Drip Portfolio Report
Tuesday, September 2, 1997
by Jeff Fischer (TMF Jeff)
ALEXANDRIA, VA (Sept. 2, 1997) -- We're building a long-term portfolio of world-leading companies. We sent our first check to buy INTEL (Nasdaq: INTC) on August 21st, and we received confirmation of the order one week later. Our first share of Intel has probably been bought for us by now, and we should know the price and be enrolled in Intel's direct purchase plan by the end of this month. We plan to send this month's $100 to Intel, too, and perhaps last month's $100 as well. (We save $100 and add it to the portfolio on the 15th of every month, and last month we didn't have a company to send the $100 to yet.)
We currently have about $470 to invest. We began with $500 which was to be invested in five companies over the coming few months. We're working on our second purchase now -- again, with the goal of building a diversified portfolio holding world-leading companies. Randy, meanwhile, has been working on "special situation" companies -- companies that we would most likely buy after our initial portfolio was in place. These companies offer more potential price appreciation but probably more risk, too. The first such possibility, OWENS CORNING (NYSE: OWC), has initially been denied a place in the Drip Port due primarily to the company's debt, which Randy took apart and analyzed. We'll probably reconsider Owens Corning later, though.
In the bullpen we have COCA-COLA (NYSE: KO), the first company that we considered for the Drip Port. Our purchase of Coke has been put on hold until after the mid-October earnings report, following company news in late August that earnings would be about flat from last year. We want to see why. Randy will write about Coca-Cola later this week. I think we're both hoping that the company can be our twenty-year purchase in the food and beverage industry.
In the following days I'm going to work toward a decision for our healthcare industry investment. There's no way that we're not investing in healthcare. The industry has been a consistent winner. For Johnson & Johnson, focusing on healthcare has led to 100 years of steady growth in both revenue and earnings. For "secondary" companies like Schering-Plough, Abbott Labs, and Pfizer, the industry has provided decades of the same impressive growth. This isn't likely to change. The country is aging demographically, and Baby Boomers -- the largest generation ever in America -- are leading the charge.
Last week we took an initial look at three companies that we'll consider for the Drip Port. They are Johnson & Johnson, Abbott Labs, and Schering-Plough. We're also going to consider Pfizer.
Readers have written asking why we aren't considering Merck, Bristol-Myers Squibb, Glaxo, Eli Lilly, and SmithKline Beecham. The main reason is that all of these companies charge fees for using their direct purchase plans. There are enough great companies out there -- perhaps the best companies in this industry -- that don't charge fees, so we're not going to consider those that do charge. We wouldn't be excited to pay twenty years worth of fees to buy stock directly from a company, and we suggest that you think twice about it, too, and ask that the company drops its fees before you invest. Fees largely defeat the purpose of this type of investing. That said, the stocks that we're considering are our primary considerations anyway, so delving into the land of "fee charging" companies doesn't make sense. We have our hands full deciding among our four leading firms.
All of these companies are strong financially and have been historically. We have JOHNSON & JOHNSON (NYSE: JNJ) with $22 billion in trailing twelve month sales and a market cap of $75 billion, meaning that the stock trades at 3.4 times sales. We have SCHERING-PLOUGH (NYSE: SGP) with $5.7 billion in trailing sales and a market cap of $36 billion, so the stock trades at 6.2 times sales. Then there's ABBOTT LABS (NYSE: ABT) with $11 billion in trailing sales and a market cap of $47 billion, trading at 4.3 times sales. Finally, PFIZER (NYSE: PFE), which has $11.3 billion in trailing sales and a market cap of $70 billion, so trades at 6.2 times sales.
Of the four, Johnson & Johnson is the most mature company and is by far the least expensive on a price-to-sales basis (a valuation note: figuring the enterprise value for each company is found to make no significant difference, as none of these firms have outrageous amounts of debt or cash). Aside from girth -- which comes from success and age -- there are few reasons for Johnson & Johnson to trade at a lower sales ratio than that of its peers. Even so, 3.4 times sales for J&J is nothing to sneeze at -- though compared to the industry, it appears to be. The market is valuing the stocks on earnings more than sales, though.
All four of these companies are expected to grow between 13% and 16% annually over the next five years. Three of the four companies trade at 22 to 25 times the current year's earnings estimate. Pfizer trades at 33 times the estimate. Let's look at a snapshot:
Five-year growth rate P/E on '97 est.
JNJ 15% 23 SGP 13% 25 ABT 13% 22 PFE 16% 33
How much return has the historical shareholders' dollar earned with each company? All the firms have double-digit profit margins and have performed strong return on equity. Witness:
Return on Equity Net Margins
JNJ 28% 13% SGP 57% 21% ABT 40% 17% PFE 29% 17%
Schering-Plough is the clear recent winner here, but what's more important is the likelihood that the return on equity and margins are sustainable. Schering-Plough enjoys higher margins than the other companies for a reason.
We decided last week that what was more important than the current performance -- as all of these companies are strong -- is the product mix of each company going forward. Over the next twenty years we want as much certainty as possible. That means we want a company that is as well-diversified in the medical and pharmaceutical arena as it is in consumer brand products. We're going to study the websites of each company and we've received the annual reports, too. We'll see exactly what each company is selling to make its money.
We'll also consider these eight guidelines that we hope to see in each company -- a benchmark to shoot for.
1. A strong balance sheet (cash rather than debt).
2. Consistently growing annual earnings by double digits.
3. Consistently improving return on equity and other performance measures.
4. Double-digit net profit margins.
5. Attracting and retaining top quality management.
6. Consistently repurchasing shares.
7. Industry dominant.
8. All of this: Sustainable.
I think all four of our companies will match or come close to matching all of these criteria. We'll begin with a closer look at Schering-Plough tomorrow, looking at the numbers and -- importantly -- the products sold in order to make those numbers.