When the United States cut its corporate tax rate from 35% to 25% at the beginning of 2018, I paid special attention to large-ish cap stocks that derived most of their profits from the United States because those companies stood to be the obvious, prime beneficiaries.
My search led me to three companies: (1) Adobe; (2) Boston Beer Co.; and (3) Dr. Pepper Keurig.
For the past two years, I had been paying special attention to Adobe, the software giant with the 28.7% net profit margins that has been raking in the cash ever since it stopped selling software products and started licensing them instead.
The problem is that the valuation has been absurd. When I started studying Adobe in depth about a year or so ago, its P/E ratio was 40. It was a $70 billion or so company. Too many parallels to 1999, thank you very much.
The craziness holds true today. Even if Adobe hits its projected target of $5 per share in profits by the end of 2018, the current price of $254 as of October 9, 2018’s closing gives the stock a P/E ratio of 50 while being valued at $120. That type of investing could be described as “the best conditions must persist or doom”. Stretching for growth by paying 25x earnings for Alphabet is one thing, paying 50x earnings for Adobe is another.
Boston Beer had a similar fate. After a poor earnings report in February that sent the stock into the $160s, I intended to purchase shares but the match of “available capital” with “this is my best idea” never aligned, and with the stock now up to $280, the benefits from the tax cuts have more than fully been realized in the present stock price.
Keurig Dr. Pepper is the ruby buried amidst the overvaluation dust. I’ve bought some, and it’s on my short list to buy some more. You get the bona fide track record of Dr. Pepper, which as Dr. Jeremy Siegel pointed out in Stocks for the Long Run, was one of the best performers of the second half of the 20th century. You get the Keurig side that taps into the world’s coffee obsession, and for those who are aware of the insane stock returns at Starbucks and Dunkin’ Brands, this is another high-growth, high-profit margin option. And there is a strong hand of JAB Holdings, which is run by the various heirs of Albert Reimann, Jr., who are exceptionally talented at leveraging brands to success. And it’s almost entirely based in the U.S., so the tax environment is about as favorable as you are going to find with honest effort. Absent a recession, I would be quite surprised to find Dr. Pepper’s stock price anywhere below $50 come October 9, 2023.
N.B.: This is an article of ancient vintage that may not be relevant for current circumstances.