Blue Chip “Bonds” That Yield 17%
by Dan Ferris
October 11, 2006
Some stocks are more like bonds.
They’re that safe.
They just keep earning money, usually more than the year before, decade after decade. When you can buy a piece of one of these great companies for less than 10 years’ worth of earnings, you should do so with a large amount of money and never sell.
In the bond world, the ability of a company to pay its debt is rated by a system of letters and numbers. AAA is the safest. AA is next. A is below that, and so on, down to D (for “default”).
There are only eight public companies with AAA credit ratings:
Automatic Data Processing |
Johnson & Johnson |
Berkshire Hathaway |
Pfizer |
ExxonMobil |
Toyota Motor |
General Electric |
United Parcel Service |
I’ve already recommended two of these companies in my Extreme Value newsletter… as these big blue chips are at their cheapest levels in recent history. Both are still at very attractive levels. I’m looking at a couple of others for the next issue of Extreme Value, due out this Friday.
Think about a few of these businesses for a minute:
Automatic Data Processing handles millions of paychecks every week. It earns two days' worth of interest on the taxes it withholds for clients. Since we’re talking about more than $800 billion worth of taxes, the interest is a lot of money.
Last fiscal year (ended June 30), it came to $549.8 million, about 6% of ADP’s revenues and 35% of its net profit. Not many people want to spend the time and money necessary to switch from ADP to another payroll processor. That means ADP is going to have access to interest on tax withholdings indefinitely.
To bet against ADP’s ongoing success, you’d have to believe we’re all going to stop paying taxes some time soon. At 15.2 times pretax earnings, you have to wonder if this isn’t a great deal on a great company (which just happens to be one of the world’s safest credits, too).
Billionaire investor Warren Buffett runs Berkshire Hathaway. Berkshire trades at around $98,000 a share these days. There’s just under $90,000 per share of cash and investments. It owns the only AAA-rated reinsurer in the world (General Re), and 60 other wholly owned businesses.
The odds of something significantly bad happening to Berkshire Hathaway must be about hundred times more remote than the new planet scientists just discovered.
That Berkshire is trading at less than 10 times earnings must constitute one of the biggest pricing mistakes the public securities markets have ever made. By the way, all I have to say today about AAA stalwarts UPS and General Electric is that Buffett recently added both stocks to his portfolio. Buffett is rarely wrong about stocks.
Then there’s ExxonMobil. Over the last four quarters, it bought back $23.8 billion worth of its stock and paid out $7.8 billion in dividends – and still had $29 billion of cash left over.
Much of that cash will go to pay ExxonMobil’s outrageous tax bill (around 40%!), but even then, it’ll have a few billion left over. While I don’t think former ExxonMobil CEO Lee Raymond needs his $300+ million retirement package, I can see how it could be viewed as affordable. (Let’s not forget the $36 billion in cash and $29 billion of longer-term investments on the balance sheet.
ExxonMobil makes money when oil is $11 a barrel. With oil at more than $60 a barrel, it’s no mystery where all the cash is coming from. Getting ExxonMobil at less than six times pretax earnings is like buying a AAA bond that yields 17%. No, the earnings “coupon” isn’t guaranteed, and it can go down as well as up. But through inflation, war, “peak oil” nonsense, recession, and $10 oil, it’s been there. I suspect it will be for a long time to come.
Toyota… well… if you want to know what ails GM and Ford – it’s Toyota, now the largest car maker in the world. I’ve got one of their products sitting in my driveway. It’s got 92,000 miles on it, and I suspect that’s only a little more than half what I’ll put on it. Toyota goes for right around 10 times earnings.
Much of the time, picking good stocks is difficult. You have to think hard about the businesses you’re putting your money into. Then occasionally, as Chris Davis of Davis Selected Advisors puts it, you get a chance to “buy the stalwarts.”
That’s when stock picking gets easy. Really easy.
That’s what you should be doing with large sums of your account right now, if not all of it: buying the stalwarts. There are others that aren’t AAA-rated, but this is the short list that you should start with.
Good investing,
Dan Ferris
