When one buys a stock, there are three ways that one can profit from the investment: dividend, growing earning, and growing valuation.
Morningstar’s Pat Dorsey uses Cisco (NASDAQ:CSCO), Johnson & Johnson (NYSE:JNJ), and Yum! Brand (NYSE:YUM) to illustrate the simple truth.
Going forward, however, investors in these three stocks may have different experiences from what they have had in the past decade:
1. CSCO is traded at free cash yield of about 10%, based on the numbers that Dorsey used and it will start to pay a dividend first time ever;
2. Johnson & Johnson has a P/E ratio of 12 and is still growing its earning. How much lower the P/E ratio can go for a company that has grown top line per share 10% each year and EPS 12% each year during the past 10 years? I don’t have a crystal ball, but I know there is a bottom to each well;
3. I am not sure about how Yum! Brand will go from here. As Dorsey said, it is traded at 20 times earning, a bit high for my taste. On the other hand, the company has experienced good growth in the past decade and I don’t see reasons why it cannot carry on. So the high valuation may be justifiable.