If I had to name a stock that shares the most characteristics in common with the Johnson & Johnson of the late 2000s, I would point to Philip Morris International (PM) right now. It has become disfavored the past four years because it has struggled to grow revenues and this struggle has been exaggerated by the strength of the U.S. dollar (remember, Philip Morris International generates 100% of its profits outside the United States so that a strong U.S. dollar will artificially lower earnings while a weak U.S. dollar will artificially raise earnings. And by artificially, I mean that the earnings shifts due to currency fluctuations are illusory unless it is part of a fundamental shift in the equilibrium of exchange rates between the dollar and everything else.)
This struggle to grow earnings has put pressure on the amount of dividend growth that Philip Morris International shareholders have been able to receive. Some of it is the result of very high dividend growth between 2010 and 2014 that didn’t permit much room for strong dividend hikes in the event that earnings stalled. In 2010, Philip Morris International earned $3.92 in profits and only grew that figure to $4.72 in 2014.
Meanwhile, the dividend shot up from $2.44 in 2010 to $3.88 in 2014. This shot the dividend payout ratio up to 82% from 61%. The consequence of growing the dividend by a much higher rate than supported by the earnings is that the subsequent dividend growth couldn’t really outstrip earnings growth–if earnings stalled, so would the dividend.
As a result, the earnings stagnation of the past three years has carried the consequence of minimal dividend growth. That $4.76 per share in 2014 earnings has actually declined a bit to $4.45 today, bringing the payout ratio up to 93.4% of earnings ($4.16/$4.45). In translated dollars, this has meant that virtually all of the profits made from selling cigarettes outside the United States have been sent out to shareholders as dividends.
However, all the dividend has not grown much since 2014, it was nevertheless sitting at a 4-5% initial yield base to begin with so even modest low single dividend growth still provides a nice compounding effect. With dividends reinvested, Philip Morris has paid out $14.22 in dividends per share ($12.12 from the per share payment amount, and $2.10 from the effects of a rising share count.)
The average price for reinvestment during this time has been the symmetrical $88.88. With full dividend reinvestment, each share of Philip Morris International has produced 0.16 per share in dividends. That’s a remarkable testament to the value of compounding income–the earnings and stock price has languished, and yet, every 100 shares has grown into 116 shares over the past three years.
The average price of the stock in 2014 was $82.14, so an $8214 investment of 100 shares would have grown into 116 shares worth $11,484. The annual income has grown from $388 to an expected $482 over the next twelve months.
With full dividend reinvestment, Philip Morris shareholders have received returns of 6.42%. And the income growth has amounted to 7.50% annualized.
This is what I mean when I say that the dividend reinvestment portion of total returns is almost invisible to people contemplating investments. Looking at the recent three-year dividend record of Philip Morris, you can see that the dividend has only grown by 2.35%. But at this point in time, it’s the rapid accumulation of additional shares rather than the rate of dividend growth that is creating the mid single digit year over year increases in dividend income.
It’s short-sighted that there are so many shareholders of Philip Morris International that have become dissatisfied with their investments lately. The company itself has indicated that it expects revenues to grow 5.5% annually for the next three years, and it wouldn’t be surprising to see that turn into 7-9% annual earnings growth over that stretch.
Even though the earnings growth and share price appreciation has been lower than what most Philip Morris investors would like to see, the bottom-line remains that investors have seen their annual income increase by 7-8% over the past three years despite a modest decline in earnings and modest capital appreciation. Once you got through that first year or two hurdle with a dividend stock, especially one that pays out a decent starting yield or offers a nice growth rate, the total returns end up becoming much better than you might think because the reinvestment portion gradually becomes a bigger share of your overall returns than the change in share price alone.