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Morningstar’s Pat Dorsey uses Cisco (CSCO), Johnson & Johnson (JNJ), and Yum! Brand (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.
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