In his book Common Stocks and Uncommon Profits, Phil Fisher makes the point that it is not what is currently known about a company’s cash flow that matters, but rather, what comes to be known about a company’s profit potential in the years after we buy a given stock.
As Fisher says on page 64 of his book, “Some companies are in the seemingly fortunate position that they can maintain profit margins simply by raising prices. This is because they are in industries in which the demand for their products is abnormally strong or because the selling prices of competitive products have gone up even more than their own.”
This is why I love “indispensable products.” They have the ability to raise prices every year. As a customer, that sucks. As a part owner of a business, that is great. Your kid is going to eat cereal. That is why Kellogg has returned 12% annually since 1984, and why General Mills has been paying out cash dividends for over a century.
If your kid gets sick, you’re going to get him some Tylenol. If they raise prices a quarter, you’re not going to use an off-brand “Dr. Tim’s Special Tummy Soother” just because its cheaper. This is your sick kid we’re talking about, and you’re going to stick with quality and what you know, even if it costs a bit more (in fact, the Tylenol brand is so strong that even when CHILDREN DIED CONSUMING IT in the 1980s, the brand was still able to make a full recovery and grow more profitable over time. How many companies do you know that can sell products that can actually kill children and still be profitable years later?).
This is not to show a lack of sympathy for the insurmountable pain endured by those families in the mid-1980s, but rather, to recognize how powerful brand forces are in our own decisionmaking process. Johnson & Johnson’s brands are so strong that the company has been able to give shareholders returns of 13% annually over the past forty years while raising dividends every year during that period (in fact, Johnson & Johnson has been raising its dividend longer than that).
Imagine how much fun it is going through life owning an asset like that. Forty-three years is pretty close to an investing lifetime. If you had bought Johnson & Johnson 43 years ago, you would have had more money deposited into your checking account every year of your life. No exceptions. Why wouldn’t you want to take your surplus income and buy business stakes like that? It makes life so, so, so much more fun to have assets like that on your balance sheet.
And here is the thing. It’s not like Johnson & Johnson is the only company out there with pricing power. Have you seen what Pepsi has done to the prices of their bottled soft drinks, potato chips, Doritos, and Quaker Oats brands over the past ten years? It seems like Pepsi executives have taken a page out of school administrators that raise tuition annually by a rate twice as high as inflation each year. But here is the thing: Pepsi has been raising the prices of its products by amounts well in excess of inflation over the past ten years. That sucks if you like to eat oatmeal every morning, but it’s great if you are a Pepsi shareholder. Where do you think that 13% annual dividend growth over the past ten years come from?
Here is a great way to start your investing research process: Find the products that people around you are always complaining about going up. That product must be pretty damn indispensable, otherwise people would say, “I’m not buying bread anymore because its price has gone up 20%.” If you are complaining about the price of something, it is likely that you’re still buying it. Those are the kinds of products you want to acquire partial ownership stakes in. A little Coca-Cola here. A little Nestle there. Some Johnson & Johnson over there. Some Pepsi thrown in for good measure. These are the kinds of assets that are going to give you a reliable income stream each year so you can structure the life for yourself that you want and pursue your dreams. With DRIP investing easily available, you can buy these “perpetual price raisers” anytime you have a couple hundred bucks saved up to deploy. Buy these companies year after year, and before you know it, the world is yours.
Originally posted 2013-07-08 05:59:04.