In January 2003, Johnson & Johnson shareholders collected $0.92 per share in dividends while the stock traded at $57 per share. That was a yield of 1.61%. The P/E ratio of the stock was in the mid-20s, suggesting that Johnson & Johnson shareholders needed double-digit earnings growth otherwise there would be enough P/E compression to bring period of mediocre returns.
The latter happened. From 2003 through 2011, Johnson & Johnson had to work off the effects of high valuation, work through the 2008-2009 recession just like every other company, and deal with the effects of manufacturing recalls in the 2010-2011 years coming out of the recession.
Despite these issues, the core economic engine of Johnson & Johnson’s pharmaceutical subsidiaries proved so strong that earnings still managed to grow from $2.70 in 2003 to $5.00 at the end of 2011. You didn’t have much to show for it in terms of capital appreciation–your stock only grew in value from $57 to $68, but the business itself continued to grow along at a nice and steady 8.01% annual rate even as the stock price only advanced at a rate of 2.23% per year.
But what I find interesting is the comparison between Johnson & Johnson’s dividends from 2003 through 2011 compared to the performance of those very same dividends by 2016.
I’ll elaborate on what I mean. From 2003 through 2011, each share of Johnson & Johnson paid out $14.47 in total dividends (assuming no reinvestment). It paid $17.21 if you did reinvest as the added share count constantly improved the amount of money collected from each subsequent dividend.
As a result, the dividend component of your returns looked like this:
1 share of Johnson & Johnson worth $57 in 2003 became 1 share of Johnson & Johnson worth $68 in 2011 plus $14.47 if you didn’t reinvest Your per share ending economic value was $82.47. Your compounding rate was 4.73% annually from 2003 through 2011 if you just let your Johnson & Johnson dividends pile up in a brokerage account.
Now, suppose you reinvested. You would have gotten $17.21 that was reinvested at an average price of $58.22. Here, your economic value transformed from 1 share of Johnson & Johnson worth $57 in 2003 into 1.2956 shares of Johnson & Johnson at the end of 2011 that were worth $68 per share, for a total of $88.10. The reinvestment of dividends into additional shares of Johnson & Johnson improved your compounding rate 5.59% annually.
Now, here’s where things get interesting. Even before taking into account the additional shares of Johnson & Johnson creating from collecting years of dividend payments on each 0.2956 shares of Johnson & Johnson stock that got created for shareholders between 2003 and 2011, you should consider that the stock has also appreciated from $68 per share in 2011 to $110 in 2016 due to P/E expansion from 13x earnings to over 18x earnings and earnings growth from $5.10 to $5.85 per share.
In other words, those 1.2956 shares of Johnson & Johnson stock are now worth $142.52. Adding those extra five and a half years of compounding, and your compounding rate on those same 2003-2011 dividends has just improved from 5.59% annually to 7.64% annually.
This is a the real-life at what Jeremy Siegel was talking about when he called the reinvestment of dividends a total return accelerator. From 2003 through 2011, your patience was really tested with Johnson & Johnson if you had any intent of selling the stock. The business growth was fine, but the capital gains were not forthcoming. Reinvesting the stock at an average price of $58.22 didn’t seem like a blessing–it would have seemed like an obnoxious hindrance to wealth-building because the price never went up.
But yet, as we sit here in 2016, it was obviously a virtue that Johnson & Johnson traded around $58.22 during the mid 2000s, instead of, say, $75 per share. Instead of turning 1 share into 1.2956 shares, you would have only gotten $16.27 reinvesting at a price of $75 per share. Instead of 1.2956 shares, you would have only created 1.2169 shares.
The consequence? With the stock now at $110 per share, your worth would be $133.86 per instead of $142.52. That’s the difference between 7.64% annual compounding at 7.18% annual compounding. All because of the valuation at the time you reinvested between 2003 and 2011.
People that talk about preferring low prices for their top quality holdings often get that “Oh, come off of it already” reaction when describing this philosophy. It is understandably unintuitive.
Some of the disagreements is a result of misunderstanding the vocabulary. When someone says they root for the stock price to stay low, because they own a corporation repurchasing stock, or intend to reinvest the dividends or buy more of the stock through an outright cash addition, the recipient of the message might be interpreting that as “Hey, this guy wants his business to fail. What a moron.”
But that’s not the argument. The argument is that we want to own stock in businesses that grow, but ideally, we want there to be a lag–we want the share price to appreciate slower than the earnings per share growth. It permits more shares to pile up, and then you get this huge increase in capital gains when the day arrives.
And by “day”, in the case of Johnson & Johnson, I mean the 2012 through 2014 period that took the stock price up from the $60s to the $100s. And you might even be able to narrow it even further to the 2013-2014 comparison period that took the price from $70 to $109. That’s a very important thing to keep in mind if you intend to take long-term investing seriously: Over the past fifteen years, Johnson & Johnson improved its intrinsic value by a high single digit in nearly every year, but almost of the capital appreciation happened between 2013 and 2014.
If you got impatient and sold out before then, some other investor got to reap the benefits of the business growth that occurred during your period of ownership but didn’t realize its value in the marketplace until later. If Mr. Market were a person, he effectively said in 2013 and 2014 something to the effect of “It’s time to give shareholders their decade’s worth of capital gains right now.”
If the corporation is profitable, and a decent chunk of cash is still rolling in as dividends, don’t look a gift horse in the mouth when the share price seems to show a refusal to rise. A lot of have been disfavoring BP these past five years. And the cash continues to pour out for shareholders. Whether the low price of oil would presage a dividend cut has been uncertain, but what was certain is that the shareholders would be collecting a good chunk of cash compared to the initial purchase price with the stock near the $30 range.
BP shareholders have collected $5.34 in dividends from 2014 through the first quarter of 2016, a period that covers this steep decline in the price of oil. It’s provided an opportunity for shareholders to reinvest at an average price of $34.54. Everyone keeps mocking, ridiculing, and otherwise disfavoring this stock, yet the BP shareholder that owned it in 2014 is now sitting on 115.46 shares of BP for every 100 shares that existed in 2014. When the price of oil gets higher, all of those reinvested dividends in the $30s and $40s will serve as a significant source of pent-up value, even though it’s not something that excited people right now.
Three morals to the story:
Johnson & Johnson has a spot on my list of top ten businesses in the world. I sense there are many others that agree. If a business with such predictable growth still gives shareholders “spurty” capital gains, and can require over a decade for business performance to reflect reality, you should know the patience often required of successful long-term investing before you dive into it.
If the business operations themselves are sound, and you can monitor the earnings growth in real time, then you need not worry about whether the price of the stock will eventually catch up. If profits grow from $2.50 to $2.80, and the industry doesn’t lend itself to wild changes in technological disruption, then you can be sure that you will capture that 12% growth provided that the company wasn’t overvalued at the time you bought it. For cyclical companies, you have to recognize the change in commodities or fluctuations in demand that can lead to rapidly rising and falling profits and get an understanding for the historical performance of the sector before you extrapolate recent business performance and project it onto the future.
When the stock price languishes, and the dividends keep coming, you get to raise your share count. Each of those additional “embedded” shares will go on to take on new meaning when the price of the stock actually appreciates to your idea of fair value. Those $58 reinvestments for Johnson & Johnson shareholders during the 2000s happened to be great for the truly long-term shareholder that got to experience significant capital appreciation in 2013 and 2014. It’s not just the 2003 outlay that got to appreciate–it’s not just that 100 share investment that got to appreciate from $57 to $109 or $110, it’s also those 29.56 additional created shares that get to climb from $58.22 to $109/$110. Diversify, focus on acquiring additional surplus to deploy into investments, and wait it out. That will mitigate a good chunk of discontentment if your personality doesn’t easily lend itself to delayed gratification.