October 2, 2010

Company Case Study 1

(Hopefully the first of a regular feature.)

Important note: None of this is intended as investment advice - please do your own due diligence and make your own decisions on all investment matters!

As a sometime investor, one thing of interest to me in doing this blog is discovering how different companies performed through the Depression. I don't believe the results are directly transferrable to today for a number of reasons, but I still think this gives some information that can usefully be applied to investing now.

Today I'll be covering a company in what I'd call the small luxuries sector - American Chicle, which made chewing gum (brands included Kis-Me, Beeman's, Adams and Chiclets; (deep inhale) later acquired by Warner-Lambert in 1962, which in turn was acquired by Pfizer in 2000, which then sold its candy brands to Cadbury in 2003, which was in turn acquired by Kraft in 2010 (whew)).

Getting straight to the nitty-gritty numbers:
1928 earnings $4.15/share
1929 stock price range 27 - 81 5/8; dividend $2.25/share (including extra)
- 15% “stock dividend” in Sept. 1929 (equivalent to a 1.15 to 1 stock split)

1929 earnings $4.22/share
1930 stock price range 35 - 51 1/2; dividend $3/share (including extras)
1930 earnings $4.42/share
1931 stock price range 30 1/4 - 48 5/8; dividend $3/share (including extras)

1931 earnings $4.18/share
1932 stock price range 18 - 38; dividend $3/share (including extras)

1932 earnings $3.60/share
1933 stock price range 34 - 51 1/4; dividend $3/share (including extras)

1933 earnings $3.62/share
1934 stock price range 46 1/4 - 70 5/8; dividend $3.50/share (including extra)

Earnings recovered rather explosively to $4.51/share in 1934 and $5.94/share in 1935.

All in all, an extremely creditable earnings performance - I haven't been through too many of these cases yet, but I'd venture to guess it's in the top few percent of companies as far as maintaining earnings during those years (while earnings finally slipped in 1931-32, if we take into account the substantial price deflation in this period, along with the 15% stock dividend in 1929, I think 1932 earnings remained substantially above the 1928 level).

At first look, this performance is a bit surprising - you'd expect people in a serious depression to concentrate spending on the absolute essentials, and as far as I know no one has ever died from a lack of chewing gum (or even suffered severe distress). It appears that, while people may cut out the big discretionary items in a depression, they might maintain the small comforts; in fact, they might even tend to use more of them.

It's also a little surprising that people stuck with name brand gum, which presumably charged a price premium - the explanation may lie in an observation Charlie Munger once made about another big gum maker:
“I may see Wrigley chewing gum alongside Glotz's chewing gum. Well, I know that Wrigley is a satisfactory product, whereas I don't know anything about Glotz's. So if one is 40 cents and the other is 30 cents, am I going to take something I don't know and put it in my mouth—which is a pretty personal place, after all—for a lousy dime?”

Another interesting thing to note is the two extremes hit by the stock price during the period covered above. First there was the eye-opening runup to over 81 during the 1929 euphoria; this brought the price-earnings multiple close to the “nosebleed” territory of 20. Second, there's the amazing drop in 1932, when the yearly low was 18. This brought the price-earnings multiple well below 5, and with an annual dividend of $3 including extras, the dividend yield obtainable at the 1932 low was 16.7% (gadzooks!) - all this for a company that had maintained earnings at close to record levels throughout the Depression (lest you think this can be explained by an unexpected collapse in earnings in mid-1932, the quarterly earnings per share that year were $.89, $1.05, $.90 and $.75; so the dividend continued to be earned through 1932 and was probably not in serious doubt at the time the low was hit in June; in my opinion, the explanation for the drop is much more likely to be found in the general sh*t-hitting-the-fan situation at the time).

Aside from these two interludes, the stock price held reasonably steady through the extremely severe economic downturn of 1929-33, more or less reflecting the steady earnings at a multiple of between about 9 and 12. The sweeping conclusions I draw from this sample of one (your mileage may vary):

  • If, through careful analysis or sheer dumb luck, you find a company that can maintain or grow its earnings through a downturn, and buy the stock, it seems that you might most of the time be rewarded by a stock price that reflects that performance.

  • That said, if you simply close your eyes and buy regardless of valuation on the theory that you should just buy good companies without trying to time the market, you may be vulnerable to painful losses - note what happened if you bought at the 1929 peak. What's a reasonable valuation is of course a tricky question, but working from this example and based on my belief that, in spite of all the serious issues and government blundering currently, things probably won't get as bad as in the 1930's, I'm going to go with around 10 to 12 times earnings as a workable starting point.

  • While the stock price may usually reflect a good earnings performance, there may come a time when earnings seem almost irrelevant to the market; this might also be a time when the survival of the whole system seems in doubt. At this time, as in mid-1932, stock prices may drop to places you never thought possible. This may seriously challenge your stomach even if you managed to pick companies with stable earnings and buy them at reasonable prices. Or, looked at more positively, if by some miracle you have some investable cash left at that point and are able to act decisively, you could wind up making some very nice returns ...


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