Some People Can’t Help Themselves From Selling

Jeremy Siegel’s advice that buying large energy companies when they are out of favor, and holding through thick and thin, seems to have been going through an animadversion of sorts lately. I’ve been reading online about several oil investors that have said they are abandoning their oil stock investments after seeing the sharp declines in price since this summer. It seems they’ve taken Siegel’s advice to be—if the price declines 10%, buy more. If the price declines 20%, buy more. But any more than that, sell!

As you can already guess, I find such a strategy terrible because it guarantees that you will be a terrible investor. When oil companies have conservative balance sheets, extensive reserves, and a wide range of production sources, you should buy more with confidence as prices decline because you are incorporating a margin of safety in your purchase price so that your future returns will be a result of: stock buybacks + production growth + price of commodity growth + dividends paid out + P/E multiple expansion. That’s why buying out-of-favor oil stocks is often associated with long-term wealth—the dividends are high, get reinvested at favorable prices, and surplus cash gets used to grow production so that profits will be higher as the price of oil, natural gas, other chemicals rise over time.

The oil giant that has especially caught my eye of late is Chevron. It strikes me as the best current combination of value plus future growth among the oil giants today. You get the three decade record of consecutive dividend increases (and something absurd with over 600,000% dividend growth since the Supreme Court ordered the breakup of Standard Oil in 1911) that is backed up by $76 billion in reserves and $14.5 billion in cash on hand. It’s grown profits by 21% annually over the past ten years (and even with the downtick in prices, it has still grown profits by 6% annually from the summer of 2007 highs to the current winter 2014 lows which is a tough measuring period that shows the resiliency of the company—you got 6% growth plus a nice dividend even during this unfortunate comparison period).

I would think that, at a certain, people would want to stop repeating past mistakes. In the summer of 2008, Chevron traded at $104 per share. Then, it fell to $90. Later that year, to $80. Then, $70. And it didn’t stop there as the stock price crossed the $60s, and then into the $50s. The snapback with oil stocks, which is often quick and unpredictable, came in 2010 and 2011. Chevron grew its profits from the low of $5.24 in 2009 to $9.48 in 2010 and then up to $13.44 in 2011. The important thing is that Chevron possessed the quality to grow its dividend from $2.53 in 2008 to $2.66 in 2009 to $2.84 in 2010 to $3.09 in 2011. You collected a little over $11 in cash dividends from 2008 through 2011, some of which got reinvested at a price in the $50s and $60s, and people just looking at the price volatility of oil stocks will miss out on the important role those reinvested dividends play in total returns (e.g. someone who bought at the absolute high in the summer of 2008 at $104 would have made 4.7% annual returns all the way to 2014 even when the price there was at $104 as well).

And if you bought the stock in 2007 before it had its crazy 2008 spike in price, you’d have 8.9% annual returns to the present day. Oil dividend becomes lucrative, and not scary in the way it is portrayed, when you let the dividends get reinvested for a few years in a row. I have particular fondness for Exxon and Chevron because those two companies have the highest likelihood of raising dividends through a period of extended lower prices, and if it is accompanied by a lower stock price, a growing dividend mixed with a favorable reinvestment price plays an important role in giving you excellent risk-adjusted returns.

If someone isn’t cut out for oil investing, there are other intelligent things you can do. For instance, there are a lot of investors that like to see stable earnings and annually rising dividends, and look to food stocks to meet this criteria. Nestle is probably the best option in this field, but there are also investors that: (1) are investing in an IRA and don’t want to surrender a tax from the annual payment to the Swiss government, or are (2) investing in a taxable account and don’t want to go through the paperwork of getting tax credits and worrying about currency fluctuations.

For these people, I offer the solution: J.M. Smucker. It is an excellent company that I haven’t covered much, but plan to in the future. The quality of its brands, which include Pillsbury, Dunkin Donuts, Folgers, Jif, and Crisco, among dozens of others, is outstanding. It has never had a three-year stretch in its corporate history in which profits failed to grow (e.g. if you compare 2011 profits to 2008 profits, 2005 profits to 2002 profits, or choose any three-year comparison period, the earnings are always improving over time). The dividend goes up every year, and the current payout ratio is only 40% (whereas a lot of other food companies are currently paying out over 60% of profits to shareholders as growth has been slow of late).

One of Smucker’s advantages is size. It is only a $10 billion company. Nestle is a $235 billion company. Smucker’s earnings quality is nearly as high as that at Nestle, but it has a much more favorable growth profile due partly to its smaller size. You have perfect symmetry between the earnings growth and dividend growth, as both have gone up by 10% annually since 2004.

It doesn’t get a lot of attention, because the business is “boring” and the price of the stock is $100 for a P/E ratio of 19, which doesn’t scream discount. What gets ignored is this: Earnings march forward every year, so that the price of the stock continually marches forward with time. Here’s how the price marched up from 2006: highs of $50.00 in 2006 became $64 in 2007, before retreating to $56 in 2008 and $62 in 2009. As the country moved out of recession, the highs hit $66 in 2010, $80 in 2011, $89 in 2012, and then $114 in 2013. Plus, you get a dividend that started around 2.5% and grew each year throughout that measuring period. When viewed through that lens, the current price of $100 isn’t a bad deal at all.

You could intelligently make the argument Smucker is one of those ten stocks that could be the “signature stock” of a portfolio, built to grow dividends through thick and thin, and have profits hold up even during the worst of times (e.g. profits actually grew throughout the Great Recession, from $3.77 in 2008 to $4.37 in 2009 to $4.79 in 2010). I expect I’ll continue to focus on energy stocks in the near future, as that is where the best value is at. However, there are other options. The fair value offered by J.M. Smucker right now, for investors that want a lifetime holding that will reliably grow dividends every year and profits much year, is something worthy of due diligence.


Originally posted 2014-12-11 23:11:55.

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