One of the blessings that comes with the territory of investing in individual companies rather than a widespread basket of stocks like the S&P 500 is that you get to allocate your money to specific companies that are either growing faster than the S&P 500 or selling at a substantial discount to the typical stock in the S&P 500. It’s a style of investing that lets you personally find intelligent places to put your money even when “the average stock” in corporate America does not offer you an attractive entry price.
In the ‘50s and ‘60s, you had IBM outperforming the S&P 500. In the ‘60s and ‘70s, you had the tobacco giants and conglomerate-type businesses of General Electric, United Technologies, ITT, and Procter & Gamble roaring to life. Someone who bought Coca-Cola in the early 1980s has been compounding at 15.5% ever since. Buying Disney and Nike in the 1990s was incredibly intelligent. There is always something intelligent to do.
For someone looking to figure what the intelligent thing to do in November 2014 might be, you can look no further than the oil sector. Did you see what happened to commodity stocks on November 28th? There is one of those rare times where you can throw darts and buy just about any large-cap in the commodities field, and you’ll be setting yourself up for great long-term returns.
Want an oil company with a high earnings per share growth rate over time? Look at something like Phillips 66. Want a big honkin’ dividend yield? Look at BP and Royal Dutch Shell. Want something that will be raising its dividend for decades, something quite unusual in the extra-cyclical commodities industry? Look to Chevron and Exxon. Want to capture the declines in other commodities beyond just oil? Look to BHP Billiton. This is a very attractive time for long-term investors that don’t mind working their way through the inevitable swings in prices—I mean, Chevron is on the verge of yielding 4%, for heaven’s sake. Where else can you get a 4% yield that will grow in the 8-11% for the lifetime of your holding?
This is one of those amazing opportunities, and I would credit Dr. Jeremy Siegel at Wharton for having the state of mind/framework for recognizing this as an opportunity rather than looking at the price declines as something to lament. Page 7-9 of his book The Future for Investors is one of the most persuasive bits of investment wisdom I’ve ever encountered. Siegel mentions these facts by way of a comparison between Exxon and IBM: From 1950 through 2003, Exxon grew its revenues by 8% annually, grew its dividends by 7% annually, and grew its earnings by 7.5% annually. IBM, meanwhile, delivered much better operational metrics over that period of time: it grew its revenues by 12% annually over that fifty-three year stretch, grew its dividends by 9% annually over that stretch, and grew its annual earnings per share by 11%.
By each of those measures, IBM would appear to be the far superior investment. Yet Exxon delivered 14% annual returns to investors over that time frame while IBM delivered 13.8% annual returns. Why is it that Exxon, which grew its profits and dividends slower than IBM, was able to outperform it over the course of 53 years? The valuation. Oil stocks like Exxon, Chevron, BP, Shell, and Conoco are prone to extended periods of cheapness, and this is where the oil stocks get their ability to outperform.
Professor Siegel puts it well: “A very important reason that valuation matters so much is the reinvestment of dividends. Dividends are a critical factor for driving investor returns. Because Standard Oil’s price was low and its dividend yield much higher, those who bought its stock and reinvested the oil company’s dividends accumulated almost fifteen times the number of shares they started with, while investors in IBM who reinvested their dividends accumulated only three times their original shares. Investors in Exxon had very modest expectations for earnings growth and this kept the price of its shares low, allowing investors to accumulate more shares through the reinvestment of dividends. These extra shares proved to be the margin of victory.”
It is fun getting to see a textbook case scenario unfold in real time, right before our very eyes all over again. Buffett often speaks of how when a stock is cheap, you just know it, and you don’t have to break out the calculator to study its pension assumptions and so on because the clarity of the value is there. I get that vibe from Chevron right now. This $108 price is getting 15-20% undervalued, which is extra-nice given its extraordinary safety (in terms of generating profits over the long term) and excellent growth profile given its planned volume growth in 2016 and 2017. It is paying out $4.28 per share in dividends which has been increasing annually for three decades and still only consumes about a third of the company’s profits in this depressed environment. Exxon tells a similar story, as it now yields over 3%. A lot of people are frustrated that they can’t buy things like Hershey, Nike, and Disney today because they are so pricey compared to current profits. The decline in the prices of oil stocks is welcome news for those with cash to invest and looking for something to do today.
Originally posted 2014-11-28 20:42:04.