Eighth Pick in the WMD Portfolio - Diageo

The more real they are, the more fun blogs are to follow. So in that spirit, rather than talking about ideas in the abstract I maintain a hypothetical portfolio to track ideas where I'll semi-regularly (and hypothetically) invest and track buying (and where required selling) shares.

For tracking purposes I will use $1,000 to keep it nice and simple. The overall goal is long run income and dividend growth. Portfolio page with goals and tracking is here.

The previous two portfolio picks, Spectra and Oxy, are both in the energy industry. There are still lots of bargains to be had in energy, that should pay off eventually. For my next pick I am going a little more simple than trying to predict what the Saudi do, how OPEC reacts, and when energy prices run back up; in the case of Diageo its a simple matter of brand and distribution excellence meets global consumer preferences for quality beverages. 

Despite an overall solid year for the stock market as a whole, Diageo shares have been left behind. The S&P 500 is up about 13% year to date as of now Diageo shares are down around 10%. That's a wide gap. But why? One reason is that Diageo relies on emerging markets for growth and that has slowed. Another is that China has been on a concerted effort to reduce corruption and high priced booze is an easy target. 

But Diageo has the brands and global scale to weather these events. Diageo owns number one and/or number brands in most categories for example:

• Vodka - Smirnoff, Ketel One
• Scotch - Johnnie Walker, Caol Ila, Talisker
• Gin - Tanqueray, Gordon's
• Rum - Captain Morgan
• Canadian Whisky - Crown Royal
• Tequila - Don Julio

This is just to give you a taste, they own a lot more besides the above. Plus Diageo owns Guinness which a National Geographic photographer friend who has been everywhere says is his first choice beverage because you can rely on it pretty much wherever you are in the world. Diageo does have a hole in its portfolio for bourbon and American whisky, but beyond that its a dominating player in the categories its in. When he invested in Harley-Davidson, Warren Buffett remarked that he liked buying into brands where the customers tattoo the name on their chest. Some Diageo brands have a similar following. I wonder how many people have Guinness tattoos?

Diageo's current yield is 2.98%. That's a yield 50% better than the market for a company that is not an average company. Diageo's five year average Return on Equity is 38.7%. 

The company does operate with some leverage, its Debt/Equity ratio is 1.1 which is higher than I normally like. However Diageo has excellent interest coverage ratio at 5.7. It can afford to pay off its debt. And its one of the few companies where acquisitions can make sense because they have the distribution network across the world to push brands through. The dividend is safe at a 54% payout ratio.

Diageo has grown its dividend at 7.5% annualized over the last five years. Still, the price is not cheap at a P/E of 20, but these kind of companies do not really go into the bargain basement.  The overall quality and yield make it a good combination to add to the WMD portfolio.

The Profit Gets to the Heart of What Matters in Business

For busy people there is not much time to sit around and watch TV. On the plus side, there is not much on TV that's worth watching! One happy exception is CNBC's "The Profit." The lessons that are packed into this one hour show combine to give you about half of the most important things that you may learn from an entire MBA program.

A lot gets written on "teaching kids to invest." Before you skip ahead to teaching your high schooler what P/E ratios are, remember that investing is buying into part of a business. For most people understanding businesses is an abstract concept at best. But learning how businesses function is very educational, not just for those specific businesses but indeed how much of the world functions.

The Profit focuses on businesses that are up against some kind of threat, perhaps liquidity or product or customer or legacy issue. The Profit aka Marcus Lemonis, goes to great pains to point out that he is not a consultant, but he clearly has learnt the old consulting rule of thumb - its never process problem, its never a tech problem, its always a people problem.

The shows give you a slice of life in a wide variety of businesses from Key Lime pie companies to auto sales to coffee roasting and a lot more. What the show excels at is quickly getting a clear picture as to the value (if any) that exists in the company, and then efficiently figuring out where the blockers are. The main lens is people, process, and product to slice and dice where the strengths and weaknesses are. But its the people that must be genuinely convinced to participate, both the business owners to do the deal and Marcus Lemonis that the deal is worth doing.

So much of business is taught (and practiced!) as a bloodless operation, I think that's a real turnoff, sure numbers matter, but unless the people side is working you won't get the numbers over the long haul. Real world business is incredibly personal. The show does a great job showing the human side, good and bad, of business.

As we're still in the middle of the uneven post 2008 recovery, its especially fraught with emotion and meaning as you watch business owners fight to save their creations and employees fight to save their jobs.

There are a lot of great lessons embedded in the show. Some that stand out:

• Find diamonds in your backyard - a recurring theme is employees going to heroic lengths to keep businesses rolling. This happens in a lot of small businesses (and all successful ones), what's missing often is that investment in people will pay off more than any other 
• Know when to say no and walk away - its easy to get swept up in the dealmania, only look at the upside, but some deals just do not make sense
• Be decisive - small businesses do not have layers and layers of bureaucracy, its all hands on deck. Whether its chucking old merchandise that won't sell or closing stores that don't make sense, tough calls have to be made and acted on efficiently
• Simplify then scale - a number of the businesses have solid cores but extended in too many directions at once. Marcus Lemonis leads the businesses through a process of simplicity first. There is a good episode on a South Carolina Barbecue restaurant with huge customer demand. Instead of adding another location, Marcus Lemonis has them get one location right and then plan to scale from there. Walk in to a Chipotle, the menu could not be much simpler. I recall interviews with Chipotle CEO/Founder Steve Ells when they became successful asking him what is next? Breakfast? Late night? Bigger menu? Ells replied 'we are not going to do any thing new. We are going to do what we already do and we are going to do it better.' In software development we say "one is more than none" don't overengineer out of the gate. That's a crucial business message that comes through in many The Profit episodes. 

There are other business shows on TV, but none that get to the heart and head of business. Shark Tank can be fun, but its too often a bloodless VC conversation and while its fun to see all the different business ideas, you do not get the day to day operations or any visibility into the people that make the business tick. Here again The Profit gets to the heart of what matters.

Seventh Pick in the WMD Portfolio - Occidental Petroleum

The more real they are, the more fun blogs are to follow. So in that spirit, rather than talking about ideas in the abstract I maintain a hypothetical portfolio to track ideas where I'll semi-regularly (and hypothetically) invest and track buying (and where required selling) shares.

For tracking purposes I will use $1,000 to keep it nice and simple. The overall goal is long run income and dividend growth. Portfolio page with goals and tracking is here.

The previous pick in the WMD Portfolio was Spectra Energy. I am taking further advantage of falling energy prices with Occidental Petroleum. I have no idea if this is the bottom and it probably isn't. For all I know oil prices could go much lower and stay low for years.

But we have to balance the positives. Oxy has simplified its business model. At the end of November Oxy spun off its California assets into a separate company (California Resources). Oxy also plans to sell off its Middle East/ North Africa assets. Those transactions will leave Oxy as a focused player in the Permian basin.

Since, I have no idea what oil prices will do, Balance Sheet safety is paramount. Levered players are already starting to get washed out. Oxy has a Debt/Equity ratio of 0.2 they can weather low prices.

During the financial crisis, Oxy continued to raise its dividend. In 2004, Oxy paid $0.55/share in dividends and today its $2.80/share. That is excellent dividend growth. The current yield is 3.5%.

Oxy is a very shareholder friendly company. They have steadily brought down the share count. Management plans a major buy back which could result in retiring almost 10% of its shares. Since Oxy is trading at its lowest P/E valuation since 2008 this should be an excellent time to shrink the share count.

All in all, even with the vast uncertainty around oil markets, Oxy's simpler business model, safe balance sheet, and shareholder friendly actions make it a good addition to the WMD portfolio. 

Investing in what lies clearly at hand

Today is Thomas Carlyle's birthday. Charlie Munger cites his philosophy and its influence on operations at Berkshire Hathaway.

From Charlie Munger's comments the Wesco 2004 annual meeting

"And there has never been a master plan. Anyone who wanted to do it, we fired because it takes on a life of its own and doesn’t cover new reality. We want people taking into account new information.

It wasn’t just Berkshire Hathaway that had this attitude about master plans. The modern Johns Hopkins [hospital and medical school] was created by Sir William Osler. He built it following what Carlyle said: “Our main business is not to see what lies dimly in the distance but to do what lies clearly at hand.”

Look at the guy who took over the company that became IBM. At the time, it had three equal sized business: [a division that made] scales, like those a butcher uses; one that made time clocks (they bought this for a block of shares, making an obscure family very rich); and the Hollerith Machine Company, which became IBM. He didn’t know this would be the winner, but when it took off, he had the good sense to focus on it. It was enlightened opportunism, not some master plan.

I happen to think great cities develop the way IBM or Berkshire did. I think master plans do more harm than good. Anyway, we don’t allow them at Berkshire, so you don’t have to worry about them."

There are plenty of people who invest with the hope of finding the next big, disruptive thing. Or playing some big investment "theme." But there is more than one way to invest. The Carlyle/Munger approach.

As to themes, the top down mentality has its limits, it can work for certain people, but macro tends to be pretty unpredictable. Just in the last couple of years we have heard peak oil, the decline of the dollar, the decline of US economy, rise of the BRICs and numerous other plausible sounding grand theories offered by smart people, but none of these have really played out as predicted. I prefer a bottom up approach. It may not be as neat and orderly appearing as a top down approach where you allocate 10% to ten different industry sectors or countries or some such, but if each company in your portfolio has sustainable earnings power does it matter if there are 25% more consumer defensive stocks than energy? I do not think so.

The other dimension this brings to mind is a quote from Howard Marks "If we avoid the losers, the winners will take care of themselves." Notice the shift in mindset from how many investors work. Many investor look for the next Tesla, but that assumes you can predict a long list of things that will happen. It also assumes that you go in with a big enough purchase to make a real difference. If instead you assume that its not practical to guess the winner 10 years down the road and just focus on looking at dealing with the risks clearly at hand, you end up with a fundamentally different portfolio.

Sixth Pick in the WMD Portfolio - Spectra Energy

The more real they are, the more fun blogs are to follow. So in that spirit, rather than talking about ideas in the abstract I maintain a hypothetical portfolio to track ideas where I'll semi-regularly (and hypothetically) invest and track buying (and where required selling) shares.

For tracking purposes I will use $1,000 to keep it nice and simple. The overall goal is long run income and dividend growth. Portfolio page with goals and tracking is here.

With all the churn in energy prices, prices reverting back to long term lows, there will be winners and losers. We are already starting to see losers shake out of the process. But what about winners? The big integrated companies like Exxon and Chevron are weathering the storm pretty well. I would like to add one of these type of companies to the WMD portfolio at some point, but at the same time the fact they are weathering the storm means the shares are not as cheap relative to the rest of energy. What about smaller E&P? These are pretty risky and while I am sure there are bargains, I am also sure I am not smart enough to know which ones are the right ones to pick.

But whether through ETFs or bots or other reasons, there does seem to be interesting knock on effects in many parts of the energy space. Pipeline operators are also getting blown away, but some of these have limited direct exposure to the price of oil or gas at any given time. One of these is Spectra Energy, which is mainly in natural gas, not oil.

Spectra's pipelines give it the ability to move natural gas across most of the eastern US and beyond.

Spectra's yield is at 3.7%, the company announced a 10.5% dividend increase for Q4. The company has a long list of projects in motion and a well covered distribution so it should be able to deliver double digit dividend growth for near to mid term. I am sure there are better bargain prices in energy than  Spectra. But Spectra's 3.7% yield offers a fair deal for quality income over the long haul.

You don't know who is drilling naked until the tide goes out

Given the grim near term outlook in energy, @PlanMaestro asked a prescient question a few weeks back:

This story has a personal angle for me, because some years ago I used to own Seadrill shares. I liked the overall business model which was the leader in off shore drill rigs. They were very shareholder friendly, paid a huge dividend around 7% at the time. It seemed the demand for oil rigs would go on and on. Problem is they borrowed from existing rigs future to fund the next rigs. Turtle stacking exercise that works until it doesn't.

The lesson to me is about process. I could not have predicted the level and pace of both increasing oil supply combined with the slackening of demand of this year. In fact, were I to bet a few years back,  I would have bet the other way on at least one of those. However, I avoid betting on future, macro events as much as possible. What I could do and luckily did, was just snap the chalkline against Seadrill's leverage and say - no matter how wonderful the dividend appears (remember not many 7% payers), no matter how much I think being a leading driller will matter, I just do not want to own a cyclical company with that much debt. Luckily I sold at a small profit. 

Today Seadrill suspended their dividend. That sent the shares down 17% for the day so far. The shares are down 50% for the year. Also the appeal was the dividend, and that is gone.

The big lesson here is quality matters - especially in dividend investing. You do not get the 10x kind of growth that growth investors may see in a Tesla.  If you are buying McCormick Spice and Unilever, its way more about mistake avoidance, grinding out great results over decades. 

Mistakes always hurt in investing, but for dividend investors they matter way more. For dividend investors it has to be don't lose first, because you do not have the 10 baggers to make up the difference for the flameouts. Growth investors can swing for the fences, whiff on 7 out of 10, and crush a couple out of the park and have a great overall result. Dividend investors have to look more like George Brett - hit .380, get on base, bang out some doubles. 

One thing I learned programming computers is that order of operations matters a lot. Its not just what you do, but in what order of execution. The motto of this blog is Safety, Dividends, Growth in that order. The dividend investing process has to set a bar that ensures the overall safety of the company before you consider the dividend and the growth, because otherwise its too easy to get swept away by an eye popping, yet illusory yield.

Fifth Pick in the WMD Portfolio - Tupperware

The more real they are, the more fun blogs are to follow. So in that spirit, rather than talking about ideas in the abstract I maintain a hypothetical portfolio to track ideas where I'll semi-regularly (and hypothetically) invest and track buying (and where required selling) shares.

For tracking purposes I will use $1,000 to keep it nice and simple. The overall goal is long run income and dividend growth. Portfolio page with goals and tracking is here.

I first came across Tupperware as an investment idea some years ago, through the work of one of the finest investors I know - Jeff Fischer who runs Motley Fool's Pro service.

Tupperware has a lot to recommend it on the business side. The most famous characteristic is the parties themselves and how they illustrate the Liking principle that Robert Cialdini describes - "People are easily persuaded by other people that they like. Cialdini cites the marketing of Tupperware in what might now be called viral marketing. People were more likely to buy if they liked the person selling it to them."

There is a lot to like in how Tupperware is able to engage with its target market, from Cialdini's book Influence - "It’s gotten to the point now where I hate to be invited to Tupperware parties. I’ve got all the containers I need; and if I wanted any more, I could buy another brand cheaper in the store. But when a friend calls up, I feel like I have to go. And when I get there, I feel like I have to buy something. What can I do? It’s for my friends.”

Its hard to find anything resembling a good price, so why is Tupperware in a zone of reasonableness? One guess as to why Tupperware shares are priced well compared to the market overall is that investors conflate them with Herbalife which is undergoing lots of scrutiny as to its business model. However, Tupperware gets its income from the consumers at the parties. 

Tupperware 10-Q: "The vast majority of the Company's products are, in turn, sold to end customers who are not members of its sales force."

Tupperware is a truly global business, its focused on the emerging market consumer. The U.S. is less than 10% of its business, and its sees India and Indonesia as its top markets going forward. Tupperware levels the playing field for women in emerging economies. The business model enables women all over the world to create profitable businesses.

The regional sales breakdown is as follows:

• AsiaPAC 32%
• Europe 28%
• North America 25%
• South America 15%

Tupperware sees itself as an AND company as in Developed Markets AND Emerging Markets. Still the latter plays the biggest role going forward - Argentina, China, Indonesia, Brazil, and Turkey grew over 20% last twelve months.

With so much to like about the business model, what about the goals of the Wide Moat Dividend portfolio - Safety, Dividends, and Growth?

The first red flag is the Debt/Equity level which sits at 2.4, that normally would be enough to stop the analysis. However, looking to Todd Wenning's single most important metric Free Cash Flow cover shows that Tupperware's Free Cash Flow provides ample coverage.

Tupperware has the Free Cash Flow to pay its dividend, and with an Interest Coverage ratio of 7.5 it also has the ability to handle its debt load.

Tupperware's current yield is 4.0%. It has a five year annualized dividend growth rate of 23%. Tupperware buys back its shares, and has reduced its overall share outstanding from 64m in 2010 to 51m outstanding today.

Tupperware puts up very strong ROE and ROIC metrics year after year.

The overall combined effect shows a good opportunity for quality income. Tupperware's 4% yield is substantially better than average and above even what many Utilities pay today. But Utilities have pretty limited growth, whereas Tupperware more than doubled its revenue in the last decade.

Tupperware's current valuation also looks relatively attractive. Its P/E is 15.4 versus a five year average of 16.6. Its Price/Cash Flow is 12 versus five year average 13.4. Add it all up you get quality, income, and a fair price for an excellent business.

Last year, Tupperware "logged 24 million Tupperware parties worldwide in 2013, up incrementally from 22 million in 2012, 21 million in 2011, and 18 million in 2010." The company has a motivated, global sales force, treats its shareholders well, and room to grow.I plan to buy the shares, and keep them sealed up for a long time.