightest? No, because Hershey was growing its profits along the way. Profits per share in $4.41 (2016) had climbed to $4.76 (2017) then to $5.36 in 2018. The company was growing profits at a 10.25% compounded annual growth rate. It was moving along, doing what it has always done.
What I find noteworthy right now is that the stock has climbed from $105 in February to $138 now for a quick 31.43% gain in a less than four month period of time. We have all seen those studies that point out if you miss the top ten, twenty, or forty days in the stock market’s performance, your total returns tumble rapidly–i.e. if you subtract the ten biggest market up days between January 1, 1998 and December 31, 2017, an S&P 500 Index fund would have only returned 3.53% rather than 7.20%. With Hershey, you can see this principle play out right now as approximately three years’ worth of returns have been delivered to shareholders over the past four months.
For the past ten years, Hershey has grown profits at 8.5%. Over the past twenty, 9.2%. Over the past 30 years, 8.7%. Something close to that is probably going to continue, and Hershey will continue growing its profits at around 8%. My guess is that, five years from now, earnings per share will be around $7.50 per share, and at a valuation of 21x earnings, stock should trade around $160 per share. Right now is probably the first time in five years or so that Hershey could be fairly classified as an overvalued stock. I’ll continue to hold because it’s a great business, there are dividends, and I don’t part with spectacular recession-resistant assets growing at a high single-digit growth rate just because some future return might be sacrificed due to P/E compression.
When you study Hershey, I think you should pay attention to the fact that the shareholder wealth is generated in “rapid wealth clusters” that come in abrupt spasms rather than a linear fashion. Since 2008, Hershey has climbed from $32 per share to $138 per share. With Hershey stock in particular, $53 in capital appreciation occurred on just 11 days. That figure is a little bit particular to Hershey because Mondelez made a failed takeover bid in June 2016 that took the stock from $90 to $115 instantly, but still, that moment passed without a takeover and eventually that abrupt price rise became embedded in the value of the stock.
Warren Buffett has frequently referenced that successful investing is more about temperament than intelligence, quipping that you don’t need to be the kind of person who wakes up in the middle of the night and understand why “E=MC squared” in order to be a successful investor. He is right about that.
Anyone can figure out that Hershey is a great business. Anyone can figure out the same thing about Coca-Cola, Johnson & Johnson, Nestle, and Procter & Gamble. The recognition of the business’ greatness on the merits is not wherein the difficulty lies. First, it’s about getting your hands on the capital so you’re actually executing the buy orders and getting your hands on ownership in these companies, and secondly, it’s about the temperament to withstand years of underperformance.
Each of these businesses I mentioned have had periods where the stock didn’t do much in a 7 out of 10 year stretch. That is tough. At best, we are looking at an investing lifetime of fifty years. One fifth of that could be spent with a stock underperforming, with you wondering whether you selected a poor investment or whether the payoff is around the corner.
The answer is that the business will eventually be worth its future cash flows. If the profits are growing annually right before your eyes, but the capital appreciation isn’t coming, you stand a high likelihood of having your patience rewarded unless you dramatically overpaid or the business may be subject to some earnings impairment down the road. The businesses I have mentioned are almost never overvalued until their P/E ratio exceeds 20, and their business lines are so core to the human experience and the business lines are so diversified that the earnings impairment is as remote of a risk as it could be.
From there, it comes back to patience and recognizing that years of gains can be realized in months, seemingly like a success that comes overnight when really a foundation lasting years was the necessary condition precedent to realize the objective. I find it is easier to deal with the “patient” part of the equation if you spend your time improving your labor market skills and generating surplus cash elsewhere to make other investments that can be planted in accordingly.