Even though I’ve generally anointed The Coca-Cola Company as the signature stock that I associate this website with, I’m opening myself to the possibility that perhaps Colgate-Palmolive should be the quintessential company that I reference here.
At this point, I realize we’re arguing degrees of perfection in the business model. But the reason why I’m considering the possibility that Colgate-Palmolive should become my primary exemplar is this: there are two factors that make a company a quality investment. First, there is the quality of current profits. And secondly, there is the long-term growth prospects for those profits.
In terms of quality of the business model, Coca-Cola and Colgate-Palmolive are nearly identical. They sell well-branded products that people buy regularly, and they do it at a cheap price. The returns on shareholder equity for both companies is enormous; in the Wild West days, you would need a ski mask and pistols to get the kind of returns that Colgate-Palmolive and Coca-Cola shareholders have experienced. They both get about 35-40% returns on total capital. Coca-Cola spends a dime coloring water and then selling to for a buck or two, and Colgate-Palmolive spends a quarter or two packaging toothbrushes and toothpaste and cleaning solutions, and then selling it for a couple bucks. Both are wonderful long-term business models.
One thing in Coca-Cola’s favor is this: Colgate-Palmolive has “generic risk” in a way that Coca-Cola does not. With Coca-Cola, the business model risk is two-fold: first, they might lose market share. But the market share is largely limited to PepsiCo and Dr. Pepper, and to a smaller extent Kraft and Nestle. You might switch from drinking Coca-Cola to Pepsi, from Powerade to Gatorade, from Dasani to Aquafina, from Diet Coke to Diet Dr. Pepper. With Colgate-Palmolive, they have to deal with warding off Procter & Gamble and Kimberly-Clark, but they also have to deal with generic, bland no-name brands like Wal-Mart’s “Equate.” During the recent financial crisis, some shoppers showed a willingness to transition from Colgate toothbrushes to generic brushes with no brand backing. In Coca-Cola’s case, you don’t really have to worry about people drinking a Wal-Mart soda-water concoction.
And then, there is the fact that Coca-Cola has to deal with declining volumes for some carbonated volumes as well as more intense scrutiny from government regulations that want to curb soda consumption, either through regulations on serving sizes or additional taxes on the product. Coca-Cola will overcome this and generate substantial wealth for shareholders in the long run, but it’s a slight headwind nevertheless. Colgate-Palmolive, meanwhile, is growing volumes just about everywhere, and it’s pretty inconceivable to imagine a world in which toothpaste and wood cleaner products draw the ire and intense scrutiny of politicians.
That leads into the second component of what makes a perfect investment: the growth story. Coca-Cola is still growing very well in emerging markets, but it’s already in 210 countries. That probably sets Coca-Cola long-term organic growth rate at a ceiling of 11% or so. Colgate-Palmolive, meanwhile, is still in the earlier stages of its international growth story. In some emerging market countries, the company is growing profits at rates north of 20% annually. You don’t see it as clearly in the recent earnings reports because Venezuela is devaluing its currency in a way that has cost Colgate-Palmolive almost $500 million in total compared to the dollar, but in about a year or so, the “clean” earnings per share figures will start to reflect Colgate’s long-term growth power a bit better.
But like I said, a lot of this is arguing perfection: Coca-Cola has grown profits 9.5% annually over the past five years. Colgate, meanwhile has grown profits 8.5% annually if you count the negative currency conversions, but has grown around 11% annually if you pretend that every currency remained static against the dollar over the past five years. Obviously, you can’t spend that 2.5% that doesn’t exist because of the dollar’s general strength, but it offers a useful glimpse of Colgate’s profit engine.
Long-story short, Coca-Cola might have slightly higher earnings quality, and Colgate-Palmolive might report slightly higher earnings per share over the long term. If not Coca-Cola’s superior, I should at least start treating Colgate-Palmolive as Coca-Cola’s equal. And of course, it’s not an all or nothing proposition. You don’t have to hitch your financial fortunes to just one company. You can easily make both Coca-Cola and Colgate-Palmolive the twin pillars of your portfolio.
If the business model quality is so obvious, and the growth prospects so predictable for both, why doesn’t everyone do it? Shiny object syndrome. A guy that sells his business for $750,000 isn’t going to want to slug away $100,000 of it towards Colgate because it will pay out $2,230 in initial dividends. You can very easily find higher yields elsewhere. It’s not what Colgate does for you now that is so impressive, but rather, what it does for you as a lifetime partner that causes jaws to drop.
In 1983, Colgate yielded 1.8%. Nothing impressive. Yet, every $1,000 you invested in Colgate back then would be paying out $6,483 in annual dividends. Every 56 days, Colgate would generate as much dividend income for you as your entire initial investment. The catch is that it took 32 years to do that. It’s not every day you meet someone that thinks, let alone acts, in terms of decades, but it is nice to know that sweet rewards await those who wrap up diligence, patience, and money into a giant ball of delayed gratification and let it roll.
Originally posted 2014-04-04 11:08:41.