Between 1957 and 2012, shares of Tootsie Roll stock compounded at an annual rate of 13.57% (it was originally called The Sweets Company). You would have turned $10,000 into $4.5 million over a forty-five year period by selling Americans Junior Mints, Andes Confections, Mason Dots, and of course, Tootsie Rolls. It would have been the simplest way to passively build wealth—you would be a part owner in a business that repeatedly sold products over and over again that earned 13% profit margins and executed on a very understandable business model.
And yet, the 2002 period onward only saw the stock compound at a rate of 3.1% per year. Why did one of the best investments in the American stock market suddenly become mediocre at best? Three reasons: (1) a slashed advertising budget; (2) a maturing candy market in the U.S.; and (3) an expectation of a takeover that has made the stock perpetually overvalued.
You know why companies like AT&T and McDonald’s spend hundreds of millions of dollars advertising everywhere? Because it works. Reaching an audience, and hitting them over the head over and over again with your latest offering, is a component of building a successful brand. In 1989, Tootsie Roll spent $25 million in advertisements, around the time period that its famous “How many licks to the center” ad campaign was taking off. Today? It only spends $20 million in advertising. And those figures aren’t even adjusted for inflation! In 1989, it occupied the number 3 position in the candy industry for advertising. Now, it is not even in the top five. When you stop promoting your products, what do you expect to happen?
This slashing of the budget occurred at the same time that the domestic candy market has matured. From 1957 through 2002, candy consumption increased at a rate of 6.5% per year. From 2002 through the present? Only 2% growth. Basically, Tootsie Roll settled for lower market share at a time when the industry was stagnating. That is why sales of the candies under the Tootsie Roll corporate umbrella has only grown from $495 million to $535 million over the past ten years. As a result, profits of $65 million in 2006 only grew to $70 million in 2016.
Even worse, as the growth slowed, the P/E ratio expanded. Back in 1957, the stock was trading at only 12x earnings! You were looking at almost fifty years of 10% earnings growth ahead of you. By 2002, the P/E ratio increased to 30. Today, it sits at 33x earnings.
You can’t get rich paying 33x earnings for a business growing profits at 2%. It is utterly crazy, and yet, the current buyers of Tootsie Roll stock find themselves doing exactly that. This isn’t a strawman—there really are people out there buying TR stock. Over the past twelve months, almost 2 million shares of Tootsie Roll stock traded hands. That means some capital allocator out there, or some auto-indexer, was willing to overpay dramatically for an excellent business that cannot grow faster than inflation.
If you want to pay over 30x earnings for a candy company, you might as well pay 40x earnings for Lindt because at least that Swiss chocolatier is growing at almost 9%. Not that I consider that the wisest course of action, but it is wise relative to paying 33x earnings for a similarly situated business giving you 2-4% growth. If Tootsie Roll stock ever traded at something ridiculously cheap like $15 per share, I’d love to write about it here. But it doesn’t, and when you compare the growth prospects to the current valuation, you’ll see that the disappointment of the recent past is more likely to continue than the excellent returns of the long-term past.