Friday, April 17, 2009

Best and Worst Performing DJIA Stock

CNBC is celebrating 20 years on the air today. They just mentioned the best and worst performing Dow stock since CNBC went live.

CNBC Turns 20

The best performing Dow stock over the past 20 years is Procter & Gamble. The Dow Jones Industrial Average returned 248% over the same period of time.

Procter & Gamble (PG) had a 780% increase in past 20 years (excluding dividends). Companies like P&G are categorized incorrectly as just "defensive stocks" (related previous post) in my view. Yet, stocks like P&G are routinely described this way. They certainly tend to do well in down markets but "defensive", at the very least, seems an incomplete description.

Generally speaking, in addition to P&G, companies like Coca-Cola (KO), Pepsi (PEP), Philip Morris International (PM), Diageo (DEO) and similar -- those that make and distribute leading branded small-ticket consumer products (fast-moving consumer goods: FMCG) on a big scale -- are higher quality businesses. As always, shares of even the highest quality businesses still must be bought at a plain discount to estimated value.*
(Over the shorter run -- less than five years or so -- anything can happen as far as price action and relative performance goes.)

P&G's performance is what happens to shares of durable high return businesses if allowed to compound long-term and bought well in the first place. The reasons for this is not particularly complicated. The $ 12 billion of free cash flow that P&G will approximately generate this year can be used to pay $ 5 billion in dividends with the rest going into some combination of buying back stock**, developing/acquiring new brands, or expanding distribution etc. The returns that P&G will generate on these new investments will eventually be roughly reflected in per share intrinsic value. Add the impact of new investments and buybacks to the high returns on capital that P&G generates from its already existing assets and, over a longer time frame, the stock is likely to compound nicely in per-share value.

So it's not magic (even if how compounding works sometimes seems that way). It's just consistent with what Ben Franklin said long ago.

"Remember, that money is of the prolific, generating nature. Money can beget money, and its offspring can beget more, and so on. Five shillings turned is six, turned again it is seven and threepence, and so on, till it becomes a hundred pounds." - Ben Franklin

Any one of these businesses can and, in fact, likely will go through extended periods of difficulty from time to time and, of course, so might the stocks. Some investors/traders will -- and it's somewhat understandable even if more generally unwise -- attempt to jump in and out of the shares based upon short-term or even intermediate-term factors. Yet, the casino-like culture that has emerged seems to have Sisyphus as its inspiration instead of good old Ben. As a result, a lot of unnecessary frictional costs and mostly useless hyperactivity have become embedded in the system.

"And that's where we are today: A record portion of the earnings that would go in their entirety to owners – if they all just stayed in their rocking chairs – is now going to a swelling army of Helpers." - Warren Buffett in the 2005 Berkshire Hathaway Shareholder Letter

"...the burden of paying Helpers may cause American equity investors, overall, to earn only 80% or so of what they would earn if they just sat still and listened to no one.

Long ago, Sir Isaac Newton gave us 3 laws of motion, which were the work of genius. But Sir Isaac’s talents didn't extend to investing: He lost a bundle in the South Sea Bubble, explaining later, 'I can calculate the movement of the stars, but not the madness of men.' If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases." - Warren Buffett in the 2005 Berkshire Hathaway Shareholder Letter

Bottom line: It's better to own great businesses (those with durable advantages), bought at fair prices (better yet, at a plain discount to well-judged intrinsic value), with the intention to hold them a long time. They won't necessarily do well over shorter time frames (less than five years or so) but the durability of their economics increase the likelihood they'll do just fine over the longer haul. Even if shares of the higher quality businesses did not outperform over the long haul going forward (and they may not, of course), the sheer simplicity of the approach compared to alternatives needs to be considered.

So does the reduced likelihood of permanent capital loss and more narrow range of outcomes.

Now, anyone buying the higher quality stocks expecting them to outperform during the next bull market will likely be disappointed.

That is, in part, how they have earned the reputation of being defensive.

Look elsewhere for exciting price action.

Yet, this reputation seems verifiably incorrect when you look at the historic returns of these stocks over the longer haul (a full business cycle or two). That, of course, guarantees nothing going forward but is, at least, noteworthy. Also, over shorter time frames, it's easy to see why these are perceived to be defensive investments. They generally don't go down as much when the market crashes, and they don't go up as fast during bull markets. It's over several bull and bear markets that their historic merits become more obvious.

Still, as I've said, just because something that seems to be a higher quality investment has done well in the past guarantees nothing.

Oh and by the way GM was, not surprisingly, the worst performing Dow stock over the past 20 years at -94%.


Related post:
Defensive Stocks?

Long positions in KO, PEP, PG, PM, and DEO. My top choice wouldn't be PG among the higher quality franchises even if it is as good an example as any of a higher quality franchise. My preference happens to be PM and DEO but consider each of these long positions worthy investments when bought at the right price. With any investment, no matter how seemingly attractive, margin of safety is all-important. What's sensible to buy at a price that represents a nice discount to intrinsic value doesn't make sense at some materially higher valuation. Margin of safety protects against the unforeseen real, even if fixable, business problems. Still, it's worth considering this: "If the business earns 6% o­n capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return - even if you originally buy it at a huge discount. Conversely, if a business earns 18% o­n capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result." Charlie Munger at USC Business School in 1994
** Only if selling at a discount to intrinsic value.
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