A Case Study of Nestlé SA Shareholder Returns With and Without Dividends Reinvested

Joshua, when you look at companies that make your "permanent" list (JNJ, PG, GE, KO, etc.), do you do an all-out DCF analysis, or is simply glancing at the fundamentals relative to historical values good enough? For example, if the price of JNJ dropped down to 12x earnings due to a temporary problem, would that be enough to start grabbing shares?

For a company to get to the point that I know it well enough to put it on the "permanent" shopping list, I'm familiar enough with its economics that I can glance at the stock price and know within three seconds. That is because I studied the businesses in-depth in the past, and keep up with the filings.

If I were looking at a new firm, I'd delve into the filings and discount the cash flows. A couple of years ago, for example, there was a major blue chip stock that I won't mention, which looked like it was a good possibility. However, when I got into the multi-hundred page 10K filings, it turned out that the "increases" in earnings per share were really just a pension accounting trick. The earnings weren't high quality; the accruals were too high. So I passed. It would be more expensive at 12x earnings than a higher quality firm at 15x earnings.

Several years ago, accounting rules were different and pharmaceutical stocks suffered from perpetually under-stated profits. That isn't so much the case these days.

So, in the beginning when I'm getting to know a company, I might break out a spreadsheet but at this point, I can pretty much run the numbers on the back of an envelope and know if I'm interested or not. Ben Graham called it the "fat man" test. You don't need to know the exact weight of a morbidly obese man to know he is fat. Intrinsic value bargains are the same way. The last time I had to actually break down spreadsheets and calculate values was when I was looking at a company with three classes of stock, a short trading history, and somewhat complex financials.

And for a 30+ year time frame, Johnson & Johnson at 12x earnings is a steal, even if it goes to 6x earnings the next day in a stock market crash.

P.S. The more I think about it, the Dividend Adjusted PEG ratio would work 90% of the time in protecting an investor from overpaying. There would be exceptions, in the case of outright fraud or accounting tricks, but on a diversified enough portfolio, it should work out over several decades in minimum time horizon. The key would be to avoid over optimism in the growth variables of the equation.

But, really ... the dividend adjusted PEG ratio, with a target value of 1.00 or less for all purchases, is almost all a layman would need.

Thanks! I learned about the PEG ratio, but I must've glossed over the dividend adjusted version. What about Ben Graham's net current asset value per share metric? I think he used the 33% margin-of-safety rule for this one.

That model hasn't been viable for 30 or 40 years, at least. It was possible back in the 1930's and 1940's when standardized databases were hard to come by and to find those companies, an investor had to dedicate significant time to pouring through the thousands of pages found in things like the Moody's manuals. Keep in mind, too, this was the aftermath of the Great Depression when so many people lost everything that they were engaging in mass non-economic selling because they had no choice. Even firms like Coca-Cola were, for a moment, worth more liquidated than as an on-going concern.

It may come back as a strategy is we ever go through Great Depression II and you are one of the last men standing.

Dang. Investopedia left out this crucial piece of information ಠ_ಠ Thanks again.

Speaking as someone writing an investment policy manual right now, that last sentence gave me shivers. It's why I'm committed to building such a large emergency fund. I will structure my affairs so that I will be one of the last people standing. Thanks for the inspiration.

Interesting point about estimating the eps growth - do you think a sensible approach would be to use a long run historical eps growth and then apply a healthy margin of safety to that? Obviously this is far from perfect, but I don't place a great deal of trust in analyst forecasts either...

That's one approach. The problem comes in when you are dealing with an industry or product that can experience rapid change. Twenty years ago, the historical growth rate of Nintendo looked fantastic until the Playstation came along and knocked it off its throne. Then, the Wii outsold everything. To project earnings would have required a look at unit figures and profits per unit.

Projecting growth is much easier for a business like Nestle or Johnson & Johnson. If I were looking at Nestle, you can assume that in a stable economic environment without a lot of price competition, growth is going to increase as a result of 1.) net increases in population, 2.) additional efficiencies in cost or pricing increases, and 3.) growth in market share, either organic or purchased via acquisition. There isn't a lot of variation in the figure.

For me, I consider the safest route to forecasting growth to be: Take the net capital added to the capital base (adjusting for retained earnings modified by distributed cash dividends and net share repurchases, for example), multiply it by the return on equity figure, and then calculate what is known as the maximum sustainable growth rate. From there, try to figure out which of the three components that make up ROE using a DuPont analysis are likely to change in the near future. Then, you have to bring the art into it and start messing with the figures. I looked at a clothing company the other day that is growing very rapidly but one glance at is product line and I threw it off the potential buy list because the clothing looks like the sort of thing a streetwalker in the 1980's would have worn. There is no way that kind of look flies in the deep south or Midwest of the United States, so management projecting unit growth outside of Los Angeles and New York is idiotic. They are in for a horrible surprise. You can't quantify that, though. ROE growth, in this case, is unsustainable because it can't be replicated in Nebraska or Arkansas, which is what the company model is based upon now that it is expanding beyond its startup territory.

Joshua, did you find that clothing company by browsing Value Line? Is Value Line all you really need to find promising prospects?

Question 1: I don't recall where I first discovered the clothing company.

Question 2: Between the Value Line Investment Survey and the Value Line Small & Mid-Cap Edition, you get historical data on roughly 3,600 companies, including virtually every major corporation of importance.

So, yes. I think any investor could put together an entire portfolio using nothing but those two Value Line products (not for their recommendations, but for the historical financial data it provides as a starting point) to find businesses as a starting point.

For me, it's about my work method. Sometimes, I want to look up a specific historical records, and other times, I just want to look at, say, industrial manufacturing companies or regional banks. They are grouped by industry so it is much easier to open it, like a newspaper, and look for something that fits my requirements. If the payout ratio is declining over time, I want to know why management is hanging on to more money and whether or not they are earning good returns on the capital that, otherwise, should have been paid out to me as an owner. If returns on equity are increasing, I want to know if it is due to improved asset turns, higher profit margins, or additional leverage. Value Line lets you see all of that in a few seconds so it is a huge time saver if you are a long-term, fundamental analysis person.

I imagine it would be useless for stock traders.

TL;DR: Every stock in my personal, household, and company portfolios is covered by the Value Line Investment Survey or the Small & Mid-Cap Survey. So, yes, you could use it exclusively to find ideas. There are times I'll come across a business that isn't in the records but the last time that happened was two or three years ago when I was buying up a tiny regional insurance group that had almost no float and it would take days between trade executions.

Thanks for the heads-up. Due to inexperience I'm mostly sticking with blue chips and mutual funds, but I'm slowly moving into higher-risk, higher-reward territory. Value Line seems to be the best way to go about it.

This is exceedingly helpful - thank you!

can u mention the market cap of nestle in 1991

Again, judging by your questions on this and other threads, it seems probable that you are making this mistake so I'm not going to answer the question as I think it would harm, rather than help, your understanding.

what? Ok, you don`t know. Thas`s faire. Yes : in history Nestle is better investment that Buffett Berkshire. But always: first: share price 100 years, market cap 100 years, dividend 100 years etc. Only this is a serious !

I'm interested on acquiring Nestle but if I chose to buy the ADR, the dividend would be hit with a 35% withholding tax in a tax-sheltered account in Canada.

Out of curiosity, I took your numbers, subtracted out 35% from the total dividends, and looked at the CAGR with that massive withholding tax hit. The results?

Even with a 35% dividend withholding tax drag, in your case study above, one would have STILL compounded at 10.9%.

I couldn't (well I can) believe it.

I hate withholding taxes. It really hurts the TFSA especially.