Drip
Portfolio Report
Friday, January 30, 1998
by Jeff Fischer
([email protected])
ALEXANDRIA, VA (Jan. 30, 1998) -- We never mentioned the issue of "ethics" that some potential investors attribute to Philip Morris (NYSE: MO), and we won't mention it today, either. We don't need to. We analyzed twenty-one food companies on the merits of their business, management, and valuation. We're investing based on what we have come to understand after months of study, and therefore we're investing in what we think, based on that knowledge, offers us the best chance of a market-beating return over the coming two decades and longer. Ethics is not part of the decision. Knowledge is.
To do three months of research and then not invest based on the clearest and most complete knowledge obtained would be wrong. Such a decision would partially negate the research done and eliminate the advantage that an in-depth study gains an investor. So, we never needed to mention the ethical issue that is often attached to Philip Morris. The level of knowledge that we've been able to obtain about the company and its future is enough to merit that our attention (and our capital) be directed elsewhere -- to a company in a business that we understand as completely as possible, now and going forward.
The Campbell Soup Co. (NYSE: CPB) states that it still provides less than 2% of the world's soup, and that by entering new markets, launching new products (such as healthy low sodium soup last year), and focusing on the growth of its three primary food segments, it will work to grow its world market share consistently for decades.
Contrast that to Phillip Morris...
This company can't state how it plans to increase its market share for tobacco, or how it will get more people to buy cigarettes, or how it will work to have much more of the world smoking in twenty years. In fact, the outcome of litigation could eliminate much of the tobacco industries' means to effectively advertise its products, leaving them in a bind that no business should face. We want to invest in the long-term growth of the food industry; diluting that investment by purchasing a company that has a core business outside of this industry doesn't make much sense. We can't ignore the fact that a bulk of this company's earnings comes from tobacco, so in retrospect perhaps Philip Morris should not have made our food finalist list for this reason alone.
Consider this...
Will the tobacco industry be larger in twenty years? There is not a definitive answer. Will the food industry be larger in twenty years? Yes. (Barring human disease or massive war that causes the population to shrink.) Will the soup and biscuit industry be larger in twenty years? Yes. (Barring disease, massive war, or the regression of human nature to that of strictly leaf-eating mammals, no longer interested in soups, biscuits, sauces, and chocolates.)
On the message boards, Fools wrote that whatever our decision, they hoped that we explained it well and then discussed why we weren't buying the other companies and share our concluding thoughts on those finalists. I'll do that in this column.
As I began to write in the Fool Port column on January 26, there are many different types of appreciation that an investor can obtain, just as there are many kinds of risks in investing. The risks include business risk, valuation risk, knowledge risk, macroeconomic risk (external factors that can't be controlled) and, in some cases, legislative risk. Philip Morris contains all of these except perhaps the valuation risk, so therefore the lower valuation is arguably justified. (I say "perhaps" it doesn't hold the valuation risk because maybe it does indeed hold this risk, too. Even Randy's analysis of the possible legal outcome didn't, in my opinion, present an incredibly favorable scenario.)
Meantime, what risk does Campbell Soup entail? The only considerable risk currently is the valuation risk. Even the macroeconomic risk is lower than normal because people still buy food and soup in slow times. And as I wrote Thursday, I think that the valuation risk is only moderate rather than high. In fact, I say this with more certainty than I can say that Philip Morris is valued inexpensively. MO's valuation might actually be only reasonable, not inexpensive, considering the circumstances and the possible outcome. Either way, the risk that Campbell Soup does hold we understand. But the risk that Philip Morris holds we can't completely understand. Nor can we trust management to understand it as well either, especially because much of it is outside of their control.
Readers will ask, "But what about the fat Philip Morris dividend?"
Wrong industry to be looking for that big dividend, Fools. Investors love the food industry because it can be a stable grower in both bad and good times, and it provides a steady if not mind-blowing long-term rate of return. Nobody should buy food stocks for a big fat dividend payment alone. A dividend of slightly under 2% is the average of the stocks that we looked at, so the main incentive to invest in this industry is its inherent stability, not lofty dividends. We'll be analyzing industries like financials (banks) and energy (oils) and that is where we will be looking for the bigger yield. That is where we'll place more importance on the yield and where we'll get a higher yielding stock. Banking stocks have been offering above-market dividend yields for most of this century -- yields that remain high because of the perceived nature of the business.
Which brings me to Philip Morris: the high yield will disappear if the risk disappears or lessens. The stock will rise quickly and the yield will revert back to a more reasonable level. Investing long term for a high yield in a company of this ilk is like pulling petals off of a rose and hoping that the petals are infinite in number. But if the wind changes, you have a stripped rose bud in your hand. Sure, Philip Morris will likely always pay a more generous yield than most food companies, because of the tobacco issue, but probably at the cost of share price appreciation. In the end, it could be a wash. One return (yield) might be cancelled out by another (lack of share appreciation), just as we've seen recently. As long as the risk is perceived as unfavorable (meaning, the stock price is low and the yield is high), investors will likely be collecting the yield and not much share price appreciation. Once that risk lessens, the yield will decrease after a share price adjustment. This is the wrong industry in which to count on a higher than normal dividend yield indefinitely.
I hope that in this condensed format I've made clear why Philip Morris isn't the stock being bought, and that our past columns have shown why Campbell Soup is a strong choice. With a market cap of $25 billion (compared to $90 billion and $133 billion for J&J and Intel, respectively), Campbell Soup is a relative "small-cap" in a business that we understand with risks that we understand, growing at a market-beating pace, dominating its business, and run by a management that we trust and that has shareholder value in mind.
So what about PepsiCo (NYSE: PEP) and Quaker Oats (NYSE: OAT)? After we looked at PepsiCo closely as a finalist, I find it hard to choose the number two soft drink company over the number one, Coca-Cola (NYSE: KO). The valuation of neither is "run out and buy it now" cheap, but my opinion is that the valuation of PepsiCo is not attractive enough to prefer it over Coca-Cola. I'd rather take the leader if I was forced to buy one to hold for at least ten years.
Meantime, Quaker Oat's management has not grown earnings per share over the past five years (due in part to acquisition mistakes), and the company has the lowest margins and not as broad a portfolio of food products as does Campbell Soup. Based on recent history, I don't trust the ability of management at Quaker as much as I do at Campbell. But Quaker, alongside with PepsiCo and Philip Morris, are probably all good long-term choices for their own reasons, but they are not the choice for this portfolio.
But before you mail your form to buy Campbell Soup, don't! If Campbell is your choice, you may want to hold your horses. Campbell Soup is spinning off its Vlasic-Swanson division in March. Here at the Drip Port, we're going to wait until the formal deadline for the spin-off passes and then we'll send our money to buy our first share of Campbell. Why? We don't want the paperwork or trouble of acquiring a position in the new company. For all we know, it may not even offer a DRP, while we do know that it is a lower margin business anyway, and one that isn't growing as quickly (which is partially why Campbell is spinning it off). We only want to own Campbell Soup. So, we'll let you know when it's clear to send the money. Probably in late February or early March we'll be clear.
As our third buy in a portfolio that will probably not hold more than seven or eight stocks, we welcome Campbell Soup Co. to the ranks.
With this good news there is also unfortunate news to announce tonight. Randy told me in early January that, for many reasons that he outlines in tonight's Evening News column, he is leaving the Fool to pursue other opportunities. Having known this since early January, we worked as normal to complete the food decision, but in his new position of employment Randy will no longer be able to participate in the Drip Portfolio. Rather than re-state Randy's reasons for leaving (which you can read in the Evening News), for now it suffices to say that this is an unfortunate loss for the good old Drip Port.
What does this mean for the Drip Portfolio? We're continuing as normal with all of our plans, of course. I'm thinking of possible folks to replace Randy, but that isn't an easy position to fill. Our good friend, Vince (TMF Elwood from the message boards), will be writing columns for us periodically, while the next industry that Randy and I were actually thinking of covering (after a cool down and some rest anyway) is the financial industry -- for which we were going to try to employ the resident "Fool Expert," Dale Wettlaufer (TMF Ralegh). That industry perhaps more than any other offers many lessons.
Meantime, it's reassuring to me that all of the purchases that Randy and I have made we've agreed on independently before agreeing on them together. We've had relatively very little to argue about, including with Campbell Soup -- not a lick of disagreement.
Randy isn't falling off the face of the earth. He's moving to Baltimore. But I'll have more on this change and on the Drip Port's movement going forward on Monday. For now, to discuss Campbell or to post your thoughts to Randy, or to share anything regarding the Drip Port, Vince and I will see you on the "Drip companies" message board on the Web and on AOL. Those are the boards that are developing the great communities and that we read each day.
Though I'll write more about this on Monday, for now, I just thank Randy for all of his hard work here. Fool on!
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