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The Science of Hitting
The Science of Hitting
Articles (451) 

A Unique Period of Time... Continued

December 12, 2012 | About:

At the start of this year, I wrote an article entitled A Very Unique Period of Time - A Quick Case for Blue Chips. Here’s a reprint of that article (it’s only a few paragraphs):

“With so much going on in the macroeconomic environment, it’s easy to run from an intelligent investment approach and instead cower away from equities; the words of an investment guru should hopefully abate some of that fear and help individual investors confidently invest in some fantastic businesses selling at cheap prices...

In a recent interview, Consuelo Mack of Wealth Track spoke with Donald Yacktman, who runs the Yacktman Funds; for those searching for a successful investment strategy, look no further: in the past three, five, ten, and fifteen year periods, the fund has beat more than 99% of its’ peers. During the interview, Yacktman had this to say:

“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 5th, 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.”

At the close on Friday, the 30-year Treasury yielded 3.07%. This compares to 3.13% for PepsiCo, 3.27% for Procter & Gamble, and 3.48% for Johnson & Johnson; in addition, while the Treasury yield will stay stagnant for more than a quarter of a century, let’s look at how these companies have fared historically: since 1987, PEP, PG and JNJ have increased their dividend payouts (per share) more than tenfold.

As I noted above, it’s easy to step back from the markets while developed markets muddle along and deal with piles of debt; for long-term investors, now is the time to buy great businesses and to profit on the short-term blindness of the herd.”

Let’s start by looking at the results for those three companies (all of which I own, for full disclosure) since that article was written on Jan. 28 to approximate the one-year return:

Stock Price, 1/28 Price, 12/11 Return
PEP $65.80 $70.40 7.0%
PG $64.30 $70.65 9.9%
JNJ $65.55 $71.10 8.5%

To be clear, those returns exclude dividends – and with all three companies yielding 3% or more (still more than the 30-year), that means each stock had a double digit return over that time period. As people who read my articles know, I don’t care about short term returns (I would rather have seen these stocks fall – I’ll be a net buyer for years to come, and would love to buy a claim on PEP’s future cash flows for as cheap as possible); however, I think the results from these companies are very instructive for the individual investor for a couple of reasons:

1. These companies are the cream of the crop – You don’t increase your dividend for half a century at a rate of 9.5% per annum by chance, as Procter & Gamble has done (JNJ and PEP have similarly impressive records); while it certainly will be much tougher to replicate that rate of growth through 2060, it’s quite astounding that one would choose their long-term bonds, with lower yields, rather than tag along with P&G as they look to replicate their success as the global leader in consumer packaged goods throughout the world over the coming decades (developing market sales have compounded at 12% per annum since 2000, reaching $32 billion in fiscal year 2012).

2. Even in terms of volatility, these companies are not “risky” – While I don’t agree with it, I understand why some people are scared of volatility and see declining prices as a reason to sell – the simple truth is that they don’t consider themselves to be long-term minority owners of the business in question (if they did, they would cheer on price declines, particularly at companies like the ones mentioned that spend billions year after year repurchasing common stock). With that said, if these people are still looking to dip their toes in the equity markets, you’d be hard pressed to find a less volatile place to put your money: As measured by Google Finance, these three companies are (on average) about half as volatile as the markets as a whole.

3. The valuations are reasonable, at worst (by my calculation) – This is the critical point: In terms of comparable investment yields (namely bonds), it’s astonishing to me that someone would pass on a basket (if they’re so inclined) of solid blue chips with an average earnings yield around 6% to 7% and instead settle for 10-year AAA corporate bonds yielding a paltry 2%.

The saying of the day is that stocks (usually referring to blue chips) are “the best house in a bad neighborhood.” For the individual investor who can only handle the slightest bit of risk and is either giddy or depressed at the latest macroeconomic developments, I think the choices are clear:

One, you can accept that you cannot handle volatility in the form of daily stock quotes, and settle for a decade of low single-digit bond returns AT BEST (you could also smash your computer so you don’t have to bother with those pesky ticker symbols day in and day out).

The other option (that still enables you to sleep at night) is to seriously consider the PepsiCo’s, Procter & Gamble’s and Johnson & Johnson’s of the world; mixed with some portfolio insurance in the form of Fairfax Financial (FRFHF), as well as some cash and bonds (if you must), there’s almost no question that this will prove much more fruitful over the coming years.

I think Don would agree it continues to be a very unique period of time.

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct". I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 4.1/5 (19 votes)


Vgm - 4 years ago    Report SPAM

Thanks for the stimulating piece, as ever.

Any thoughts on Buffett exiting JnJ last quarter? When asked about it, he made comments along the lines of not knowing what exactly was going on inside the company, suggesting he was worried. He also said something about it having underperformed for an extended period.
The Science of Hitting
The Science of Hitting - 4 years ago    Report SPAM

Thanks for the kind words!

In terms of Warren's comments, I can understand why - management destroyed value (in my opinion) by paying for Synthes they would potentially alter the weighting of equity and cash, then when asked about it later made it sound as if that was never an option), have risked serious destruction of brand equity by failing to quickly stem consumer segment product supply issues (which largely continue to this day), as well as poor corporate governance (again, my opinion); that might not be why they pulled the plug on JNJ, but that's why I would consider doing so.

With that said, I've stuck with JNJ (though getting closer to FV); I'm not sure it's a great answer, but the valuation still looks attractive by my analysis - even without accounting for the turnaround of the consumer division over time (which hopefully will happen, even thought the past few years suggest it might not...); with that said, the top issues concern me - I don't like it nearly as much as PEP or BRK.B, to name two other holdings of mine.

Thanks again for the comment!

Marcolanaro - 4 years ago    Report SPAM
I always look forward for your articles, they are great.

fairfax is a company and stock that I like at current valuation , I like it as you do as a protection for the whole portfolio for the obvious reason of its massive hedge but also for the opportunity that offers, just look at the 20% stake in RIMM that is moving quite strongly as of late. Do you have any other insight into Fairfax?

thank you
The Science of Hitting
The Science of Hitting - 4 years ago    Report SPAM

Thanks for that - I appreciate the kind words.

In terms of Fairfax, my articles provide a decent summary on my thoughts: cheap valuation, fantastic track record, improving insurance operations (at a company-specific level), and a better alternative than cash, from my view - I get particularly scared of events that seem unlikely to happen (in my mind, this would be deflation), and LOVE the cheap protection I get against it from the CPI-linked derivative contracts Prem purchased for us (remember, that protection, if it proves to be worthless, has a pretty small impact on FRFHF's overall intrinsic value - but the upside is potentially huge if he's right).

Thanks again Marcolanaro!
Graemew - 4 years ago    Report SPAM

Thanks for another good article. I also hold all three, JNJ, PEP and PG. However I have reduced both JNJ and PEP recently. My reduction in JNJ was mainly in immitation of Buffett, which I don't mind admitting, but also because I am concerned that the company has around 80% of its business in pharmaceuticals and medical devices, both of which rely on high R&D expenses and both of which operate in highly competitive markets. However since the valuation still looks quite favourable and the company is so defensive, I maintain a reasonable position in the stock.

I have also began to reduce in PEP, since I am concerned that the top management has not done a good job in recent years. The debt has increased considerably and now is over 100% of equity. I am afraid of increases in interest rates which could increase interest charges and I am also concerned that management may make a mistaken acquistion or another misstep to destroy value. However I will also continue to hold this stock as an average portfolio position.

I am actually more concerned about the possibility of inflation rather than deflation, wth all the currency printing going on in developed countries. In this scenario, what happens to Faifax CPI linked derivative contracts? I have not researched Fairfax...but will now read your articles on this company.

I would welcome your feedback on my comments above. Thanks again.
Shaved_head_and_balls - 4 years ago    Report SPAM
“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."

Relative valuation is a concept appropriate for a salesman's bag of tricks, not for an analytical mind. Obviously the companies mentioned above are expensive "relative to" March 2009.

None of these stocks is especially cheap based on historical metrics and growth potential--unless your version of history goes back only to the mid 1990s (when valuation multiples started marching up in the pre/post-Bubble era of overvaluation).
The Science of Hitting
The Science of Hitting - 4 years ago    Report SPAM

Thanks for the comment. In terms of the inflation linked derivatives, Fairfax can only lose a few hundred million dollars (can't remember the number off the top of my head, but want to say $450M or so); to date, the company has written them down to a fraction of that due to mark-to-market. In essence, when you look at book value, a VERY small portion (say $200M or so, but don't quote me on those numbers - I'm in a rush and can't check right this minute, but I've mentioned it in previous articles) is at risk from those contracts.
Balajisridharan - 4 years ago    Report SPAM
Interesting article and comments!

I would like to buy stocks that Buffett is buying on the terms he does. So, I did follow him in adding to my Berkshire holdings following the buybacks from WEB. (Voting rights don't mean much in a stock like BRK) I have a mix of BRK and FRFHF. BRK has a bigger and bigger piece of earnings coming from the operating businesses and FRFHF gives one the protection from deflation. (FRFHF trades at about $350/share with shares per investment at three times the share price) Float + Decent Combined Ratio + Good Capital Allocation == Long Term Compounding!
The Science of Hitting
The Science of Hitting - 4 years ago    Report SPAM

Agreed! Thanks for the comment!

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