Oxstones Investment Club™By Morgan Housel, Motley Fool,
There’s probably never been a time of such staggering technological change as the period from the end of World War II through the early 2000s. Nowhere is that more apparent than the computer industry.
There were no personal computers in 1950. By 1983 there were 13 million. By 2005, 800 million. In 1950, the editors of Time magazine wrote: “Modern man has become accustomed to machines with superhuman muscles, but machines with superhuman brains are still a little frightening.” They had no idea.
But the single best stock to own from the 1950s to the early 2000s had nothing to do with computers, or technology in even the loosest sense. It was Altria (NYSE: MO ) , the maker of Marlboro cigarettes, which returned nearly 20% a year for 50 years. During a period when new industries transformed the lives of nearly everyone in the developed world, the most money was made in a company that stuffed tobacco into paper tubes the way it had for more than a century.
This wasn’t a fluke, as more recent years offer a similar example. Measured by the number of PCs added annually, computer growth really took off in the mid-1990s as the Internet became mainstream. There are about 800 million more PCs worldwide today than there were in 1995. One of the biggest winners from this explosion should have been Microsoft (Nasdaq: MSFT ) , whose operating system the majority of those computers run on. Indeed, Microsoft’s profits have grown 16-fold since 1995.
Yet once again, the best stock returns may surprise you. With dividends, Microsoft has returned 511% since mid-year 1995. But Clorox (NYSE: CLX ) returned 560% during that time — so bleach actually bested the last leg of the computer revolution. Colgate-Palmolive (NYSE: CL ) returned 651% over the same period, so toothpaste did, too. As did garlic powder: McCormick returned 642%. Ditto for hamburgers, with McDonald’s (NYSE: MCD ) adding a 540% gain. Hormel Foods produced a 544% gain over the same period, so Spam was actually more profitable than computers during the big boom. Our old friend Altria scored a 1,300% gain, nearly trebling Microsoft’s return.
Admittedly, I’ve cherry-picked the dates to make my point. Back up a year or two, and Microsoft wins. But the fact that any period — a 17-year period no less — can be found during which a company with a virtual monopoly on a booming industry underperforms the dullest of products is extraordinary. It also underlines two important investing lessons.
The first is that valuation always matters. There are no exceptions to this rule. Microsoft shares have trailed its earnings growth since the 1990s because starting valuations were high — nothing more complicated than that. As early as 1995, before the dot-com bubble took off, Microsoft traded at more than 40 times its annual profits. Those hefty expectations meant only a fraction of future earnings growth could materialize into shareholder returns. By contrast, Clorox traded for a quite reasonable 15 times earnings at the time, so effectively all its earnings growth accrued to shareholders’ pockets. Even with slower growth, the latter consistently leads to better investment results over time. One reason Altria’s long-term compound returns are exceptional is that the company has been beset with litigation worries for decades, keeping valuations low. That kept its dividend yield high, which made reinvesting those dividends a wealth machine. That valuations determine future returns is probably the most important investing lesson history provides us with. It’s also the most ignored.
The second is that simple products that rarely change often make better investments than those undergoing breakthroughs. Many have wondered recently why Apple trades at a fairly low valuation given its success. It may be because investors finally realize that companies like Apple must reinvent themselves every few years, imagining, designing and engineering entirely new products. What are the odds one of those reinventions won’t live up to past successes? Quite high. Yet the odds that consumers will still be using the same toothpaste 20 years from now are good, as are the odds that Colgate will still own a sizable share of the market. The biggest risk to any company over the long term isn’t that it won’t be able to grow earnings fast enough; it’s that it will go extinct. If you think in years instead of months, sustainability can be far more valuable than picking the next breakthrough.
“They say the world has become too complex for simple answers,” Ronald Reagan once said. “They are wrong.” He may as well been talking about investments. Little else should be more attractive to investors than cheap, simple, companies.
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