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Stepping over Dollars to Pick up Nickels

September 27, 2012 | About:
A few months ago a large multinational company borrowed money at rates that, I would assume, even its decision makers chuckled about.

European consumer goods manufacturer Unilever (UL), which owns such household brands as Hellmann’s® and Lipton® Iced Tea, sold five-year notes with a coupon of 0.85%. Just to put this in perspective: U.S. Treasury notes — the safest investment in the world and guaranteed by the U.S. government — are currently yielding 0.75% at five years (Aug. 14, 2012).

Investors were willing to lend money to Unilever at only 10 basis points more than they would lend money to the U.S. government.

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Investors too are concerned about the return of their assets instead of a return on their assets. Instead of being lenders and receiving such absurdly low yields, why wouldn’t these same investors rather be owners?

Buying shares of UL makes much more sense to me. Owning pieces or shares of a business gives investors part ownership of a business that has the ability to grow and allows them to share in the upside. There is no upside for lenders. The most they will make is 0.85% per year for the next five years. That’s it.

Now here’s what really doesn’t make sense to me.

When inflation, currently 1.7%, is factored into the return, a 0.85% yield turns out to be a real rate of negative 0.85%! Each year the owners of those five-year notes will see the buying power of their investment dollars decrease, and after five years they would have lost more than 4.5% of their purchasing power. And that assumes that inflation stays at 1.7% for the next five years.

I don’t know how likely it is that inflation will stay at these levels when you consider the rise in grains and food prices. Over the next few months, higher prices are in store because of the Midwestern droughts.

That same investor could buy shares of UL, receive a 3.3% dividend, and share in the growth of the business. True, the price of the stock could go down and the investor would lose money if he or she needed to sell. But what is a given is that Unilever noteholders would not receive a percentage point more than 0.85% for five years.

I would rather take my chances with the possibility of making a 3.3% dividend yield, plus any price appreciation of the stock, than I would a guaranteed real return that is negative.

Here is a list of companies that have strong balance sheets, trading at a discount to my estimate of intrinsic value, and pay a dividend greater than 1.7%:

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I can’t tell you where stocks, interest rates or the economy will be five years from now. In fact no one can. But I would bet dollars to donuts that owners of financially sound companies that were purchased at discounted prices will fare much better than the lenders.

About the author:

Charles Mizrahi
Charles Mizrahi is editor and publisher of Hidden Values Alert newsletter, which focuses on finding stocks trading significantly lower than their underlying business value. He has over 30 years experience in the financial world as a money manager and investor.

Visit Charles Mizrahi's Website


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