Peter Lynch once remarked that casual investors know just enough to be dangerous when they start combining two principles—the belief that having heard of a company that’s been around for a while is proof that it is of blue-chip quality with the belief that a low price-to-earnings ratio is proof that a stock is cheap.
By way of example, Lynch pointed to Ford Motor Stock (F) at the high point of a business cycle right before the economy turns for the worse because: (1) stock prices tend to be high when the economy is doing well, making investors feel more comfortable about making new stock investments despite all the historical studies pointing out that this is a bad impulse, (2) Ford “feels like a blue-chip” because investors have heard of it, and (3) the low P/E ratio lures people in, who are unaware that automotive profits fall 50-75% as the economy moves from the top of the expansion to the bottom contraction part of the business cycle.
I had this Lynch example on my mind as I recently compared two companies that sound very blue-chippy—Campbell Soup and The Walt Disney Company—but offer very different prospects for long-term investors.
At first glance, Campbell Soup sounds like an equal, almost superior investment, to Walt Disney. You could have the abstract notion that when times get super tough, soup would be more indispensable than entertainment luxuries, and plus, you could see Campbell Soup’s dividend yield in the 3% range and compare it favorably to Disney’s dividend in the 1% range.
The catch? Disney is much more diversified than you might think—they own what you watch on television (Disney, ABC, ESPN, etc.), they own what you watch at the movies (the list of movies dating back to Mary Poppins is too long to specifically mention), and then the remaining third of the business is the cruiseliners and theme parks that are most readily identifiable with the Disney brand.
And the growth rate differential between the two is enormous: Over the past ten years, Campbell Soup has grown at 5% per year, growing the dividend at the same rate as profits. For Disney, the results are much better. Earnings have grown by 15% over the past ten years, and the dividend has grown by 11% annually.
That leads to significantly different results over time:
In 2003, you could bought both Campbell Soup and Disney for $20 each.
If you bought 500 shares of Campbell Soup for $20, your starting dividend income would have been $0.63 per share, or $315 annually. Now, those $20 shares are worth $44 each, and your annual income would have become $624, or roughly double your starting place in 2003 if you did not reinvest the dividends.
In the case of Disney, that $20 share would have grown to $90 per share, and your starting income of $105 in 2003 would have grown to $430 today. It’s still a few years off from catching Campbell Soup, but the capital gain differential is enormous—Campbell Soup’s price more than doubled, whereas Disney’s stock price is crossing over from quadrupling to quintupling over the same time frame.
If someone already owns Campbell Soup, I get why they would keep it in the portfolio—it hums along, giving you reliable annual that makes it a nice part of a diversified portfolio. But when you are at the beginning construction stage, you are trying to balance two interests: quality plus earnings growth. Campbell Soup passes the test on the quality front, but lacks on the growth front.
If someone needs a yield around 3%, I don’t understand what kind of thought process would lead someone to prefer Campbell Soup or Exxon Mobil or Chevron. In the case of the oil giants, you’d be at roughly the same starting point you’d get with Campbell Soup, but your earnings growth rate and dividend growth rate would be much higher (in the 8-12% long-term range, compared to the 5% range you’d get with Campbell Soup).
Meanwhile, I can completely understand why someone would like Disney—it’s one of the few established blue-chips that realistically has a chance of growing at a rate over 10% for the upcoming ten years, and this creates the potential for significant capital gains that you won’t get with Campbell Soup. A common admonishment from financial professionals is that you should avoid yield-chasing—which is something that can occur when you accept much lower growth rates in the pursuit of a higher starting yield. When you compare companies like Campbell Soup and Disney side by side, sure, you get a higher starting yield from Campbell Soup, but Disney’s growth rate and potential for significant pops in share price is so substantial that it would be a bad tradeoff to pursue Campbell Soup’s higher immediate dividend income.