David Gardner at the Motley Fool is usually the “growth” guy — he’s the one who has most famously grabbed on to “story” stocks when they were crazy expensive but had big growth potential, and held on for gains of several thousand percent (Netflix, Priceline, etc.).
So it caught my eye that he’s recommending a stock that has paid a dividend for almost 80 years… and, well, since we looked at the teaser pitch for his brother Tom’s recent favorite last week, it only seemed fair to dig up the name of Dave’s current teaser pick.
The ad I got last week was from Eric Bleeker, all about Dave Gardner’s most recent pick that was just “revealed” to their subscribers, and it draws you in if you’re anywhere near retirement age (as a lot of Gumshoe readers probably are — “near retirees” are the target demographic for almost all investment newsletters):
“If you’re getting close to retirement (or already retired), I think you’re going to be really excited about David’s latest Stock Advisor pick.
“I wasn’t allowed to share this information with you yesterday, but I wanted to send you a quick note this morning to make sure you have a chance to act before the market opens on Monday.”
Well, too late for that — here it is the following Monday already and I’m just getting to this one. But if it’s stodgy enough to have paid a dividend since before World War II, then the stock probably hasn’t changed dramatically in the last week. In fact, given our crazy Brexit-driven tumult, it’s probably cheaper now.
So what do we hear about this one? Well, as is often the case, we get a secondary endorsement from a rich guy…
“I’ll tell you what’s so special about this stock in a second, but first let me tell you about another ‘senior citizen’ who is really excited about this same company…
“You might have heard of him, he’s the world’s richest man, his name is Bill Gates.
“Gates has so much faith in this company that he quietly acquired over 11% of this company’s stock…and he was just getting started.
“In fact, Gates is so confident in this stock that he negotiated with the company to amend its stockholder plan, so Gates would be allowed to buy EVEN MORE shares!”
“The truly remarkable thing about this obscure powerhouse is its treasure trove of intellectual property.
“These guys have over 6,700 patents locked away in their vaults …and they are using those patents to bludgeon their competitors.”
OK… that makes it sound like some kind of hot-stuff tech or biotech company, though there aren’t many of those that have long dividend histories. Can we please make it easy on the Thinkolator and get a couple more clues?
“… this company has a borderline fanatical obsession with its dividend…the company has paid cash dividends on its stock for 79 consecutive years!
“And even better, the company has increased its dividend payout every calendar year since 1986…making it a member of the elite club of ‘dividend aristocrats.'”
Pretty impressive… there are only 50 or so dividend aristocrats in the S&P 500 (those are the stocks who’ve raised their dividend annually for at least 25 years). So which one is this?
Thinkolator sez: this is Ecolab (ECL)
Ecolab has indeed been around for a long time, and has paid a dividend for decades. It has not been a high current yielder for a long time, the dividend has been below a 2% current yield for the past 20 years… but the dividend has consistently risen every year since 1986, so if you had bought way back in 1986 for about $3 a share, split adjusted, you would now be earning about a 50% yield on cost (the annual dividend right now is $1.44).
That’s why you buy dividend growth companies even if the yield is low: if you pick the right companies that can survive for decades, the long-term growth can be fantastic.
The impact of dividend growth from a low dividend base, like ECL has now, does not really show up in shorter time periods — over the past five years, ECL’s stock price has gone up by 120% and dividend reinvestment would have made the total return just 135%. But over longer periods it’s a big deal — since 1986 ECL’s share price is up 4,500%… but the total return, dividends reinvested, is 7,400%.
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But we don’t have a time machine, we cant go back and buy ECL shares in the ’80s… so how does ECL look now?
EcoLab started out as a cleaning company, developing carpet cleaning and dishwashing technologies in the 1950s, and they gradually grew and made acquisitions, including the large acquisition of Nalco about five years ago that made them a much stronger player in water treatment chemicals and technologies.
And yes, Bill Gates is a major investor in Ecolab through both Cascade Investments (his investment fund) and the Bill and Melinda Gates Foundation — and though Gates has been consistently selling Microsoft shares for years, he did just buy another $50 million worth of ECL this year at about $105 (though that’s only 500,000 shares, a small portion of his holdings — and insiders have not been buying at all). The filings I saw indicate that Gates controls about 10% of ECL, roughly 28 million shares. I have no idea whether this is Bill Gates having personal interest in the company, or if it’s his advisors and managers who like it — he doesn’t generally talk a lot about his investments.
I haven’t looked at ECL very closely, but it’s a very appealing business with very strong staying power — they’re pretty evenly dividend among industrial services (water treatment and chemicals for businesses), institutional services (cleaning products for restaurants, institutions, etc.) and energy (chemicals for energy production and processing), and they have a very strong recurring business model with customer retention of something like 90%. You have to buy the chemicals and services pretty much constantly, much of their business is in proprietary consumables, and they aren’t the most important cost drivers for their customers’ businesses but there is a cost in switching providers for these services. That combination of things should make a company fairly expensive, because strong recurring revenue streams that don’t necessarily encourage or attract competition are rare and worth paying for.
The stock hit some snags last year and had to cut their forward guidance a couple times, probably largely because it has meaningful exposure to the energy business — chemicals and services for treating energy waste water, and for making oil and gas production more efficient, among other things… but it still held up pretty well. They explain their “business case” for investors on their website, and a quick browse in that part of their site will tell you that they are pretty investor savvy.
And yes, the stock has come down pretty sharply with Brexit — the shares have spent most of the past three years moving up and down in a pretty narrow channel from $100 to $120 per share, and the stock was just shy of its all-time high on Thursday before the Brexit vote and the subsequent drop of 5% or so… so the price is better than it was last week, but it’s not cheap.
The shares are at about $114 as I type, and ECL is in the midst of what is expected by analysts to be a “no growth” year — they are forecast to end the year with about $4.45 in earnings per share, which is just a few cents better than 2015, and analysts predict a return to at least 10% annual earnings growth in future years. Just a quick look at the chart of their last few years will reinforce the impact that energy’s fall has had on the business — 2015 was their fist year since 2009 that saw a decline in revenue from the prior year.
But that historical look also provides some reason for confidence — clearly there’s energy exposure, and they’re not in a huge growth trend… but since revenue in 2015 was only down about 5% from 2014’s record highs, it’s also clear that oil prices are not a dominant driver of their results.
Probably there’s going to be some level of cyclicality in their results as well, meaning they’re not necessarily going to grow well through recessions… but they don’t really suffer dramatically either (revenue and earnings were both down in 2009, but by less than 5%). Which makes sense — even if there maybe aren’t as many restaurants opening or they’re a little less busy, just to think about one of their important business segments, you don’t see all restaurants close down in recessions… and all the restaurants that are operating are still going to need to clean and sanitize their facilities.
There’s something to be said for a relatively stable business, though you can debate in your own head (or with a comment below) about how much of a premium you want to pay for that kind of stability. Right now ECL trades at about 26X expected earnings for 2016, and at a forward PE on 2017 estimates of about 22. With expected growth in the 10-12% neighborhood going into the future, that means you get a PEG ratio of just over 2 — that’s pretty high, so you can’t really call it a “bargain” and investors are still paying up for stability (though not as much as they do with telecom or utility stocks these days — many of those “stable” stocks have PEG ratios in the 4-5 neighborhood, which is not unusual).
And though the shares are dropping post-Brexit as folks rush into cash, there’s no particular Brexit connection for Ecolab — their European business is pretty small (18% of sales, versus 57% for North America). This is the kind of investment that I can see folks wanting to “hide” in, and I’d certainly hold it if I owned it, but it’s also not cheap and there’s no real reason to think it should trade dramatically higher in the near future.
Their dividend growth should easily be sustainable, they only pay out about 40% of their earnings as dividends and the balance sheet looks quite manageable, but dividend growth has also slowed a bit in the past year as the revenue dipped, and even in a zero interest rate environment people don’t get excited about a 1.2% current yield.
So it really depends on whether you think they’re in an earnings trough, as analysts expect — and whether you expect them to resume growth. If energy recovers as a growth engine it could be that analysts are even understating the potential… it’s a large company so growth can become more challenging each year, but they did have several years of 20% earnings growth leading up to 2014. Their trough PE ratio in the financial crisis was about 17, so if something on that level of tumult hits the market that might be a reasonable downside to consider — if ECL traded at a trailing PE of 17, which would not be all that irrational if investors are pessimistic about growth, that would bring the shares down to about $75-80.
If you think of this year as their trough earnings year, it becomes easier to buy… if you think we’re heading into a weak economy and results will flatten, I wouldn’t blame you for wanting to be a bit more patient. This one won’t bring you rapid overnight growth, and I don’t see any reason you’d have to rush into it, but this is an appealing company to keep on your watchlist for those times when the market is falling apart and you’re wondering what to buy.