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 hen
people ask me what stocks to buy, my answer sounds flippant, but
I'm dead serious: Buy the stocks of the best companies. Or, to put
it simply, buy the best businesses.
As simple as
that exhortation sounds, many investors ignore it. They buy stocks
they consider cheap or shares that are shooting up in value. I am
tempted to ban the word "stock" from investing vocabularies.
Instead, think of yourself as becoming a partner in a great business.
How do you
find such a business? Work backward. Almost always, a great business
will have a long-term track record of rising earnings and (if it
pays them) rising dividends. A business that can increase its profits
consistently is a business that must have a powerful advantage over
its competitors — a protective moat that keeps the enemy at
bay. A moat can be a great brand name or reputation, or a special
way of doing business, or a series of patents. If you can't find
the moat, don't worry. Rising long-term profits are a clear signal
that the moat exists.
Just remember
to put the emphasis on the "long-term." In his fascinating
1996 book, What Works on Wall Street, James P. O'Shaughnessy
used a powerful database to determine the effectiveness of a slew
of strategies, such as buying stocks with low price-to-earnings
ratios or high dividend yields. One of the strategies he tested
was investing in companies that have had big gains in earnings over
five years. It didn't work. "Unfortunately," he wrote,
the strategy "doesn't help us pick thoroughbreds." In
fact, stocks with the best earnings gains over five years did 1.5
percentage points worse than the market as a whole.
Luckily, there's
another way. Since 1991, Bill Staton, a financial adviser and analyst
in Charlotte, has been publishing an annual compendium called America's
Finest Companies www.billstaton.com).
To deserve a spot on the list, a company has to have increased its
earnings or its dividends for the past 10 years in a row. Staton's
latest edition, which covers the period that ended Dec. 31, 2000,
identifies 317 such companies out of more than 8,000 listed on the
three major exchanges.
So where are
these great businesses? The single biggest sector is banking, which
represents one-fifth of the total list. Other groups with large
numbers of consistent gainers are natural gas, foods, electric utilities,
chemicals, manufacturing and health care. Technology is nowhere
in sight. In fact, the only high-tech firms on the 2000 list —
Microsoft Corp., EMC Corp. and Cisco Systems Inc. — will all
be bumped off when Staton publishes his next book.
Staton, who
likes sports metaphors, calls the very best of these companies his
"Super 50 Team." To qualify, a firm needs to rack up a
combined 50 years of consecutive earnings-per-share gains plus dividend
gains. For example, Abbott Laboratories qualifies with 30 years
of earnings increases and 29 years of dividend increases. Staton
is particularly fond of dividend payers, especially in the wake
of the Enron scandal. "You can't deceive investors with dividends,"
he says.
Since the next
issue of America's Finest won't be out for a few months,
I updated the Super 50 through 2001 myself. The economy was rough
last year, but only two of the top 10 fell off the list: At Emerson
Electric Co., which had been No. 1, earnings declined for the first
time in 43 years — though dividends rose a bit. It was a similar
story at Genuine Parts Co., an auto-parts distributor whose earnings
streak went back to 1982.
The new leader
of the Super 50 is a company you probably have never heard of: Park
National Corp., a small ($3 billion in assets) bank based in Newark,
Ohio. It has increased earnings and dividends for the past 41 years
in a row. In fact, five of the top 10 are banks. That should tell
you something. While banking has become more competitive in recent
years, small and mid-size regional banks, especially, have maintained
strong franchises. A reputation for stability and safety can build
a broad moat for a financial institution. The list includes Comerica,
which has raised its dividend every year since 1943 (it's the current
record holder for all stocks, according to Staton); Peoples Bancorp,
with an average annual return of 15 percent for the past 20 years;
Regions Financial Corp., whose annual dividend has been rising consistently
at 10& annually; and the largest of the bunch, the curiously
named Fifth Third Bancorp.
The other five
great businesses on the list are more varied. Automatic Data Processing
Inc. (ADP) has increased earnings for 51 years in a row (and at
a double-digit rate for the past 40), performing payroll and tax
services for mid-size employers and handling stock-exchange transactions
as well; Washington Real Estate Investment Trust specializes in
modest properties in the D.C. area and has boosted its dividends
and earnings for more than 30 straight years; Sigma-Aldrich Corp.,
based in St. Louis, makes specialized chemicals used in research
and disease diagnosis, a protected niche that has enabled the company
to boost profits every year since 1970; Abbott Labs makes diversified
health products including Murine eye cleanser and Similac baby formula,
among dozens of others; and Wal-Mart Stores Inc. is simply the world's
largest retailer, with 41 years of rising earnings and a stock with
an average annual return of 34.8 percent over the past decade.
Together, the
top 10 stocks have earned an annual average return of 17.6% over
the past five years, nearly double the return of the benchmark Standard
& Poor's 500-stock index, which has returned 9.1%.
Size doesn't
seem to be a factor in determining a great business. Peoples Bancorp
has a market capitalization (that is, value according to its stock
price) of $156 million and total revenue of just $97 million. Wal-Mart
has a market cap of $278 billion and sales of $210 billion.
But geography
appears to count. Six of the businesses are based in the Midwest
(three in Ohio!), two are based in the South and two in Mid-Atlantic
states. None is headquartered in California, New York, Texas or
Florida. Isolation from the big centers of money and population
seems to be beneficial.
There's no
such thing as a mutual fund based on a strategy of finding companies
with long profit streaks, but the best money managers understand
that consistent earnings and dividends in the past often mean consistent
stock gains in the future. Of the 25 top holdings of the Torray
Fund, seven are among Staton's "finest companies," including
ADP, Abbott and Johnson & Johnson. Robert Torray is my kind
of manager. With his colleague Douglas Eby, Torray looks for great
businesses and holds them for a long time. It's a strategy that
has paid off. The fund, based in Bethesda, has whipped the S&P
by an average of 3 percentage points over the past 10 years. So
far in 2002, Torray is up an impressive 7%.
What distinguishes
Staton's list is moderation. With few exceptions, the businesses
just keep growing, slowly but surely, year after year. Bob Torray,
in his annual report to shareholders last month, expressed this
philosophy of investing well:
"The undeniable
reality is that making a lot of money on passive investments like
mutual funds takes not months, not a few years, but many decades.
Rushing the process only guarantees failure. The task becomes a
whole lot simpler when we tune out the background noise and keep
our eye on the ball."
For those of
us who enjoy buying individual stocks, keeping our eye on the ball
means focusing on proven businesses — companies like the ones
that Bill Staton has so graciously identified for us.
—
Among the stocks mentioned in this article, Mr. Glassman owns Automatic
Data Processing, Microsoft and EMC. This artice first appeared in
the Washington Post.
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