"A Unique Period of Time," Revisited

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I wrote an article in January 2012 entitled “A Very Unique Period of Time”. The article focused on commentary from Donald Yacktman (Trades, Portfolio), a well-known investor with a track record that suggests he’s worth listening to (through the second quarter of 2014, the Yacktman Fund (Trades, Portfolio) has outpaced the S&P 500 by an average 2.75% per annum over the past decade); at the time, Mr. Yacktman said the following:

“I’ve been doing this for over forty years, and I can’t remember another period of time where I’ve seen so many high quality, profitable businesses selling at prices relative to the market this cheaply. To give you an illustration, the 30-year treasury today [January 5, 2012] has a lower yield than many of these companies like Pepsi (PEP) or Johnson & Johnson (JNJ) or Procter & Gamble (PG). That’s a very unique period of time.”

We’re coming up on three years since those comments were made, so I thought it would be a good time for an update; here are the returns for those companies since that time – before accounting for the dividend yields that exceeded the 30-year treasury at that time:

Company 1 / 5 / 2012 9 / 18 / 2014 Price Change
PEP ~$66 ~$94 +42%
JNJ ~$65 ~$108 +66%
PG ~$66 ~$84 +27%

In less than three years, an investor who put an equal weighting in each of these three companies is sitting on a gain of more than 40%, before dividends (on a three-year measurement period, including dividends, that’s a CAGR in the mid-teens). Compare that to the approximately 1.4% rate on a ten-year treasury back in January 2012; if you didn’t listen to a great investor telling you to buy high quality companies when they were on sale, you’re kicking yourself now.

But let’s take a different perspective: what if you had bought these companies back in January 2012 on Mr. Yacktman’s comments and they didn’t budge? Assuming the only change we account for is price action, here’s what you would currently find yourself holding:

PepsiCo at ~$66 / share – A stock with a dividend yield of 4.0%, expected to generate roughly $4.60 per share in free cash flow this fiscal year, for an FCF yield of ~7.0% (~14x FCF)

Johnson & Johnson at ~$65 / share – A stock with a dividend yield of 4.3%, expected to earn nearly $6 per share in the current fiscal year (forward P/E of less than 11x)

Procter & Gamble at $66 / share - A stock with a dividend yield of 3.9%, expected to earn roughly $4.40 a share in earnings in the current fiscal year (forward P/E of 15x)

(By the way, it’s worth noting that these companies buy back their own shares in a big way: in their most recently completed fiscal years, PEP, JNJ and PG repurchased $3 billion, $3.5 billion, and $6 billion of stock, respectively; as an example, if JNJ had stayed in the mid-60s as opposed to trading in the mid-90’s for much of the past year, the company could’ve repurchased 40-50% more shares than they actually did – reducing the number of shares out even further.)

How does JNJ at a low-teens multiple and a dividend yield that’s nearly 200 basis points ahead of 10-year treasuries sound right about now? Would you be a buyer if you saw that opportunity Monday morning? I haven’t found anything that sounded nearly that good in quite awhile…

Oddly, people now seem less wary about investing in JNJ and others at their new heights; they’ve watched multiples move closer to – and in some cases above – 20x earnings / free cash flow and must believe that they will either continue moving higher, stay where they are (in which case these companies are still likely to win by a wide margin versus treasuries over 5-10 years), or not decline too much. At 12-15x, I would agree with that sentiment; any significant decreases in the earnings multiples would’ve been much appreciated – presenting the opportunity to buy more of high quality companies at 10x or less.

At 20x, the fall to 15x isn’t too fun: over a five-year measurement period, that requires a 6% annual increase in earnings per share for the stock to be unchanged; while the dividend still puts you a point or two ahead of the comparable treasury (from where we currently stand), that’s not nearly as attractive as the gap we were looking at in early 2012. The bigger issue for most people comes back to the fact that the price action alone – the drop from 20x to 15x - would make them less interested in buying the same company at a 25% discount; they can’t make the connection between the way they buy groceries and the way they purchase partial ownership in businesses.

Conclusion

I like to keep things simple: recent history suggests that companies like JNJ, PEP and PG can’t be expected to put up much more than a mid-single digit annualized earnings growth rate, plus or minus a few points (leaning towards the over long term, in my opinion); add in the dividend yield and you’re up to a TSR in the mid-high single digits.

Compared to treasuries, that’s a clear winner – though that’s not a very high bar to clear.

Personally, I thought these companies were highly likely to produce solid double-digit returns a few years ago – and that’s proven pretty accurate for the most part; recently, I have grown disinterested as Mr. Market has asked for more and more money for a dollar of assets, earnings and free cash flow. Without a double-digit decline in the share prices of these companies (and many like them), I simply don’t see the merit in opening new positions at recent levels. The math to annualized returns of 12-15% seems like quite a stretch.

Said differently, Mr. Yacktman’s “unique period of time” appears to have passed.

It was fun while it lasted…