Coca-Cola. PepsiCo. Chevron. Exxon. Colgate-Palmolive. Procter & Gamble. Johnson & Johnson. Those are the companies that I have in mind as signature “this is my largest investment which I will rely on for retirement income” companies that ought to be a hallmark of blue-chip portfolios build to last throughout whatever economic environment presents itself in the coming decades. There is another company that deserves consideration on that list: Nestle.
It is widely underrepresented in the financial literature on long-term investing for a couple of reasons: it is a foreign business, and the reported profits and dividends don’t quite have the smoothness that you get from, say, checking out a profit and dividend history of The Coca-Cola Company. But still, the trajectory for Nestle owners is pretty darn upward over time. The payment is annual, with the company typically declaring a dividend in April and then paying it out to shareholders in May.
Also, the taxation situation is slightly trickier. With U.S. companies in an IRA, the situation is clear: The dividends aren’t taxed when they’re paid out. With taxable dividends, your rate can vary from 0%, to 15%, to 20%, to 23.8%, depending on your ordinary income tax rate. Nestle dividends are different. They are taxed at 35% in a regular taxable brokerage account, and then you fill out a firm to get twenty percentage points reimbursed to lower the tax rate to 15%. In something like a Roth IRA, you have to pay a 35% tax on your Nestle dividends, and you don’t get it back. I hope that will change with time, because Nestle as a business is the perfect retirement company because of the perpetual demand for its cookie and milk products, and it’s unfortunate that the tax code significantly deters someone from owning Nestle in an IRA.
Sure, there are backdoor ways, like owning The Harding Loevner International Equity Fund, which owns some of the greatest blue-chip stocks in the world that don’t get the press of the likes of Coca-Cola and Johnson & Johnson, but there are three drawbacks to that: (1) only a little under 4% of the assets are in Nestle, (2) the mutual fund can sell the Nestle stock whenever it wants, and (3) even though the fees are tolerable for the great collection of assets that are put together, you are still going to pay $1,073 in aggregate over the next ten years for every $10,000 that you invest into the fund.
And even if someone did put Nestle stock in an IRA, and even though it is clearly a very disadvantaged form of capital allocation from a tax perspective, I can’t bring myself to condemn the decision as stupid. That’s because it is entirely possible that someone owning a gob of Nestle stock in an IRA for the next twenty years, even sacrificing 35% of the dividend payment at the altar of the Swiss treasury, could still have beaten most competing investment alternatives. You still would have received 12% annual returns only reinvesting 65% of your dividend payment into more shares of Nestle stock over the past twenty years. How can you make fun of someone who chooses to play a game of basketball one-handed and still puts up twenty-five points?
When you pay $72 for that share of Nestle stock, you are buying an ownership stake in all of these Nestle brands.
If someone in 2008 decided that owning a bucketload of Nestle stock was a life task that needed to be accomplished, and found a way to invest $1,000 every month into shares of Nestle every month from January 2008 through 2014, you’d turn $84,000 into $168,000. It’s more impressive than it sounds because most of the contributions have hardly had any time to compound (i.e. the December 2013, January 2014, Feburary 2014, and so on contributions haven’t even been going for a year!). And yet, you would have built up a position in Nestle stock that would amount to 2,300 shares. Think about how awesome the month of May would be when you receive that annual payout: 2,300 shares x $2.42 = you’d get a $5,566 check. You’d initially have $3,617, fill out some paperwork, and eventually end up with $4,731 after your tax paperwork is adjusted. That’s your net, walking-around spending money.
What goes unnoticed is that it would be income of the highest quality. Not only have you established an awesome current situation, but it is entirely possible that the payout will double every six years due to the inflation-adjusted earnings power of the company. Those $4,700 could cross $10,000 in 2020. Then hit $20,000 in 2026, without any additional investments from your labor. The machine had been built, and the passive rewards would be coming your way. That’s a lifetime of oncoming rewards created from meaningful delayed gratification during the 2008-2014 stretch.
If the amount of invest is more modest, you delay gratification more to receive the benefits. Someone with $5,000 eighteen years ago that called up a broker to buy Nestle, and paid all his taxes while holding it in a standard brokerage account, would have 643 shares of Nestle stock today paying you $1,556 in May. Nestle would pay your mortgage your mortgage one month every year because of a decision you made in 1996.
Nestle is a great place where you not only get amazing stability—it’s one of the few dozen firms that could remain profitable in a Great Depression type of scenario—but there is also a growth component at work as well. It gets ignored because of the tax complications, but it’s one of those things that once you spend a couple hours figuring out the paperwork, you wonder why on earth you were tepid about making the investment in the first place. Plenty of investors, looking for high-quality long-term growing income, skip this stock. Determining on the alternatives selected, this may be a mistake. The thing grows like a weed. Start your dollar-cost-averaging in June, buying a few hundred dollars worth—or whatever you can afford—every month, so filing the tax paperwork will be worth it the next May. And then, just sit on it, or add to it. The company will be sending four-figure dividend checks before you know it. And the real beauty will be found over time through the growing sustainability of it.
Originally posted 2014-12-14 08:00:49.