Friday, February 13, 2009

Other Voices

We thought this entry from the Dividend Growth Investor provides more evidence on the advantages of investing in dividend paying stocks. We continue to believe our dividend approach to investing makes a great deal of sense for all investors during these uncertain times. (We like it during certain times too.)

Friday, February 6, 2009


We have written in general terms about the kinds of companies that we like. Now might be a good time to discuss an example of a specific stock that we have recently purchased.

Nike is one of the great global brands in the world today. They are the world’s largest manufacturer of athletic footwear under the Nike, Converse, Umbro, Cole-Haan and Hurley brand names. They also produce athletic clothing and equipment.

At $44, we can purchase this great company for under 12x FY2009 earnings (May year end). The company has over $4 in net cash on the balance sheet, so when you strip that away, you are buying Nike for around 10x earnings. That is not a bad price to pay for a one of the strongest brands in the world.

Analyst estimates of $4.15 for FY2010 are reasonable, but given the economy I would not want to bank on it. Still, Nike has some flexibility on its income statement. It spends 32 cents of every sales dollar on Selling, General and Administrative expenses. Much of that is spending related to building the brand. Now Nike would not (and should not) starve the brand, but it has the ability to modestly reduce its spending as a percent of sales. Over the last 5 years, SG&A spending has grown by almost $2 Billion and from 30% of sales to 32%. On the last conference call management highlighted better SG&A management as one of its objectives.

The company is focused on improving its gross margin. Management continues to work on a supply chain initiative that will shorten the lead time on products. This will help to lower costs, reduce Nike's inventory and improve its on-time performance with its retailers. The company also is implementing lean manufacturing to lower its product costs.

Nike had FY2008 sales of almost $19B and has a goal of reaching $23B in sales by 2011. While that goal may be more difficult given the economic headwinds, it is certainly not unreasonable. The company will benefit from its continued innovation (like its lightweight Flywire technology and its Lunar Foam cushioning system) and growth in its “other” businesses (like equipment, golf and Umbro). The company is also expanding its apparel business and has a very focused initiative directed toward woman.

It is also very important to remember that Nike is a global company. Just over 1/3rd of its revenue comes from the US. China now makes up $1B and is growing rapidly. The company is seeing attractive growth in other markets like Russia and Brazil.

Management of the company is very strong. Mark Parker has been CEO for the last 3 years and has been with the company since 1979. The president is Charlie Denson, another long time Nike employer. Don Blair is the CFO. He has been with Nike since 1999, and previously worked for Pepsi. Co-founder, Phil Knight, is the Chairman of Board and the company’s largest shareholder. All of these men are immersed in the Nike culture and understand the importance of building the brand.

Nike has shown a commitment to returning money to shareholders. Over the last 5 years, the company has quadrupled its dividend. The yield of 2.3% is not overly attractive, but I believe the company will continue to grow the dividend by a low double digit rate in the coming years. The company also is committed to buying back its stock. In FY2008, the company repurchased over $1.2 B of its own stock. This year, it has already spent $650 million. Based on the current authorization, the company can buy back over $5B in stock over the next 4 years (20% of its outstanding shares). The reason Nike can be so generous returning money to shareholders, is because the business is a cash machine. In FY2009, I expect Nike’s free cash flow will be at least $1.6B, or almost $3.50/share.

A company that sells a discretionary item like athletic apparel may see some modest near term weakness, but with the continued growth opportunities in many markets throughout the world, that weakness will be mitigated. In the meantime, I am quite happy to own a company with such a strong brand, excellent management team, innovative culture and pristine balance sheet at a very reasonable valuation.

(Disclosure: Harvest Financial Partners owns Nike in its client portfolios. The author owns Nike in his personal portfolio. Positions may change at any time.)

Thursday, February 5, 2009

Why I Am Disappointed In Pfizer

At Harvest we have been very happy shareholders of Pfizer since we started (and even before). We saw a company with a pristine balance sheet and a very attractive dividend yield (most recently at over 8%). We recognized that the company faced a likely earnings shortfall in a few years when the Lipitor patent expires. But, we felt the company had time and the financial ability to address the problem through its own pipeline, the strategic purchases of drug compounds still in trials or the acquisition of small companies that could benefit from Pfizer’s size. We also were very pleased to see management, under Jeff Kindler, work hard to right size the cost structure of the company.

But our happiness gave way to disillusionment last week when Pfizer announced its plan to purchase Wyeth. We see no great growth benefits from the combination, only large cost reductions. While cost reductions are valuable, the price Pfizer is paying for them is too high in our estimation. Pfizer is significantly weakening its balance sheet, paying a high interest rate to borrow money from the banks (while gambling that the credit markets will thaw in the next year as this debt matures in 12 months) and cutting its dividend in half.

As shareholders, the dividend was one of the reasons we liked the company and we felt that it was safe. It has been the one reward for shareholders who have suffered while the stock price dropped by over 50%. Instead, management reduced the dividend to make an acquisition that shareholders were clearly not thrilled about (note how the stock has dropped over 10% while the S&P is flat).

We thought Kindler and his management team saw the value of cash and a strong balance sheet in such tough economic times. Instead, he appears to be like so many other CEOs, only concerned about the size of his empire and not at all concerned about his shareholders. We thought shareholders were in better hands. We were wrong!

(Disclosure: Harvest Financial Partners owns Pfizer in it client portfolios. The author owns Pfizer in his porfolio. Positions may change at any time.)

Wednesday, February 4, 2009

Price vs. Value

Have you ever heard the story of the six blind men who come upon an elephant for the first time? (If not, you can read a version here) I ask because deciding whether the stock of a company trading at a certain price represents value has something in common with that fable. The more ways we look at that question, the more informed our opinion is. So, I was just writing this post about one way we look at that price/value question.

We look at how much each dollar of a stock’s price gets us in earnings and how that compares to other investment alternatives using an earnings yield. Earnings yield equals earnings per share divided by the share price (the reciprocal of the P/E ratio). It is quoted as a percentage, allowing an easy comparison to going bond rates. And that is usually how it is applied, as a tool to compare the earnings of a stock, sector or the whole market against bond yields. (The earnings yields of stocks should be higher than the yield of risk-free treasury bonds because they are riskier.)

As of 12/31/2008 Morningstar calculates the following P/E ratios for some popular indexes and from that we calculate the earnings yield:

Forward P/E

Forward Earnings Yield

S&P 500









Morningstar also calculates that the effective yield on the Lehman Brothers Credit (corporate bonds) Index is about 5.98%.

Based on these values, stocks seem undervalued relative to corporate bonds since the earnings yield for all these indices are higher than the yield on the corporate bond index. To put it another way, investing $100 in corporate bonds gets us $5.98 in interest over 2009 but $9.35 of earnings if we had invested in the stocks of companies in the S&P 500.

As we mentioned above, this is just one of many metrics we use when evaluating stocks and bonds. Given the economic weakness, it is very likely that we will see the estimates for corporate earnings decline markedly throughout the year and therefore the forward earnings yield will also decline. We also recognize that as shareholders, we will not receive every dollar that a company earns. A portion of those earning dollars may go to debt repayment, capital investments or acquisitions.

Still, this is an interesting metric to monitor. It would clearly indicate that investors should not be moving out of equities. It also would suggest that international stocks could be a very attractive investment in the future. But it is not foolproof, as this would have flashed a signal to by equities last year, and we all know how that turned out.

Back to the fable, the earnings yield may tells us what the ear or the trunk looks like, but we still do not have the complete picture of the elephant.