(Published March 8 by Nicholas McCullum)
Investors have a lot to gain by investing in inflation-protected stocks with a long-term horizon.
“The single greatest edge an investor can have is a long-term orientation.” – Seth Klarman (Trades, Portfolio)
A long-term orientation minimizes transaction costs and capital gains tax. Deferred capital gains tax can compound over time, leading to a ‘Buffett Loan’ of deferred capital gains that can work in favor of shareholders.
Moreover, inflation-beating dividend growth means shareholders who rely on these companies for retirement income can rest assured they will not lose real (i.e. inflation-adjusted) purchasing power over time.
This begs the question – how do we find inflation-beating businesses likely to be around in 50 years?
One of the easiest filters is found by applying the Lindy Effect to businesses with long operating histories.
The Lindy Effect states the observed lifespan of non-perishable items (businesses, ideas, books, etc.) is most likely to be at its half-life.
Put simply, if a business is 100 years old, we should expect it to be around for another 100 years. Similarly, we would expect a 10-year-old business to be around for another 10 years.
It is important to note the Lindy Effect provides an average expectation and might not necessarily hold for any one company.
One of the best places to find businesses with long operating histories and strong histories of dividend growth is the Dividend Kings – a group of elite companies with at least 50 years of consecutive dividend increases.
You can see the list of all 19 Dividend Kings here.
This article will examine four Dividend Kings with inflation-beating dividend growth that are likely to be around in 50 years.
Procter & Gamble Co.
Based on its market capitalization of $230 billion, Procter & Gamble (PG, Financial) is the largest consumer goods conglomerate in the world.
Procter & Gamble owns a number of highly popular brands, including:
- Crest
- Tide
- Pampers
- Head & Shoulders
- Gillette
Certain details about Procter & Gamble’s business can be seen below.
Source: Procter & Gamble Investor Relations
Procter & Gamble qualifies as an inflation-protected stock. It has consistently grown its dividend faster than the rate of inflation.
Procter & Gamble’s dividend history can be seen below.
Source: Value Line
Procter & Gamble has compounded its dividend payments from 64 cents in 2000 to $2.66 in 2016 – which is good for a compound annual growth rate of 9.3%.
Despite the company’s strong record of dividend increases, Procter & Gamble has not met investor expectations over the past decade. Since 2007, the company has grown earnings per share at 2.1% per year.
This number is significantly worse if we exclude a strong performance from 2007 to 2008. Procter & Gamble has grown the bottom line at 0.1% per year since 2008 on average.
The company’s EPS trend over the long run can be seen below.
Source: Value Line
Much of this disappointment has been caused by some underperforming brands in the U.S. and the company’s overseas earnings being weighed down by the strong U.S. dollar.
Accordingly, Procter & Gamble is taking measures to restore earnings growth. For instance, some of the company’s less profitable brands are being divested.
Procter & Gamble is also focused on improving the productivity among its core brands. An example of this is its complicated supply chain.
The company has many core fulfillment centers across the domestic U.S., which historically have had plenty of overlap. This is not ideal as there is always a shortest path to a given fulfillment center that will minimize cost.
Procter & Gamble is looking to optimize the supply chain moving forward. This transformation can be seen in the following diagram.
Source: Procter & Gamble Investor Relations
The elimination of overlap from Procter & Gamble’s supply chain will reduce the company’s expenses and boost EPS.
Along with divesting non-core brands, Procter & Gamble is reducing the number of markets in which it competes.
The company’s simplification efforts are aiming to reduce its product categories by 60% and the number of brands by 70%. This will allow the company to focus on its most profitable avenues.
Source: Procter & Gamble Investor Relations
Similarly, Procter & Gamble is exiting non-core geographies.
As of right now, more than half of the company’s net sales come from outside North America, and the strength of the U.S. dollar has made these international currencies less valuable when reported in USD.
Half of its country clusters will be eliminated during the company’s restructuring efforts.
Source: Procter & Gamble Investor Relations
Aside from restructuring efforts, Procter & Gamble’s shareholders will continue to be rewarded by its substantial capital return program.
In the first half of fiscal 2017 alone, the company returned $15.5 billion to shareholders.
Source: Procter & Gamble 2017 CAGNY Presentation
Procter & Gamble shows no signs of slowing down either – management has communicated the intent to return up to $70 billion of capital to shareholders between fiscal years 2016 and 2019.
Source: Procter & Gamble 2017 CAGNY Presentation
Procter & Gamble has a very good chance of still being in existence in 50 years.
The company was founded in 1837 – 180 years ago. According to the Lindy Effect, Procter & Gamble can be expected to last until the year 2197.
Looking at it another way, if we consider only the period during which Procter & Gamble has consistently raised its dividends (the past 60 years after the increase last April), Procter & Gamble can be expected to last until the year 2077.
With the company’s renewed focus on its core products and business simplification, shareholders are likely to be rewarded along the way.
3M Co.
3M (MMM, Financial) is the world’s largest diversified manufacturing company with a market capitalization of $112 billion.
Originally named Minnesota Mining and Manufacturing, the company has grown over the years to manufacture more than 60,000 products sold in 200 countries.
3M is divided into five segments for reporting purposes:
- Health Care
- Safety and Graphics
- Industrial
- Electronics and Energy
- Consumer
3M’s Industrial segment is by far the largest. Each segment’s contribution to revenues can be seen below.
Source: 3M 2016 Investor Day Presentation, slide 7
3M qualifies as an inflation-protected stock because of its dividend history.
The company’s payout has increased from $1.16 in 2000 to $4.44 in 2016, good for a CAGR of 8.8%.
3M’s dividend growth has been particularly impressive in the past five years.
Source: Value Line
Recently, 3M’s international revenues have become less valuable when swapped back to USD because of the continued strength of the U.S. dollar.
The U.S. dollar is trading above historic levels however. When the domestic currency returns to a more normalized level, this will present a tailwind for 3M.
The company will also continue to benefit from an industry-leading research and development team.
3M has obtained more 100,000 patents over the course of its operating history, largely due to its substantial research and development budget:
- 2014: 5.6% of revenues spent on research and development
- 2015: 5.8% of revenues spent on research and development
- 2016: 5.8% of revenues spent on research and development
3M’s management team is remarkably candid with their shareholders, giving guidance bands for a number of financial metrics. Between 2016 and 2020, the company is expecting organic revenue growth in the range of 2% to 5%.
Source: 3M 2016 Investor Day Presentation, slide 13
Until 2020, 3M is expecting EPS growth of 8% to 11%. The company is also aiming for 100% free cash flow conversion (which means that for every dollar of net income, the company generates a dollar of free cash flow).
The company’s other medium-term financial objectives can be seen below.
Source: 3M 2016 Investor Day Presentation, slide 14
3M will almost certainly still be a highly profitable business in 50 years.
The company was founded in 1902, 115 years ago. According to the Lindy Effect, this means the company will likely last for another 115 years – until the year 2132.
Looking at dividends in particular, Feb. 7 marked 3M’s 59th consecutive year of dividend increases as the company reported a 6% payout increase. The Lindy Effect states the company will, on average, operate for another 59 years until 2076 if we base longevity on dividend increases.
Either way, 3M’s expected remaining lifespan appears substantial, which appeals to long-term investors.
Johnson & Johnson
Johnson & Johnson (JNJ, Financial) is a large health care conglomerate. The company has more than 260 subsidiary companies and a market capitalization of $336 billion.
The company operates in three segments:
- Consumer ($13.3 billion of 2016 revenues)
- Pharmaceutical ($33.5 billion of 2016 revenues)
- Medical Devices ($25.1 billion of 2016 revenues)
Each operating group’s contribution to fiscal 2016’s adjusted income before tax can be seen below.
Source: Johnson & Johnson Fourth Quarter Earnings Presentation, slide 31
Johnson & Johnson recently reported strong financial results for fiscal 2016.
Adjusted EPS grew by 8.5%, which marks 33 consecutive years of growth in per-share earnings on a constant currency basis – the longest record known by the author.
Because of this remarkable streak of per-share earnings growth, Johnson & Johnson is the gold standard for consistency in not just the health care industry, but among all businesses.
Other select data from Johnson & Johnson’s fiscal 2016 financial performance can be seen below.
Source: Johnson & Johnson Fourth Quarter Earnings Presentation, slide 1
Johnson & Johnson’s dividend record certainly makes it an inflation-protected stock.
Between 2001 and 2016, the company grew its dividend payments from seven cents to $3.15, good for a CAGR of 10.5%.
Source: Value Line
In the second half of this sample, Johnson & Johnson’s dividend growth has slowed – but the company has still delivered great dividend growth in the range of approximately 7% per year.
Johnson & Johnson has a AAA credit rating from Standard & Poor’s– the highest rating given by the agency.
This perfect credit rating means the company is considered more creditworthy than the federal government, all but 15 states and all but one other company – Microsoft (MSFT).
Think about that, this health care company is seen as a better debtor than the U.S. federal government, which has the ability to tax domestic citizens. Clearly, Johnson & Johnson is an outstanding business.
This excellent credit rating allows Johnson & Johnson to finance acquisitions by issuing long-term debt at attractive interest rates.
Recently, Johnson & Johnson announced the acquisition of Actelion Ltd. (XSWS:ATLN)Â for $30 billion. The transaction was an all-cash deal that Johnson & Johnson financed with cash held outside the United States.
Actelion’s drug discovery operations and early-stage clinical development unit will be spun off into a new Swiss pharmaceutical company, which will be 16% owned by Johnson & Johnson.
Johnson & Johnson will also have rights to an additional 16% of the spunoff company through a convertible note – which caps its transaction-related ownership at 32%.
Further details about Actelion’s business can be seen below.
Source: Johnson & Johnson-Actelion Transaction Investor Presentation
The Actelion acquisition is a net positive for Johnson & Johnson (and its shareholders).
The deal will immediately boost the company's earnings and bolster its mid-term growth prospects as Johnson & Johnson rolls out Actelion’s market-leading pulmonary hypertension treatments globally.
The transaction is similarly beneficial for Actelion shareholders, who will receive a $280 payment per share – representing a 23% premium over the company’s price prior to the announcement.
Actelion shareholders will also receive one share in the new entity for each share of Actelion. The mechanics behind the transaction for Actelion shareholders can be seen below.
Source: Johnson & Johnson-Actelion Transaction Investor Presentation
The Actelion acquisition boosts Johnson & Johnson’s already strong pharmaceutical segment, which had more pharmaceutical products approved by the Food and Drug Administration from 2011 through 2016 than any other company.
Excluding the Actelion acquisition, Johnson & Johnson has 11 new pharmaceutical products in its pipeline that have the potential for over $1 billion in annual revenues.
These strong growth prospects will help Johnson & Johnson continue delivering strong total returns to its shareholders. The company’s total return history can be seen below.
Source: Johnson & Johnson Fourth Quarter Earnings Presentation, slide 18
The Lindy Effect suggests that we can reasonably expect Johnson & Johnson to continue operating 50 years from now.
Johnson & Johnson was founded by the Johnson brothers 131 years ago in 1886. The Lindy Effect suggests the company will last another 131 years until 2148.
The result is different if we consider only the period during which Johnson & Johnson has steadily raised dividends.
Johnson & Johnson’s dividend increase last April marked the company’s 54th year of consecutive dividend increases. The Lindy Effect suggests Johnson & Johnson will last until 2071 (considering only dividends).
Johnson & Johnson ranked as a Top 10 Stock according to The 8 Rules of Dividend Investing in the March 2017 edition of the Sure Dividend Newsletter.
As such, Johnson & Johnson is a buy and investors buying now can reasonably expect the company to last at least another 50 years.
Hormel Foods Corp.
Hormel Foods (HRL, Financial) is a diversified perishable and packaged foods business. The company is divided into five segments for reporting purposes:
- Grocery Products (18% of 1Q2017 net sales)
- Refrigerated Foods (49% of 1Q2017 net sales)
- Jennie-O Turkey Store (19% of 1Q2017 net sales)
- Specialty Foods (8% of 1Q2017 net sales)
- International & Other (6% of 1Q2017 net sales)
Hormel has a durable competitive advantage that comes from the strength of its brand portfolio, which includes (among others):
- Jennie-O Turkey
- Skippy Peanut Butter
- Muscle Milk
- Applegate Organics
- Hormel
- Dinty Moore
- Wholly Guacamole
- Spam
Investors should note Hormel has a very balanced business model, with a presence in many subsectors of the packaged food industry.
Source: Hormel’s Presentation at the Barclays Global Consumer Staples Conference
Shareholders who rely on Hormel for retirement income are protected from inflation because this foods giant has steadily raised its dividend faster than inflation.
In fact, Hormel has the best record of dividend growth since 2000 out of any of the companies covered in this article.
By growing its dividend from nine cents in 2000 to 58 cents in 2016, Hormel’s dividend income has compounded at a CAGR of 12.4% per year.
Source: Value Line
Hormel’s dividend growth would not be possible without a corresponding increase in EPS.
While companies can temporarily increase dividends faster than earnings over the short term, this will inevitably lead to unsustainable payout ratios over the long run.
Hormel’s strong earnings growth since 2006 can be seen below.
Source: Hormel’s Presentation at the Barclays Global Consumer Staples Conference
Hormel’s earnings growth has been driven by the company’s impressive profitability.
The company ranks in the top three of its peer group for return on invested capital (ROIC), which is generally calculated as:
ROIC, expressed as a percentage, shows how many dollars of annual earnings are generated from each dollar of company capital (provided through either shareholders’ equity or debt).
You can see how Hormel’s ROIC compares to the company’s peer group below.
Source: Hormel’s Presentation at the Barclays Global Consumer Staples Conference
Looking ahead, Hormel has lowered EPS growth guidance for fiscal 2017 in its most recent earnings announcement, largely due to weakness in the company’s Jennie-O Turkey Store segment.
Turkey prices have decreased more than 60% from a year ago, and Hormel has struggled with turkey supply issues. Fortunately, there issues are temporary. The long-term outlook for the turkey industry remains strong.
Turkey is taking a larger and larger share of the ground meats market – with turkey’s share growing every single year since 2010. This trend is visualized below.
Source: Hormel’s Presentation at the Barclays Global Consumer Staples Conference
Hormel will return to more rapid growth when turkey prices normalize.
Much of Hormel’s future growth will be driven through acquisitions. The company has made a habit of acquiring smaller foods brands and scaling them through Hormel’s impressive distribution network.
Hormel will very likely still be in business in 50 years. The company operates in the slow-changing foods industry, and the company already has a very long operating history.
Hormel can trace its roots back to 1891, when George A. Hormel established Geo. A. Hormel & Co. in Austin, Minnesota.
This was 126 years ago, so the Lindy Effect indicates Hormel will likely survive as a business until the year 2143 (126 years from today).
Looking at dividends in particular, Hormel’s November dividend increase of 17% marked its 51st consecutive year of dividend increases. The Lindy Effect suggests Hormel will continue to operate for another 51 years, until 2068.
Hormel looks attractive at today’s prices. Like Johnson & Johnson, Hormel ranked as a Top 10 Stock using the 8 Rules of Dividend Investing in the March 2017 edition of the Sure Dividend Newsletter.
Hormel Foods is currently a buy and its new shareholders can expect to be able to hold the stock for a long, long time.
Final thoughts
Each of the companies outlined in this article have remarkable track records of operational growth. Moreover, two of these companies (Hormel and Johnson & Johnson) ranked in the Top 10 in March’s edition of the Sure Dividend Newsletter.
These two companies are a buy right now and will likely continue to reward shareholders for a substantial period of time. The other companies (3M and Procter & Gamble) would also be a great addition to a portfolio at the right price.
Disclosure: I am not long any of the stocks mentioned in this article.
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