Published March 8th, 2017 by Nicholas McCullum
Investors have a lot to gain by investing in inflation-protected stocks with a long time horizon.
“The single greatest edge an investor can have is a long-term orientation.”
– Seth Klarman
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 that shareholders who rely on these companies for retirement income can rest assured that 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 that the observed lifespan of non-perishable items (businesses, ideas, books, etc.) is most likely to be at its half-life.
Said another way, 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 that 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 50+ years of consecutive dividend increases.
This article will examine four Dividend Kings with inflation-beating dividend growth that are likely to be around in 50 years.
Longevity Stock #1: Procter & Gamble
Based on their market capitalization of $230 billion, Procter & Gamble (PG) is the largest consumer goods conglomerate in the world.
Procter & Gamble owns a number of highly popular brands, including:
- Head & Shoulders
Certain details about Procter & Gamble’s business can be seen below.
Procter & Gamble qualifies as an inflation-protected stock. They have consistently grown their dividend faster than the rate of inflation.
Procter & Gamble’s dividend history can be seen below.
Source: Value Line
Procter & Gamble has compounded their dividend payments from $0.64 in 2000 to $2.66 in 2016 – which is good for a CAGR 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 earnings-per-share 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 their core brands. An example of this is the company’s complicated supply chain.
Procter & Gamble has many core fulfillment centers across the domestic United States 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 their supply chain moving forward. This transformation can be seen in the following diagram.
The elimination of overlap from Procter & Gamble’s supply chain will reduce the company’s expenses and boost earnings-per-share.
Along with divesting non-core brands, Procter & Gamble is reducing the number of markets in which they compete.
The company’s simplification efforts are aiming to reduce their product categories by 60% and their number of brands by 70%. This will allow the company to focus on its most profitable avenues.
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 their country clusters will be eliminated during the company’s restructuring efforts.
Aside from restructuring efforts, Procter & Gamble’s shareholders will continue to be rewarded by the company’s substantial capital return program.
In the first half of fiscal 2017 alone, the company returned $15.5 billion to shareholders.
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.
Procter & Gamble has a very good chance of still existing in fifty 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 their dividends (the past 60 years after their increase last April), Procter & Gamble can be expected to last until the year 2077.
With the company’s renewed focus on their core products and business simplification, shareholders are likely to be rewarded along the way.
Longevity Stock #2: 3M
3M (MMM) 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 & Graphics
- Electronics & Energy
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 their 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.
However, the U.S. dollar is trading above historic levels. 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 their 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 rage of 2%-5%.
Source: 3M 2016 Investor Day Presentation, slide 13
Until 2020, 3M is expecting earnings-per-share growth of 8%-11%. 3M 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 fifty years.
The company was founded in 1902, 115 year ago. According to the Lindy Effect, this means that the company will likely last for another 115 years – until the year 2132.
Looking at dividends in particular, February 7th marked 3M’s 59th consecutive year of dividend increases as the company reported a 6% payout increase. The Lindy Effect states that 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.
Longevity Stock #3: Johnson & Johnson
Johnson & Johnson (JNJ) is a large healthcare 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 earnings-per-share 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 not just in the healthcare 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 them an inflation-protected stock.
Between 2001 and 2016, the company grew their dividend payments from $.070 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 ~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 that the company is considered more creditworthy than the federal government, all but 15 states, and all but 1 other company – Microsoft (MSFT).
Think about that… this healthcare 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 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 spunoff into a new Swiss pharmaceutical company, 16% owned by Johnson & Johnson.
Johnson & Johnson will also have rights to an additional 16% of the spu-noff company through a convertible note – which caps Johnson & Johnson’s transaction-related ownership at 32%.
Further details about Actelion’s business can be seen below.
The Actelion acquisition is a net positive for Johnson & Johnson (and its shareholders).
The deal will immediately boost Johnson & Johnson’s earnings, and bolster Johnson & Johnson’s 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 (or 280.08 CHF) payment per share – representing a 23% premium over Actelion’s price prior to the announcement.
Actelion shareholders will also receive 1 share in the new spunoff entity for each share of Actelion. The mechanics behind the transaction for Actelion shareholders can be seen below.
The Actelion acquisition boosts Johnson & Johnson’s already-strong pharmaceutical segment, which had more pharmaceutical products approved by the FDA 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 $1 billion+ in annual revenues.
These strong growth prospects will help Johnson & Johnson to 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 fifty years from now.
Johnson & Johnson was founded by the Johnson brothers 131 years ago in 1886. The Lindy Effect suggests that 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 that Johnson & Johnson will last until 2071 (considering only dividends).
As such, Johnson & Johnson is a buy, and investors buying now can reasonably expect the company to last at least another 50 years.
Longevity Stock #4: Hormel
Hormel Foods is a diversified perishable and packaged food 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
- Dinty Moore
- Wholly Guacamole
Investors should note that Hormel has a very balanced business model, with a presence in many sub-sectors of the packaged food industry.
Shareholders who rely on Hormel for retirement income are protected from inflation because this foods giant has steadily raised their 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 their dividend from $0.09 in 2000 to $0.58 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 earnings-per-share.
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.
Hormel’s earnings growth has been driven by the company’s impressive profitability.
The company ranks in the top 3 of their 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.
Looking ahead, Hormel has lowered earnings-per-share 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.
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 fifty 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 & Company in Austin Minnesota.
This was 126 years ago, so the Lindy Effect tells us that Hormel will likely survive as a business until the year 2143 (126 years from today).
Looking at dividend in particular, Hormel’s November dividend increase of 17% marked their 51st consecutive year of dividend increases. The Lindy Effect suggests that 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.
Each of the companies outlined in this article have remarkable track records of operational growth and longevity. Moreover, two of these companies (Hormel and Johnson & Johnson) ranked in the Top 10 in March’s edition of the Sure Dividend Newsletter.
Each of these two companies is 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.