About this time last year, I talked about Fayez Sarofim for the first time when I referenced his extensive art collection and some of the very interesting personal life that has marked his eight decades in the United States. I was recently reviewing his ten largest holdings registered to Fayez Sarofim & Co., and I am very impressed by the quality and growth characteristics of the portfolio that he has put together.
When I study how he has made his money, it’s one of the best things I’ve ever seen, and that is not praise I give out lightly. This is how he allocates his fund money: 5.9% to Philip Morris International, 5.3% to Apple, 4.6% to ExxonMobil, 4.3% to Coca-Cola, 3.7% to Chevron, 2.9% to Nestle, 2.8% to Johnson & Johnson, 2.8% to McDonald’s, 2.6% to ConocoPhillips, and 2.6% to IBM.
That’s it. That’s the magic formula. If you don’t ever visit my site or read any of my writing here again, the construction of a portfolio that looks like that should be the takeaway. I imagine over long periods of time, Mr. Sarofim’s portfolio will trounce the S&P 500 (remember, beating the S&P 500 by two percentage points or three over very long periods of time leads to significant wealth differentials) and better yet, these are the kinds of companies that will keep pumping out significant cash profits in the event that the global economy experiences a prolonged decline.
I was thinking about the difference between ExxonMobil and something like Seadrill after Seadrill announced that it was suspending its dividend payments in response to tough operating conditions caused by lower oil prices. From an operational standpoint, it’s amazing what a difference exists between how the two companies respond to stressful situations.
With oil prices coming down, Seadrill has developed excess rig capacity that have hurt profits such that Seadrill found itself paying $4 per share in dividends while only generating $3 per share in profits. To make matters worse, it has one of the ugliest debt-laden balance sheets I’ve ever seen. It carries $13 billion in debt, and $11.3 billion of it is due within the next five years (that is why the dividend has been suspended–the $1.5 billion in profit can be used to pay down debt obligations without issuing a bunch of new shares at this depressed valuation).
And now, you shouldn’t read this as a criticism of Seadrill as an investment right now. It is entirely possible that the price decline to $15 per share has overshot the poor business performance, and a modest recovery in oil prices could send the price up quite significantly. I’m not saying that lightly—this could be a $40 stock if the price of oil shot up to $110 and stayed there for a couple of years. But the problem? This is not the kind of company that could withstand a prolonged 2009 type of operating environment. If the last recession were to strike again, and last for three years, Seadrill would not survive absent a significant share offering.
The worst-case scenario with Exxon looks much more attractive. Right now, with lower oil prices, Exxon makes $8 per share in profits and pays out $2.76 in dividends. The dividend has been growing 8.5% annually over the past decade, and the present coverage is excellent despite lower oil prices. This is a slightly less than normal operating environment, and Exxon is still retaining almost 70% of every dollar it makes in profit. The year 2009 was probably the worst year in the company’s past three decades, and it still made $3.98 in profits while only paying out $1.66 in dividends. That’s why I consider Exxon to be a bedrock of estate planning—it’s unlike most other commodity companies because it still does so well in terrible conditions. And it also performs well when prices rise because it makes capital investments to grow production by 4%, uses free cash flow to retire 5% of the stock each year, and you also get a dividend payment plus any benefit caused by oil prices that increase over the long-term.
From 2010 through 2013, Seadrill had a dividend yield between 6% and 11%. It caught people’s attention. The problem was that the dividend took up so much of the company’s profits that the only way to grow consisted of: (1) borrowing, (2) issuing new stock, and/or (3) hoping oil prices rise. People look and see how well Exxon’s dividend is covered—and everyone knows it is an excellent business—but it gets ignored practically every day because the starting yield is usually in that 2.5% to 3.0% range.
You can get over this easy dismissal of something like Exxon if you look a few years out to see what your invested capital will be producing once it racks up a few years of dividend growth coupled with reinvestment. If you bought Exxon stock in 2006, you would be receiving around 5.5% to 6.0% annually on the amount you invested simply because you chose to reinvest the dividends and received the higher payouts (and the figure approaches 30% annually once you hold on to the stock for twenty years).
The best thing of all is that something like Exxon can be your endgame. If you own Seadrill, your attitude is not going to be “I’m going to hold on to these shares for 25 years, and use the dividend payments to support me for retirement.” The business model doesn’t invite that kind of reliance. If you own something like Exxon, your life is much easier—you are using the oil giant as the vehicle to build wealth, and then you can rely on it for income support during retirements because its reserves are so vast with only Royal Dutch Shell and Chevron being in the same conversation.
When asked why he stuffs his portfolio with the bluest of the blue-chip stocks, Sarofim said: “They have the flexibility and critical mass to invest in developing countries.” For instance, on Thanksgiving, Coca-Cola teamed with SABMiller and the Gutsche Family to create a giant African bottling operation that will immediately generate $3 billion in sales and be owned 31% by the Gutsche Family, 11% by Coca-Cola, and the rest by SABMiller. When people ask me whether they should invest in third-world countries, and how to do so, this is my vision of what it looks like. You do it through large multinationals that can absorb failure if it happens but augment existing profits if the mission is successful. When you hop on the computer and buy shares of KO, you now have an ownership interest in an African bottling plant.
Someone who signed a contract with the Los Angeles Kings a while back wrote in and asked me how he should invest long-term given his lack of general interest in finance. The answer? I would want to find someone like Fayez Sarofim to invest my assets, given his ability to find excellent companies that make profits in all conditions and couple that with excellent growth profiles as well. Index funds work, too. The point is this: the probabilities of success shoot up sharply when you stop worrying about the latest fads and instead figure out the way to get your hands on big blocks of Exxon, Chevron, Coca-Cola, and Nestle stock. I prefer to do it directly because there are no ongoing fees once you make your initial purchase, but there are other ways to do it. The portfolio Fayez Sarofim built is one of the best I’ve ever seen for someone interested in risk-adjusted total returns that are excellent.
Originally posted 2014-11-28 00:33:45.