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Dividends and Buybacks at Potentially Non-Durable Businesses: Altria (MO) vs. NACCO (NC)

A Focused Compounding App subscriber had a question about something I said in a recent podcast:

“In your recent podcast you said you thought a tobacco firm should buy back its own stock rather than pay dividends – you said you don’t think it should pay a dividend at all and instead should avoid acquisitions and buy back its stock.

Could you expand on that?

This is somewhat similar to NC, actually, and why this stood out to me. You’ve told me before why you don’t want to see NC buy back stock (although now that we’re in the upper teen price range you may feel differently), because the coal business is challenged and shrinking. I think we may be able to agree that US lignite coal has a shorter life than cigarettes. But still, it seems directionally the same sort of situation with a dying cash generative business.”

I feel cigarettes are a much safer business than lignite coal. Much more durable.

I could be very wrong about this. But, it’s about the extent to which it is integrated into society and the difficulty of removing that. Decades ago, I would have had much more serious doubts. But, the fact people keep smoking cigarettes in the numbers they do even when there are plenty of other methods of getting nicotine widely available now, strong inconveniences to the actual smoking of cigarettes, higher pricing (including taxes) on the people buying the cigarettes relative to their income, etc. It just shows me the durability of cigarettes specifically – as opposed to just nicotine consumption generally – is much higher than I might have guessed decades ago.

This isn’t true with lignite. You are depending on a few corporations as customers instead of millions of consumers. They are eager to substitute to other kinds of power if it is roughly equalized. The customers are probably more rational – more open to considering alternatives. With cigarettes, we’ve seen continued use of cigarettes even when people could substitute to smokeless tobacco, vaping, etc. and even with increasing laws making life less convenient for smokers and rising prices. So, clearly, the degree to which there is seen as being “no substitute” to cigarettes is really high vs. the extent to which there is seen as being “no substitutes” to lignite. Lignite is seen as easily substitute-able. Cigarettes are seen by many customers as having absolutely no substitutes.

Now, it is true that I may have exaggerated the idea of just buying back stock – not paying any dividends – in a cigarette company, because if they never diversify at all by product (at least into other tobacco products) or by geography they could have a meaningful risk of losing everything. There is some risk that cigarettes could actually be outlawed in a single jurisdiction like the U.S. So, you can never have a 0% risk of losing everything if you don’t borrow, don’t pay dividends, but just buy back your stock. I think the risk …

A Question for Passive Investors: If You’d Buy 100% of the Business at Today’s Price – Should You ALWAYS Buy the Shares?

One of Warren Buffett’s basic tests for buying a stock is the idea that if you wouldn’t buy the whole company at this price – market cap, enterprise value, etc. – you shouldn’t buy the stock. Not even to hold it for just a week, month, or year. Does the reverse hold true though? If you would buy the entire company – does that mean you should buy the stock?

If you like the management, controlling shareholders, etc. and you like the way they’ve been allocating capital and are likely to be allocating capital in the future – then, the answer would be yes. But, what about the much more common situation where owning an entire business and controlling all of its cash flows yourself might be more attractive than buying a piece of it as a passive, minority shareholder. This situation is more common than you think. Andrew and I can usually find some business somewhere that we’d be happy to acquire 100% of at the current market cap – or even at some fairly large premium over that – but, are less sure we’d be happy as passive, minority shareholders. Why does that happen? Are we really so much more confident in our ability to allocate capital than those of most management teams?

No. The reason it happens is price. Good businesses do sometimes – though often not for long – trade at big discounts to what they would be worth to a private buyer. Sometimes very illiquid stocks, very misunderstood businesses, currently unpopular industries, etc. are also a reason why a public company might trade at a big discount to where it would sell in a private, negotiated transaction. But, a much more common reason for extremely persistent cheapness is the capital allocation. Controlled companies aren’t any better or any worse capital allocators on average than non-controlled companies. But, whatever they are – good or bad – is amplified tremendously by their control. The reason for this is the long duration of a stock as compared to most bonds you’ll come across. A lot of a stock’s value comes from the discounted future cash flows out many, many years in the future. Your average public company retains a lot of earnings. It could be 30%, 50%, or 75%. I know 30% sounds low. But, if a company is retaining one-third of its earnings each year and it’s growing, and it’s selling at 10 times earnings (a typical “value stock” type P/E) – that business will re-allocate way more than its current market cap over the next 30 years. And 30 years – given today’s extremely low interest rates – is probably a good time frame to think of the value of a stock over. You’re unlikely to hold the stock for 30 years. The stock may even be unlikely to stay public for 30 years. But, the period over which the discounted cash flows are still relevant on a present value basis is likely to be as …

How Do I Find a Company with a Moat?

Hi, Geoff. I have just recently read your old article titled “How To Find Competitive Advantages In The Real World”. My question is, is that article still relevant at this point in time (because it is quite old)? If any, what would you update or change in that article? And about your comments on books about competition, do you believe that it is still true till today (Or you would like add to other book recommendation on competition besides “Hidden Champions”) ? Is it possible to identify economic moat without scuttlebutt? In your opinion, which is better: screen stocks for cheapness first and determine whether the stock in the cheap screen has quality OR screen for quality first and determine whether the price is right?

Answer: Here are 10 Checklist Items You Can Start With

There’s a checklist you can work through to see. It’s made up of 5 items from Michael Porter and 5 items from Morningstar. You may be able to identify if some of these items might apply to the company you’re looking at. And then, you can judge how durable they are or not. So, here’s the 10-point checklist.

Porter’s 5 Forces
1. Threat of new entrants
2. Threat of substitutes
3. Bargaining power of customers
4. Bargaining power of suppliers
5. Competitive rivalry

Morningstar’s Economic Moat
6. Network Effect
7. Intangible Assets
8. Cost Advantage
9. Switching Costs
10. Efficient Scale

You could start your analysis by just finding a cheap enough stock, finding any stock at all, finding a stock that has strong enough past results, or finding an industry that has strong enough past results.

I suggest finding an industry. The performance of any stock over time might be like 50% or so the stock’s position within its industry. But, the other 50% will be the industry. If you buy a basket of regulated utilities or a basket of bank stocks at the same price-to-book ratio – the basket of bank stocks will outperform the regulated utilities over time. This is because – in the U.S. – banking is a much better business than regulated utilities.

Certain industries are better choices to look for moats. I’d suggest:

Household Products
Personal Products
Food
Beverage
Alcohol
Tobacco
Hotels
Restaurants
Food retailing
Consumer staples retailing

Really – “consumer staples” in general is the best place to look for a moat. Products that are: branded, frequently purchased, and used by people (not businesses) both in the home and away from the home are your best bet to look for a durable competitive advantage.

So, I would focus on those industries. There are other industries that are often not big enough to get included as “industries” by investors but sort of just a subset that are pretty good too. So, for example, I think theme parks tend to be good sources of moats though that doesn’t mean the group they belong to “entertainment” is necessarily as good overall. I think lime and cement companies – especially located in …

Should I Really Just Automatically Ignore High P/E Growth Stocks Even if they Are Amazing Businesses?

Someone sent Geoff this email ( to ask your own question: just send me an email ) :

Hey Geoff,

The last 10 years saw the dominance of ‘growth’ (as quantitatively defined) over ‘value’.

If you were a value (however it is defined) investor, you probably underperformed the relevant indices.

(1) Is there a lesson to be learned here? When I see stocks trading at really high multiples, my immediate instinct is to ignore them – either too hard to value or too expensive.

But by automatically ignoring such stocks, a potential stock picker immediately omitted a lot of profitable stock ideas.

(2) Do you see these high-multiple stocks’ multiples ever regressing to median multiples, potentially hurting future returns? I think arguing that stocks like Google, Visa or Amazon should have median (historical) multiples is a bit misleading since most of these are natural monopolies. On the other hand, it’s not clear to me what the fair value should be.

Answer: High P/E Stocks of Great, Wide Moat Businesses Don’t Worry Me Right Now – It’s the Super Speculative Growth Stocks with No Real Earnings That You Need to Watch Out For

So, first of all, types of stocks that have outperformed for a decade or so are not necessarily going to be great performers in the future even if they continue to be great performers as businesses. In the past, some excellent businesses have underperformed as stocks even while the underlying businesses continued to perform well. The “Nifty Fifty” stocks of the late 1960s and early 1970s underperformed for the next 10 years or so. In fact, as a group, they did not outperform over even a 25-30 years holding period. While some of the reason for that is stocks that looked like great businesses but eventually lost their competitive position – a lot aren’t. They just were expensive. A study of the Nifty Fifty stocks – it used two different lists – looked at performance from 1972 to 2001. It found that there was a strong negative correlation between the 1972 P/E ratio of the stocks on that list and their returns over the next close to 30 years. That’s an important warning. Differences in P/E ratios – even among very good businesses – can still cause differences in the returns you get over holding periods as long as 30 years.

Does this mean growth stocks will underperform value stocks in the 2020s?

It depends on what you mean by growth? If you mean Visa and Amazon and Google – I’m not so sure. They are financially sound companies. They have strong market positions. And Google is not even expensive versus the S&P 500 generally. Google’s EV/EBITDA, EV/Free Cash Flow, P/E, etc. are mostly a bit elevated at most compared to the index. It’s not a very expensive stock. Visa is even more elevated. Of those stocks – the one to be worried about is probably Visa. The stock trades at a very, very high EV/Sales ratio. It’s …

How I Analyze Bank Stocks

We did a Focused Compounding Podcast episode that was 100% dedicated to bank investing.

In that podcast notice that I analyze banks completely differently than most value investors. I don’t believe price-to-book is an especially important metric. I value banks based on the amount of their share price, their deposits per share (so P/Deposits so to speak), their growth in deposits, and finally the profitability of those deposits (how low cost are they, how “sticky” are they).

I spend very little time on the asset side of the bank except to see if I think it is safe enough for me. I just assume – and this assumption isn’t 100% correct or anything – that money is a commodity, so banks will make roughly similar amounts over time on whatever they lend out, buy bonds with, etc.

However – at least among U.S. banks – you have banks that pay very different amounts on their deposits (in interest), and even MORE important very, VERY different amounts in terms of non-interest expenses per dollar of deposits. There are banks in the U.S. that have $50 million per branch and pay HIGHER interest on most deposits compared to banks that have $200 million per branch. The bank with 4 times the deposits per branch brought in with MORE non-interest bearing accounts is going to have such a “all-in” cost advantage over the other bank that it can make fewer loans and buy more bonds, it can make safer loans that yield less, it can buy shorter-term bonds that yield less, etc. and it’ll still make more money than the bank that has to hustle to make the highest yielding loans, buy the highest yielding bonds, etc.

My belief is that a strong, durable advantage on the deposits side in terms of economies of scale at the customer level and the branch level especially is what creates value in banking.

It’s not impossible to create value in other ways. Prosperity Bank has done this. But, taking in a lot of small deposits from a lot of less wealthy people at a lot of different branches means the only way you can succeed would be extreme penny pinching on the deposit side and then really good lending on the asset side. You’d have to be cheaper than the other guys when it comes to running a customer oriented business and/or you’d have to be smarter, more driven, etc. lenders. I think that’s tough.

Recently, I also wrote-up Truxton (TRUX). You can see the same focus on economies of scale here, because:

1) Truxton operates BOTH a wealth management business and a private bank out of the location that is ALSO ITS HEADQUARTERS

2) Truxton has about 8x more deposits per branch (it only has one branch) than U.S. banks generally

3) Truxton focuses on RICH clients (this means Truxton might get 10x the dollar amount of deposits from each depositor relationship as U.S. banks generally – allowing higher ratio of employees to customer but …