Why I’m Buying Boring Stocks
I remember the good ol’ days of the Internet Bubble in late 1999, early 2000. I bought Qualcomm (QCOM) at around $300 a share and watched it skyrocket to $800 a share in less than a year. Valuations didn’t matter, only the stories behind the stocks. I had lofty ambitions of early retirement and life of luxury. Warren Buffett was widely derided (amongst my friends) as an old fool who didn’t understand the new economy – this time it was surely different.
Sadly, no one told me the party was going to end and I rode that pony all the way back down the hill.
And then my brokerage called me and informed me that not only was my investment account worth zero, I also owed them an additional thousand dollars! Yeah, leverage works both ways.
That’s when I realized that investing isn’t about excitement, it’s about buying dull, income-generating stocks and as Buffett would say, sitting on your hands for extended periods of time.
I realized that I didn’t need to be invested in growth stocks that double every year. I just need to find stocks that generate 8-12% a year in capital appreciation and dividends, and I’ll be able to beat 90% of money managers on the planet.
So why am I bringing this up today? I recently read an article about how an investor was abandoning his position in Johnson and Johnson (JNJ), citing lack of growth as the main reason.
I am not suggesting that JNJ is about to collapse or slowly fade into the background. As I said, JNJ is a strong cash flow generator and the company does generate very strong returns on capital. With such a large amount of reinvestable cash, there will always be at least the hope of better days.
The problem, though, is that JNJ just isn’t a dynamic player. If you want a company that will produce large amounts of cash, and send a fair bit of it back to shareholders in dividends and buybacks, JNJ is a fine choice. But if you really want to harness the growth potential of the healthcare market with a top-notch operator, JNJ simply does not fit the bill.
Based on the 150+ comments, it seems like the investor and numerous readers were tired of the lack of stock performance of JNJ. How anyone would mistake a humongous, global conglomerate for a growth stock is another story, but is it really a dog of a stock?
After holding it for a decade (like some of the readers claimed they did), should you sell it now in favor of a tantalizing growth stock, like maybe SalesForce (CRM) that sells for 260 times earnings?
The problem with growth stocks is that everyone knows they’re a growth stock destined for great things, and investors usually overpay for this privilege, or should I say, excitement.
Studies have shown that over the long run, growth (or glamour) stocks underperform boring, value stocks.
So are people correct in giving up on boring, no-growth JNJ?
Well, JNJ’s story sure isn’t getting any more interesting. In fact, the 100+ year-old stodgy company is so unexciting, I can’t even be bothered to read what it does on its profile page on Yahoo! Finance. I know it makes medicine and related products. It had a slew of recalls and maybe it even makes Splenda. But seriously, who cares?
I don’t need to be swayed by some BS management story. I went to business school, I know how those yarns are spun! Just show me the numbers…
JNJ has a market cap of $166B and it has zero net debt – always a good sign.
Over the past decade (2001 through 2010), income has almost doubled from $33B to $61.6B. Operating cash flow has almost doubled from $8.8B to $16.38B. And most importantly, free cash flow (or as Benjamin Graham
In terms of valuation metrics, the P/E fell from 32 to 12.7 over the same time period, and the P/CF fell from 20.5 to 10.3. Which meant that it went from being grossly overvalued in 2001 to being favorably-valued in 2010.
At today’s prices, the P/FCF is currently 11.84, which is quite cheap for a blue-chip stock and it has a projected yield of 3.6%, which incidentally, puts in on par with the yield of the 10-year US Treasury.
However, JNJ has been growing its dividend around 9-10% every year since 1972. In fact, it has increased the dividend every single year for 48 years!
If you had invested in JNJ 10 years ago, your entry price (adjusted for splits and dividends) would be about $37. It’s currently trading around $60.50, so while a 64% increase over a decade may not be the dreams that growth stocks are made of, at least your initial quarterly dividend payment of 0.16 cents has more than tripled to 0.54 cents.
And even though you made the wrong decision in buying an overvalued stock a decade ago, you’re still not doing too badly. At your entry price of $37, you’re almost making a 6% yield today.
Buying this boring, no growth stock today gives me an annual yield of 3.6%. If it repeats its performance over the next decade and the dividend triples again, I’ll be making 12% annual yield from the dividends, based on my purchase price. I can live with that sort of sub-par performance!
And if the P/E expands to growth-stock levels, causing the share price to soar and the dividend yield to drop back under 1% like it did 2001, I’ll be happy to sell it to some growth-story-chasing investor. But until then I’m happy eschewing the glamor stocks in favor of the cheap, boring, no-growth, value stocks.
Disclaimer: I bought some JNJ for my retirement account yesterday around $60.50. I’m happy to keep it for a decade, or until they cut their dividend. I also shorted CRM at the same time.
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March 9th, 2011 at 7:21 am
Great summary.
March 9th, 2011 at 1:52 pm
Oy!
If people are so “bored” with a company like JNJ, rather selling it, maybe it would be more entertaining to do something like write the January 2012 65/55 strangle on JNJ for $380 or so for every 100 shares you own. That arguably increases your yield on JNJ by 6 percentage points in less than a year.
If by expiration in January 2012 JNJ remains between 55 and 65, you’ve pocketed the proceeds. If it goes above 65, you’ll be forced to sell your JNJ shares at 65 due to the written covered call, and if it goes below 55 you’ll be forced to buy an additional 100 shares of JNJ at 55 due to the written naked put.
Of course, writing the naked put side would tie up $5500 until January on a cash account or probably $1100 on a margin account.
Geez, if your readers and friends are so convinced a stock they own will do nothing and acts boring, there are ways to make it exciting. Retail investors need to learn that there’s more to the market than just buying and selling stocks otherwise they’ll get screwed every time.
March 19th, 2011 at 3:12 pm
Nice short on CRM. Looks like the momentum finally died. Looks like forward estimates have been cut too..
March 19th, 2011 at 4:22 pm
Wow. You’re back! You should do another online income update. That’d be cool to see where’s it come, what’s working and what’s not anymore these days.