One of the reasons why I like studying companies that have been growing their dividend by a rate of 7% or more annually for the past ten years is that, not only am I finding businesses that are returning more and more cash to their owners over time, but I am also getting a firsthand glimpse into what the leaders of the company are projecting about the future cash flows for the business. It cuts through all the BS you see on the first few pages of a company’s annual report and tells you what those with the innermost knowledge of a company really think—after all, if you’re running a company that is anticipating trouble growing profits in the next couple of years, are you going to give shareholders a 10% raise in the payout? Probably not, because it’s a lot easier to deal with a few years of 1% or 2% increases than a year of a 10% increase followed by a cut.

Likewise, when a company with a record of raising dividend payments suddenly stops doing so, you should take a hard look at the company and re-evaluate your position. I’m not saying you should sell—there are plenty of great companies that have to work through problems (that is particularly true in the commodities industry, particularly oil) and it would be foolish to sell after a dividend freeze or a dividend cut because you’d be engaging in the act of selling low. That said, contemplating a fair price at which you’d exit wouldn’t be unwise.

Let’s walk through a real-life company to show you what I have in mind—say, Eli Lilly. From 1995 through 2009, with the exception of 2003-2004, Eli Lilly raised its dividend. A payout that was $0.26 quarterly in 2000 grew to $0.49 in 2009. If not excellent, it’s certainly nice: you almost doubled your payout in a little less than a decade, and you get a pay raise during the 2^nd worst recession of the past century. At a time when even some of the Coca-Cola heirs were being sent into bankruptcy due to bad real estate bets, owning a cash-generating asset that was raising its payout to you was a nice place to be.

But then something worthy of attention happened: Eli Lilly kept the payment static in 2010. That should have made you scratch your head a little bit: After all, Eli Lilly grew its profits that year from $4.42 to $4.74. The dividend payout was declining from 44% to 41%. If profits were growing, why wasn’t management sharing more of those profits with owners? Sure, it could have been post-recession shock, and a new era of fiscal conservatism washed over the company, or it could have been something else. If you pulled up the company’s statement, you would have seen that Cymbalta was about to go off-patent. Hmmm, the leading drug responsible for much of the company’s profits was about to lose its special patented protection.

What’s interesting, though, is this: The stock was trading at only 7x profits. It was in the $30s. If you had been a part owner of the stock for five years or less, and didn’t buy it during the selloff in 2008-2009, you probably paid in the $40s, $50s, and $60s. It wouldn’t have seemed wise to sell, because the stock was so cheap. In other words, even if you correctly realized that the company’s earnings power was set to decline, it didn’t make sense to sell the stock because the price of the stock had gotten cheaper than the amount of the earnings power decline.  And after all, this is still a company making $5 billion in annual profit, and collecting $1.96 in cash per share is no great hardship.

Still, aware of what was happening to Eli Lilly’s earnings power, you decided you would get out of the stock if it saw a price in the $50s, and then set your eyes towards greener pastures (by the way, this is a part of investing that is more art than skill—you could have some very intelligent ladies and gentlemen that would disagree as to whether the fair value exit price would be $45, $55, or $65).

When 2011 came along, it was more of the same: the dividend remained at $1.96, but the earnings came down a bit to $4.41. The price of the stock peaked a bit into the low $40s. Even recognizing the trouble with the core business, I still wouldn’t have yet been interested in selling: the price of $40 would still be too cheap for me to be interested in leaving (note: you should keep in mind that we are talking about a struggling but ultimately solvent and profitable company here—if we were talking about a company facing the prospect of bankruptcy, you cut your losses, hopefully learn something and have a sense of humor as best you can about it, and then move on—the rules are different when the waiting game could lead to 100% wipeout which is not the case here).

By 2012, earnings continued to get worse than expected with Cymbalta going off patent and losing 69% of its sales, with profits going down to $3.39. The stock, meanwhile, crossed the $50 threshold and hit a high of $54. Somewhere between $47 and $50, I personally would have left. It was a price that would let me leave a business struggling to grow profits (heck, struggling to maintain profits) without selling low.

The dividend, meanwhile, stayed at the $0.49 quarterly rate throughout all of this. 2009, 2010, 2011, 2012: the quarterly payout remained the same. In this case, the frozen dividend was a signal that the management team did not see earnings growing, and they were right. You get happy that you’re given the opportunity to exit Eli Lilly at a good price, and move on.

Now interestingly enough, the stock has since crossed into the mid-$60s, going for $66.96 at the time of my writing. If I sold around $50 in 2012, I’d have no remorse about “missing out” on the subsequent $15+ price appreciation because it’s illusory; the stock is overvalued, the pipeline is generally weak (compared to the loss of Cymbalta), and the dividend continues to eat up a substantial amount of profits. When I talk about stocks generally being overvalued to the tune of 20% or so, companies like Eli Lilly are stereotypes I have in mind.

This is where a superficial reading of the Peter Lynch quote “buy what you know” can get you into trouble. A lot of people have heard of Eli Lilly. It’s huge; it’s been around a while. It sounds vaguely blue-chippy. But unless the stock gets more overvalued, or some unanticipated blockbuster drugs come through the pipeline, or Trulicity becomes an even more lucrative source of long-term profits in the fight against diabetes than even optimistic projections suggest, then you will get disappointing returns.

Eli Lilly has earned $2.49 in the past twelve months. The dividend, which is still at $0.49 quarterly, accounts for 78% of the company’s profits now. The $66 price of the stock amounts to a 26x earnings ratio, which is only tolerable when you expect a very high likelihood of 12% annual growth or more for 5+ years. Maybe $66 per share would be a fair price to pay if Cymbalta profits were still rolling in and had five years before going off patent. This current valuation is in no way connected to value investing—to do well, you need higher than expected growth to happen for a while.

The good news is, if you’ve been owning the stock, now isn’t a bad time to get out. The good news is that Eli Lilly has a good balance sheet. The only carry $5 billion in debt and have over $5.1 billion in cash assets. Humalog is the only drug in the entire portfolio growing sales at a rate over 10% (in the case of Humalog, the growth rate is 11%).

My guess on what is likely the next five years? Eli Lilly will grow profits a bit, perhaps up to the $3.50-$3.75 range from the current base of $2.50. But the P/E ratio will contract significantly, probably somewhere around 16x profits. In other words, I anticipate the journey from 26x profits to 16x profits will be a headwind to a larger extent than profit growth will be a tailwind, and you will see the stock trading at $60 five years from now ($3.75 in profits x P/E multiple of 16=$60). I’m not saying Eli Lilly is a terrible company. I’m not guaranteeing there aren’t scenarios under which it could be a good investment. But I am saying there is a significant NEGATIVE margin of safety in the current stock price, and total returns will lag the growth of the firm in the coming years. And given that I think Eli Lilly will grow at a single-digit rate in the coming years, the P/E compression could very well wipe out most of your gains. Given that we only have to make one investment at a time in a world of 15,000 publicly traded securities, I’m not sure there is wisdom in putting Eli Lilly on your current shopping list.

With the price of oil now at $78, something I consider unusually low because Saudi Arabia rarely maintains its production amidst declining prices (usually, the Saudis run their oil spigots in a self-correcting manner, decreasing production during hints of substantial price declines and calibrating production increases as necessary during price hikes to keep energy prices in a desired zone), I have made no secret of the fact that I’ve recently been turning my attention towards oil stock investments. I think the prices for many have become attractive in their own right, and especially attractive on a relative basis compared to much of the rest of the blue-chip universe (though with Nestle now in the $72 range, it’s not like there aren’t any growth-at-a-reasonable-price blue chip investments out there).

In a way, it almost doesn’t matter which oil giant you choose: BP. Total. Royal Dutch Shell. Exxon. Kinder Morgan. Chevron. Conoco Phillips. Phillips 66. Marathon Oil. They are all solid twenty-year holdings, and the kind of things that will generate a good chunk of income to you as you work through the next stage of your life. BP remains my favorite from a current dividend and future capital appreciation perspective (what do you think happens when you reinvest a 5.6% yield into an undervalued stock year after year while the dividend grows?) but I can also acknowledge that the company’s risk profile has heightened in the previous few months as well—after all, BP generates 30% of its production in Russia, and if these lower prices remain for twelve to twenty-four months, you could conceivably encounter a worst-case situation in which BP would have to pay out a high gross negligence ruling and sell its assets during a period of low prices and uncertain profits through its Russian production arm.

That said, BP is still one heck of a bargain. I expect BP in the low $40s will be something that investors will look back on and go “D’oh, what was I thinking” for passing up the opportunity after fear. This is still a company with 5 billion barrels in reserves and 34 trillion cubic feet in natural gas to its corporate name, plus other partial interests. This is still a company that makes $14 billion in profits per year, roughly 1.5x the profits that Coca-Cola makes (and Coke operates in 210 countries). And they have $27 billion in cash currently on hand, and an adverse gross negligence ruling would cost somewhere around $18-$21 billion. Since BP is currently using some of that cash on hand to repurchase stock, believing (correctly in my opinion) that the stock is undervalued, it is possible they could have to sell a few more assets in a particularly bad case scenario. But on the whole, especially adjusted for the current price of $40 per share and likely considerations of where BP will be ten years from now, the concerns you hear about BP are largely headline risks that strengthen my belief that having too much financial information on hand can be hazardous because it is going to force some otherwise intelligent and good people to dispose of their stock out of fear when they would have been better off just going through life and letting the cash payments pile up.

I continue to hold the opinion that most people underestimate how lucrative it can be having 15-20% of your portfolio dedicated to the assets of the old Rockefeller Empire (plus Total SA and Royal Dutch Shell). To illustrate the point, just look at this twenty-year chart of Conoco Phillips. Without dividends reinvested, you beat the S&P 500 by a few percentage points, getting 12.26% annual returns over the past twenty years (you should note that the chart example just includes the pure Conoco stock, and leaves out the Phillips 66 spinoff which would have established a concomitant ownership stake of Phillips 66 as you received one share of Phillips 66 for every two shares of Conoco that you owned in April 2012). Even if you spent every single dividend payment along the way, the amount of income generated by your invested principal continued to march upward with time. And what I really like is that sloping upward yield-on-cost; after all, if you do it right, you’ll only live off the income and your beneficiaries and favorite charitable causes will reap the rewards of capital gains on the principal.

In the case of Conoco, someone living off the dividends would have seen each share grow income production from $0.60 annually to $2.92 annually, so that the original 3.7% yield on the Conoco shares grew to a 18.3% annual yield on your invested money. Better yet, those Phillips 66 shares would be independently pay you a 6.27% yield on your initial investment as well.

For someone with $10,000 to set aside towards Conoco in 1994, and chose not to reinvest, the results would look something like this: 628 shares of Conoco paying out $1,833 in current annual income, and 314 shares of Phillips 66 paying out $628 in current annual income. In short, you’d be getting $2,461, or 24.61% in annual dividends on the amount you invested twenty years ago.

If you were in a situation where you were making much more than you needed to spend, and trying to create wealth rapidly that would generate significant annual income at a later date, the results would have been more impressive as you would have received 250% of your investment as cash to get plowed into brand new shares. This would have quietly almost doubled your share count over the past twenty years, amplifying the effects of future dividend increases and the value of those Phillips 66 shares.  You’d currently be collecting about 33.46% of your invested capital in annual dividends alone. The Phillips 66 shares have only had two years of dividend reinvestment, so that part of the narrative is still young.

There’s a lot to like about making the oil majors important parts of your overall investment story. They offer important hedges against inflation—if you’re worried that American politicians will turn to the continual creation of new currency to flood the market with electronic dollars to eventually create 4% or higher inflation (rather than raise taxes directly), then you can hedge against this threat by owning commodities stocks. When people talk about oil getting “expensive” this past generation—it wasn’t all attributed to oil becoming more expensive—it was oil getting more expensive in conjunction with the U.S. dollar growing weaker.

Because oil stocks naturally fluctuate in prices quite substantially—BP and Conoco are going to see significant rises and falls in their stock prices much more so than General Mills and The Southern Company—I think some investors get scared off by that volatility. What I find interesting though, is how a few years of dividend reinvestment can hedge your starting investment against volatility as the years go on. This year BP has seen a high of $53 go down to $42 right now. People on TV will talk about the significant volatility of that. What’s missing is this: From 2011 through 2014, BP will have paid out $8.18 in dividends. Those $8.18 in dividends these past four years covers about 75% of this year’s volatility. And if you reinvested those dividends, the payouts would grow larger, smoothing out the fluctuations more. And that’s just four years of reinvesting oil dividends. If BP didn’t raise its dividend at all the next decade, you’d collect $24. That’s over half the share price, based on merely continuing the rate of the 2014 payout. The fat oil dividend payouts matter, and they mitigate against a lot of the short-term volatility associated with oil stocks. That’s why I find Exxon, Royal Dutch Shell, Chevron, BP, and Conoco to be central cast members in building an estate.

Collecting $10,000 in annual dividend income from a $10,000 initial investment is the holy grail of income investing. More broadly, collecting annual income equal to the amount you invest is almost always a signal of an investment well-chosen. Assuming you get there within two or three decades, it represents an extremely efficient use of capital that comes with a huge margin of safety because you can re-allocate the dividends to new investment opportunities, continually extracting the amount of money you put at risk from your labor into a business enterprise.

I want to talk about such a golden goose that rarely gets discussed: Buckeye Partners, one of the greatest energy partnerships in the world that is very rarely discussed on financial commentary websites. When someone says “I don’t want to fill out the paperwork or go through the hassle of a K-1 form to own an MLP”, this is what they are missing out on:

Someone that owns any Buckeye units would be receiving current distributions of $1.1125 per quarter (units and distributions are the jargon in MLP world to express shares and dividends that we associate with typical corporations). The amount of the payout increases each quarter, so your cash payment makes you richer every three months even if you freely spend the distributions along the way. If you reinvest, the wealth-creating effects amplify. How much do they amplify?

Over the past twenty years, a $10,000 investment in Buckeye Partners would have grown your share count from 575 units to 2,223 units. The price quadrupled over that time frame, which is nice, but MLPs aren’t really designed to be trading vehicles because of the tax structure. Most importantly, the annual payout has grown from $1.40 per unit to $4.45 per unit. Your annual income would be 2,223 x $4,45= $9,892. Someone who bought Buckeye Partners in 1994, and has since reinvested, will see a $10,000 investment payout over $10,000 annually sometime in 2015. That is a testament to the power of high reinvested dividends in a growing oil enterprise.

What I find so interesting, and what escapes most people, is that the twenty-year growth rate in the payouts is only 6.2%. Most people who aim for prodigious income or capital appreciation set their sights on businesses growing profits at 15-20% annually. Things like Visa, which are appropriate places to search for capital appreciation. But they are not the only place. In the case of Buckeye, the 6% distribution growth powered you towards 15% annual returns because the starting yield is so high that the act of reinvesting fat payouts, again and again for years and years, leads to eye-popping results years down the line. A single $10,000 investment in 1994 could fuel your retirement with more income than you’d get from Social Security payments. It’s one of those crazy good investments setting out there, beyond notice.

Alas, I do not currently own any Buckeye Partners. I had/have an outstanding buy order at $58 which has never been filled. The logic behind the buy order? You know in advanced negotiation classes, you learn about BATNA, or the best alternative to a negotiated agreement? My oil investment equivalent was this: I refrained from buying Buckeye until it could reach a point it surpassed the best oil alternative—BP stock in the $40s. After all, you have to keep in mind that energy MLPs have to distribute almost all of their net income to owners to maintain their special tax classification. There’s no magical bevy of retained earnings on hand to fund growth—firms like Buckeye have to access the capital markets and issue debt to grow (that’s why the unit count has increased from 34 million to over 130 million in the past ten years; constant dilution is inherent in the business model—what counts is that the debt and units created are invested into lucrative projects).

BP is very different. It makes about $14 billion in profit and pays out about $7 billion in dividends. Seeing a yield in the 5% range from Buckeye and BP comes with very different implications; Buckeye’s 5% yield comes attached to the fact that it sends almost all the income your way. In the case of BP, half the profits are retained on hand for future growth (you see a 5% yield plus there is another 5% retained by the company to grow, making the company much more attractively IMHO).

At $58, Buckeye would be paying out 7.67% (putting it back at the high end of fair value, in my opinion), and thus tolerable for purchase. It’s a pipeline that typically grants investors starting points in the 7%, 8%, or 9% range. And by typically, I mean, pre-crisis and low interest rates. Coming out of the recession, the shares have been perpetually overvalued, because it is a high-quality source of income and people want yield that is hard to find.

During that October swoon, I thought I was going to get my price. It came down to the $63 or $64 range. I remember seeing it break under $64, and thought about revising my buy order upward. I didn’t, because I remembered considering the same thing when the price went below $70, $67, $65, and then under $64. I thought it was going to come down to my price. After all, when oil swoons, it swoons hard (in 2008, for example, Buckeye fell from $50 to $22 in the calendar year). Even though the long-term results for Buckeye bought at $64 will likely be very good, I’m not bumming about it too much. The high-yield asset classes are all trading out of whack compared to their historic valuations, and come with a negative margin of safety. I’d rather suffer the fate of being too picky rather than not picky enough.

I wonder if BP investors twenty years from now will have a similar story to the Buckeye Partners investors that chose to reinvest. It’s so wild—BP’s market cap is over $100 billion—making it one of the six largest oil firms in the world, and yet I anticipate it will eventual be a huge source of wealth creation for those that dutifully reinvest. There will come a time when reinvesting in the $40s will be looked up fondly years from now, the same way someone might be looking back on Buckeye trading in the $20s years ago. Buckeye had a 7.5% starting yield that grew at 6.2%. BP has a 5.6% yield that might grow at 7% or 8% long-term. While not perfectly symmetrical, there are enough comparative qualities to catch my attention. I expect the yield-on-cost for someone that buys BP stock today and keeps on reinvesting will become quite substantial a generation from now.

Sick of the commodities posts yet? No? Good, because that’s what is cheap right now. Let’s cover I don’t think we’ve discussed here before—BHP Billiton, the most diversified materials producer on the globe. It’s a niche long-term holding—like Tiffany, Disney, and Berkshire Hathaway—in that there are not a lot of peer companies from which you get to choose. If you want a long-term alcohol company in your portfolio, you can choose from Anheuser-Busch, Heineken, SABMiller, Molson Coors, Diageo, Brown Forman, and probably more, but I’m going off the top of my head.

BHP Billiton is unique in that it produces iron ore, nickel, natural gas, oil, diamonds, coal, and steel. It has a very wide collection of assets that are heavily mined in Australia, Chile, and South America, with some operations in the United Kingdom as well. The company is spending $14 billion in developing new mines and oil fields—it is no laggard when it comes to capital investment (also, it’s in the process of spinning off its silver, coal, and aluminum mines to shareholders because the company wants to focus on the more lucrative mining and drilling operations).

If you run value screens within the realm of blue-chip stocks, it should be showing up on your lists right about now: The price has declined from $71 in July to $53 right now. Even though companies do go from very overvalued to less overvalued, it catches my attention when a high-quality holding falls 25% in four  months. Each ADR of BHP Billiton (and if you’re an American, you want to buy the British rather than Australian shares because of the tax treaty unless the price differential between the two becomes so steep it’s worth the additional tax and that would be rare) makes $5.18 in profit. This is a very serious firm that makes over $13 billion in annual profits, putting it in BP’s company. It’s very large. Even during the 2009 earnings collapse, it still made shy of $6 billion in net profits. This company is a beast.

It pays out a $2.36 dividend, which amounts to a dividend yield of 4.45%. This is the highest yield BHP has offered this generation. Even during the recession, the yield only reached 3.3%. In 1999, BHP Billiton yielded 3.9%, and that’s the closest it has come to the present situation. Considering that earnings are on pace to grow in 2015 and 2016, based on current commodity prices and expected production gains, the current P/E ratio of 10 is on the undervalued side. Reasonable minds can disagree, but I would peg the current margin of safety at around 10% to 20%.

This company’s long-term performance is fairly awesome—even with the current low price, it has returned 13% annually since 1987. It would have taken $36,000 in 1987 dollars to make you a BHP Billiton millionaire today. It has grown earnings by 29% annually over the past decade, and dividends by 23% annually over the past decade. If you have held the stock for twenty years and reinvested the dividends, you would have turned every dollar invested into $8.51. You’d be collecting $0.34 in dividends on every dollar invested. It’s a very solid company, with a very solid track record, that is currently on sale because of the dip in commodity prices. Even with this dip, it is still going to make over $13 billion in profits over the next twelve months.

The valuations in the stock market amuse me right now. Take something like Colgate-Palmolive. It is an excellent company, something I’d want to own long term, and a great all-weather holding. But the current price…is getting out of control. It makes $2.28 per share in profits. But it trades at $68 per share. That is a P/E ratio of 30. Based on common sense, history, and projections of future cash flows, it will eventually revert to 20x profits. Heck, you could buy it at 20x profits for most of the 2000s! At best, it is worth $45-$50 per share. Now, profits grow every year, so you may never see a steep fall in the price of the stock, but you will see long-term performance of the stock lag the growth of the business itself for those that buy the stock here in early November 2014.

Yet, in the very same market, BHP Billiton is on sale for 10x earnings and comes with a full margin of safety. It produces 84 million barrels of oil each year. It produces 839 billion cubic feet of natural gas.  It produces 1.7 million tons of copper. And 5.2 million tons of aluminum. It has $8.8 billion in cash on hand. Exxon only has $6 billion in cash on hand! It’s giving you a dividend yield in the 4-5% range, historically high. It’s at 10x profits that are expected to grow. The dislocations in value between something like Colgate and BHP Billiton are amazing.

BHP is historically cheap. It has a historically high yield. Its profits are growing. The long-term record is excellent. It is diversified across commodities. It has a management team that keeps the share count tight, refusing to dilute the owners. What more are you looking for in an investment?

I was recently studying the terrible record of financial institutions when it comes to repurchasing their own stock—I read that AIG, Citigroup, Lehman Brothers, Bank of America, Merrill Lynch, and Countrywide combined to repurchase over $100 billion of their own stock respectively before the financial crisis, which then got reduced to a little over $18 when you size up what remains after the financial crisis. Obviously, those are the obvious examples of when stock buybacks go wrong.

But still, the art of the buyback is something that very few companies can get right on a consistent basis, because the times when companies are flush with cash tend to be during prosperous economic times that also correspond to high stock prices, and when stocks get cheap, the money tends to get tighter, and stock buybacks don’t get purchased at their opportune times. It’s like reading the diaries of individual investors during The Great Depression—there were men out there who know that buying AT&T and Procter & Gamble with 10% dividend yields was a once-in-a-lifetime deal, but keeping their family fed and the lights on was a struggle, so they weren’t in a position to act on the opportunity they saw.

There are very few men alive that follow in the James Tisch tradition at Loews. When James’ father, Lawrence, ran Loews, he retired 26.5% of the company’s stock that existed in the 1970s. From there, he took out 37.0% of the outstanding stock in the 1980s, and then 30.4% in the 1990s, and 14.6% in the 2000s (Source). Look at what James Tisch did with Loews stock in the early 2000s—it held steady around the 550 million market. And then the financial crisis happened, and boom, Loews had lowered its stock count to 400 million by the end of 2010. During the heart of the financial crisis, Tisch was lowering the share count from 529 million to 435 million. Boys and girls, that’s how stock buybacks ought to be done.

That managerial excellence goes unnoticed because Tisch is working with some difficult businesses—hotels, Boardwalk pipelines, and stuff like that. Over the past twenty years, Loews has returned 10.41% compared to the S&P 500’s 9.47%, but really, their managerial talent is much better than that, because they are dealing with a lot of highly cyclical businesses that have had a rough time, so their outperformance is a greater testament to their talent than that one percentage point difference would indicate. Loews doesn’t get a whole lot of attention because it only pays out a $0.25 dividend each and every year, and is the kind of thing you buy when you are bringing in $80,000 annually from passive income sources while spending $60,000 per year, and have that free hand to make long-term investments that don’t require any kind of focus on improving immediate cash flow.

Needless to say,  most companies we talk about are not run by James Tisch or Harry Singleton type figures. What are you supposed to do, then? If you cannot find high-quality businesses that only buy stock opportunistically when the stock is undervalued, either look for lucrative businesses that do not repurchase stock at all OR that constantly repurchase stock that has a tendency to be undervalued.

I see a lot of wisdom in someone saying, “Hey, I’m going to put a lot of my portfolio in Exxon, Wal-Mart, and IBM.” Those companies are merciless when it comes to retiring shares of their stock, and their shares really get too expensive—people think Exxon is too big to grow, IBM will have trouble adjusting to the cloud, and Wal-Mart can’t grow same store sales effectively anymore. Those expectations are false but have a bit of truth in them, and over the long term, prevent the stock of any three companies from getting expensive for long periods of time (you see the opposite with companies like Hershey and Brown Forman), and so the perpetual buyback tends to work out because the stock is not expensive.

From 2004 through 2014, Exxon reduced its share count from 6.4 billion to 4.2 billion, which actually understates the effectiveness of Exxon’s buyback because they issued stock for the XTO acquisition. Over that time, Exxon delivered returns of 11.20% annually. The dividend grew 8.5% each year over that time.

From 2004 through 2014, IBM reduced its share count from 1.69 billion to just under 1 billion. Over that time, IBM delivered returns of 9.49% annually. The dividend grew 19.0% over that time, as IBM’s earnings per share grew and the management team decided to pay out 25% of profits as dividends instead of 14% of profits as dividends like in 2004.

From 2004 through 2014, Wal-Mart reduced its share count from 4.2 billion to just under 3.2 billion. Over that time, Wal-Mart delivered returns of 6.5% annually. Wal-Mart’s dividend increased 18.5% annually over the decade, as management decided to increase the dividend payout ratio from 22% to 37%. The reason why Wal-Mart’s returns aren’t as impressive is because Wal-Mart stock was a bit on the pricey side in 2004 when investors were paying 22x profits for each share, and now they are willing to pay 13-15x profits for each share, and that shift explains why the results are lower than what you’d guess. From about 2006 onward, Wal-Mart stock has been perpetually slightly undervalued, and in this case, the example is a creature of the time period chosen that slightly distorts the reality of what you would expect going forward.

Generally speaking, Exxon, Wal-Mart, and IBM get it done on both the dividend growth and the total front simultaneously, because the management is always buying back stock that, more times than not, tends to be undervalued and therefore helps shareholders along. As far as big companies ago, this is what good capital allocation looks like once you get beyond the men like Tisch and Buffett who know exactly what they are doing and why regarding the repurchase of company stock.

You may have noticed that on the right bar of the site, I have added a link to Dr. Thomas Stanley’s excellent book “The Millionaire Next Door” (full disclosure: if you click on the book and purchase it, I receive a commission). But even if you don’t buy it, it’s cool if you go to the library and check it out, as the important thing is that you read it.

It really becomes apparent that there is a difference between being rich and appearing rich. This whole image that being affluent is about spending money recklessly and only buying high-end ridiculous consumer goods is completely out of line with the reality of those who build a net worth that exceeds the $1,000,000 mark (my side commentary: I find it nuts that being financially independent is often associated with expensive homes, cars, schools, etc. when I see the benefits of financial independence being that you can spend money on the little things without thinking twice about it—you can go to Subway and get whatever sandwich you damn well please, without worrying about whether it’s on the $5 menu).

Dr. Stanley’s research will spin your mind a little bit, with gems like this:

“…wealthy households are much more highly diffused geographically than are high-income producing households. There are nearly three times more millionaire households (1,138,070 or approximately 28.3% of the total, versus 403,211, or about 10% of the total) living in homes valued at $300,000 or less than there are millionaires living in homes valued at $1 million or more.”

He also points out that there are statistically more millionaires in the United States that have never made $80,000 per year than there are that come from households making more than that. Also, teachers are wildly disproportionate millionaires for their salary range, and my guess on that is that they understand compound interest, don’t face social pressure to spend heavily, and generally have better benefits than most.

Think of it like this: if you save $1,000 per month for 24 years and earn 9% on your money, you’ll cross that $1,000,000 threshold. You can do that by being a household making $60,000 and spending $48,000 or making $75,000 and spending $63,000, or whatever your ratio would be to get to that $1,000 savings per month.

By the way, there’s no reason to get discouraged if your savings rate is below this: hopefully your salary will increase as you get more experienced and skilled with time, and that will provide an opportunity to increase your savings rate. And even saving $400-$500 per month can change your life. Heck, someone who bought $500 worth of BP Oil stock every month for the past four years would be sitting on almost 670 shares paying out over $1,500 in annual dividend income, so you can get cash coming your way somewhat quickly.

There is a cultural component to wealth—we see athletes, actors, entertainers, and the obscenely wealthy on the television screen and at the top of websites regularly, and that distorts are perception of how the wealthy behave. And plus, lavish spending will always be more interesting—which TV interview of a lottery winner do you think would get the better ratings: the guy who wins $10,000,000 and talks about buying a car, house, and boat, or the guy who says he will take the money in annual installments and maximize his retirement accounts and build an emergency fund? The important part of your training, though, is recognizing that how the characters we see on TV behave is not how the typical millionaire in the United States behaves.

We all know this intuitively—people that consistently keep costs low rarely run into trouble, and it’s the gap between spending and earning that creates wealth, rather than the presence of a high income. Dr. Stanley’s book reinforces these points, which may provide reassurance if you are not a lone wolf when it comes to doing your own thing, and you desire to seek out confirmation that your “boring” style of building wealth is normal compared to similarly situated peers.

There are people in this country that make 401(k) investments by bringing up a comparative chart of the last year, three-year, five-year, and ten-year performance, and then making automatic paycheck contributions based on what had been the hottest performers over that period of time. If you don’t enjoy spending a lot of time thinking about investing, it has a certain intuitive appeal: Why not go with the five letters that can report 10% annual returns from 2004-2014 rather than the five letters attached to a 3% annual return?

The problem is this: you could performance-chasing. A fair amount of time, the reason why a particular mutual fund has done well is because the P/E ratio of the type of companies in the fund have increased, and/or the profits have grown significantly during that part of the business cycle. Other times, the past performance does act as a resume of sorts in a way that can indicate strong future performance: just look to Berkshire’s 9% annual returns the past ten years which have corresponded to 12% annual increases in the company’s book value.

That brings me to gold, silver, and other commodity-based investing. For instance, someone who speculated in gold (GLD) from 2004-2012 would have seen average annual gains of 17% annually, turning $10,000 into $37,000 during that time frame. From November 2012 through 2014, gold has not performed nearly as well. If you hopped on the gold bandwagon in 2012, seeing its excellent eight-year past performance, you would have been sorely disappointed with your results. Gold purchased in November 2012 would have returned -35% cumulatively in the past two years, whipping every $10,000 investment  towards $6,500 today.

Nowadays, speculation in gold makes more sense—the same value investing principles that call for buying low with common stocks extends to commodities as well. Right now, gold is around $1,190 per ounce. The American stock market has been performing well. There is no current threat of a government default. Global conditions are about as good as you can realistically ask for. Inflation is relatively tame. Gold is an unpopular investment. If I were inclined to speculate in gold, now would be the type of time I would choose to do so.

Would I actually use my own money to buy something like GLD, or a similarly situated commodity like SLV for silver? No, I would not. I would have a much stronger preference to own commodities businesses that are extremely large and profitable, like BHP Billiton and ExxonMobil. Businesses that deal in commodities can give you advantages that buying the commodities directly cannot get you. With Exxon, you get strong share repurchases that increase your share of ownership over the commodities being produced. If you own a barrel of oil outright as an investment, it remains a barrel of oil. If you own BHP Billiton, you benefit from increases in production over time, so that more iron ore, natural gas, nickel, diamonds, oil, coal, and steel get produced over that period of time. If you buy 10 barrels of oil, the amount stays static unless you actually take some of your money and buy more barrels of oil.

And, of course, these gains get capitalized at a rate of 10-15x profits. If the price of gold, oil, silver, or whatever goes up, someone that owns the commodity outright only benefits from that individual price change. Someone who owns a commodity stock like Exxon or BHP Billiton also benefits from the production gains and stock repurchases which combine with the rise in the price of commodities to grow profits. These grown profits then get capitalized at a rate of 10-15x profits, increasing your gains furthermore. These accumulation of benefits for owning commodity stocks can explain why Exxon has been compounding at over 14% annually for 44 years, turning $5,000 in 1970 into $2,000,000 today. Commodity-producing businesses come with additional advantages that owning the commodities outright do not give you.

And, of course, you already know my favorite—commodity businesses come with dividend payments that will boost your total return when the price recovers. In November 2012, you could have bought gold for over $1,700. Now, it’s less than $1,200. You receive no benefit from that price decline. Sure, you can go online and transfer money to buy more shares of GLD or whatever, but if you remain passive, no benefit comes your way. You just have to wait for the price to go back up $1,700.

Owning commodities is a wild ride—anyone who has been a commodities investor for 5+ years knows that, because they would have experienced significant fluctuations in the value of their holdings. Someone who owned shares of BHP Billiton (BBL) throughout the past year would have seen the price of each share hit a high of $71 this summer, and then would be sitting on $5,200 right now as the price has declined to $52 a piece. But you receive a clear benefit from that decline in price—each share pays out $2.36 in cash dividends. You collect $236 which will add about 4.5 fresh new shares to your holdings if the price remains low throughout the year.

It’s a nice little treat for when the price returns—if BHP Billiton made it back to $71 per share at the beginning of 2016, it’s not a breakeven point for you—you would have 104.5 shares worth $7,419 in comparison to that $7,100 you initially invested. And, of course, those 4.5 will be perpetually paying out dividends of their own which will also be capitalized at a rate of 10-15x profits. This phenomenon, playing out year after year, partially explains why you get this situation alluded to above when Exxon turns a $5,000 initial investment into $2,000,000 forty-four years later (because of mergers and demergers, BHP Billiton does not have as easily trace-able of a history to mention).

The only real risk that comes with owning a commodity-producing business that does not exist with the commodities themselves is managerial incompetence. To me, the best defense against that is to deal in commodity-producing firms that have storied history, conservatively managed balance sheets with no more than moderate debt, strong histories and future plans for production growth, and extensive current operations. The dividend payouts when the price is low, the stock repurchases that increase your share of the ownership, and the production gains that occur over time create substantial long-term advantages for those that choose to invest in the commodity-producing businesses over the commodities themselves.

Yes, this article you are about to read is a first-world problem. Throughout this past year, I have made no secret of the fact that Visa and Gilead Sciences are two of my favorite companies if you are looking to buy-and-hold blue chip stocks with well above-average growth rates. Over the past five years, Visa has grown profits at 22.5% annually. Gilead, meanwhile, has grown profits at 15.5% annually for the past five years. Even if the growth at both companies comes down a bit, it still figures to be above the 10% annual range throughout the rest of the decade.

That’s what prompted me to write highly praiseworthy articles of both companies over at Seeking Alpha earlier this year, such as “Visa’s Fall To $200 Is Classic Short-Term Thinking” and “Gilead Sciences Has A Realistic Path To $100.” Visa is now at $248. Gilead is now at $102. The price change in both these stocks has been quite significant. Visa has gone up 24% (plus dividends) since I wrote that article in April. Gilead Sciences has gone up 14% since I first wrote about it in July.

Now, the predicament is this: Both of these companies are still on pace for double-digit earnings per share growth. It is unlikely that you could build a portfolio consisting of many blue-chip stocks with faster growth rates than these two. But…the margin of safety principle concerning these two companies has changed by a meaningful amount of the course of this year.

Visa made $9.07 for its 2014 business year. At $248 per share, we are talking a valuation of 27x earnings. Put another way, your situation is this: you get a 0.77% dividend yield, 3.65% starting earnings yield, +the future growth rate of the firm. My concern is that a chunk of the company’s future earnings growth has already been priced into the stock. I have the company penciled in to make $15 per share in 2019. My estimate of fair value would be a valuation in the 20-25x earnings range. That would imply a 2019 stock price between $300 and $375.

My concern with adding Visa now is that there is no margin of safety in the event that the company’s growth fails to meet expectations. What if Visa only grows at 7%, and trades at 21x earnings five years from now? That’s certainly within the realm of possibilities. In that case, Visa would be making $12.86 per share in 2019, and at a 20x earnings valuation, would trade at $257 per share, just a little bit above where we are now. That’s something you need to keep in mind—what if growth is slower than you expect, and because the growth slows down, the P/E ratio comes down with it as future expectations simultaneously diminish? It would be a double whammy—lower reported profits, plus a lower multiple applied to those profits occurring at the same time. I find that bothersome: If Visa grows at 7% annually from here, you could surrender all of those gains due to P/E compression occurring at the same time. The company would be growing moderately, but your reported returns would be negligible in such a scenario.

In the case of Gilead, my concern is this: Everything is going right with the company right now. Sovaldi, the wildly successfully and wildly expensive Hepatitis C drug, has taken flight. Gilead’s profits per share have increased from $1.64 in 2012 to $1.81 in 2013 to $7.80 in 2014. The company is flush with cash, sitting on $8.7 billion. There are about 200 million HCV patients in the entire world, and it’s expected that Gilead will be providing pills to half of them.

My concerns about Sovaldi are two-fold. I think it is possible that some analysts are over-estimating the profits that this drug will be able to generate for shareholders. When Sovaldi was first marketed in the United States, the price came out to $1,000 per pill. Don’t drop that down the drain. Because of its high price, Gilead has angered many governments and patients who accurately claim that people are dying because they cannot afford to pay for Sovaldi pills. In order to avoid patent invalidation in second-world countries like India, Gilead has agreed to only charge Indians $10 per pill. I suspect this will catch on elsewhere, as well as lower prices of the $1,000 pill in the United States at some point in the next two or three years.

And secondly, pharmaceutical earnings don’t go straight up—they are like oil in that there is an element of cyclicality to the business (even though handsome profits are still made at the bottom of the business cycle). Look at GlaxoSmithKline’s profits going from $3.38 in 2009 to $0.99 in 2010. Look at Eli Lilly’s profits going from $4.15 last year to $2.75-$2.85 this year. No pharma company is immune from the effects of an ebbing and flowing pipeline, and my concern with Gilead is that the company moves from strength to strength due to the surging success of one primary drug.

It makes me wonder whether we are seeing Pfizer with Lipitor all over again. Pfizer has never come close to hitting its high of $2.20 per share in profits that it realized in 2007 because the recession hit and then Lipitor went generic in 2011, and here in 2014, Pfizer is making $1.70 per share in profits (still below its 2007 highs). With Gilead, it is now generating $24 billion in annual revenue. Over $10 billion of that is from Sovaldi alone. And Sovaldi is expected to take up a higher share of Gilead’s profits in the coming years—the stock should be renamed “Sovaldi” to give a more accurate presentation of what the company is.

I would not want to bet against either Visa or Glead. If you own either, be happy that they are in your portfolio because it is likely they will deliver double-digit growth well into the future. But if you’ve yet to buy any shares, I would be patient. Right now, each of these companies are doing everything right. Their business performances and trajectories couldn’t look rosier, and that is priced into the stock of both companies. If the rosy projections come to fruition, you will do well. But the current share price does not allow for satisfactory returns in the event that future growth comes in a bit less than expected. You could have a situation where 7-8% growth of the businesses translates into no gains for you due to P/E compression. Waiting for a better entry point seems the wisest course of action—heck, it was this very year you could buy Visa at 21.5x profits. I’d imagine you’d get your price sometime in the next few years if you’re patient—good things come to those who wait and all that.

The past decade has been a godsend for income investors that have owned McDonald’s stock because the profits have grown by 14.5% annually and the dividend has grown by 25.5% annually. Those $0.55 annual dividends in 2004 became $3.40 dividends in 2014. You were to able capture two things that were happening simultaneously over the past ten years while you held McDonald’s stock: (1) profits continued to grow, and (2) the payout ratio continued to grow as McDonald’s went from paying 28% of its profits as dividends to paying out 58% of its profits as dividends.

Such opportunities are hard to find ahead of time, but they can be lucrative additions to your portfolio when you find them because it’s great being along for the ride of a company that is raising its dividend by 10%, 15%, or 20% in a year. Do I have a candidate for consideration of a company that may be similar to McDonald’s in the next fifteen years, in terms of raisings its earnings and payout ratio simultaneously? Yes, I do, and it is Ross Stores.

Ross Stores is an off-price retailer that operates in 33 states—it still has quite a bit of room for American expansion before its growth story is over. They aim to sell designer apparel, footwear, and accessories at discount rates of 20-60% below what you would find at a specialty store.

The economics of the business are beautiful to study: Over the past ten years, Ross Stores has grown sales by 14.5% annually, cash flow by 18.0% annually, earnings by 18.5% annually, dividends by 26.0% annually, and book value by 14.5% annually. The P/E ratio is at 19x earnings, which is slightly distorted because Ross Stores has 58 new stores in existence that are pumping out profits (the company has about 1,100 stores in total) that did not exist at the start of this examination period, and the company is rolling at 28 new stores before the end of the year. It’s only a $17 billion company, and it still has 17 states in which to establish a presence.

When I examine the company’s business results, I like seeing that the company has held its margins steady—in fact, they have grown from 7% to 8% over the past five years, and I find that fact encouraging. Sometimes, when a business rolls out into new areas or establishes new locations in a state, the concern is that there is a reason why certain markets were slow to get established or might potentially saturate a market if you’re adding to existing locations, and this has not proven to be the case when you look at Ross’s numbers.

Other than Visa and BP, Ross Stores has been the stock that has been quietly though quickly winning my affections because the formula for future growth seems very clear. The company has an immaculate balance sheet—it’s a $17 billion company with only $150 million in debt. Sales are growing in the 8-11% annual range as the company continues to roll out new stores, and so far, sales have been growing 2-3% annually at existing locations.

The company is buying back massive amounts of stock—it had 377 million shares outstanding in 1998, and now only has 209 million shares outstanding. It has eliminated 44% of its outstanding shares over the past sixteen years. That is very impressive for a mid-cap company that is still in its growth stages. A lot of times, companies that are growing quickly issue capital raises so they can fund new rollouts, and the growth of the business is tempered by share dilution. Ross Stores has been able to fund its growth internally—not only does it have minimal debt, but it’s balancing its store rollouts by earmarking consistent funds for share repurchases. And they actually retired 30 million shares during the course of the financial crisis, so they earn points in my book for actually buying back stock at an opportune time when many other companies refused to do so. Heck, Ross Stores grew its profits per share from $1.17 to $1.77 during the 2008-2009 stretch and raised its annual payout from $0.20 to $0.25. It held up well during our recent bout of troubled times.

Here is what I find especially interesting though from an income standpoint—even though dividends have been growing at 26% annually over the past 10 years in comparison to 18.5% annual earnings growth, the dividend payout ratio is still only 24% (it was at 14% around 2004). I anticipate that, over the long-term, Ross Stores will pay out between 50% and 60% of its profits as dividends, in line with other retailers.

I understand why people don’t pay attention to it. It’s not as big as Wal-Mart and established as Wal-Mart, although it does do $10 billion in annual sales and has initiated a policy of raising its dividend annually (starting in 1999) and actually managed to grow profits significantly during the financial crisis. The balance sheet is extremely conservatively financed with only $150 million in debt compared to $885 million in annual profit (in other words, it could wipe out all of its outstanding debt with the amount of profit it generates over the course of two months). The store count is growing, and there is much growth left in the United States alone, to fuel 8-11% core organic growth. The company is also buying back 3% or so of its stock annually, bolstering earnings per share even more. The dividend payout ratio is only about a quarter of overall profits. The starting dividend yield is 1%, and that is automatically a turnoff for a lot of investors. I get that. I especially understand why retirees wouldn’t consider this company. But if you are looking for substantial capital gains, and a high growth rate of the dividend, I put Ross Stores on that same pedestal next to Disney, Becton Dickinson, and Visa as those very fast-growing dividend stocks.

Warren Buffett’s largest stock holdings at Berkshire Hathaway might change more often than you think they do. If you pull up an annual report of Berkshire from 2005, you will see the largest stock investments listed as follows: American Express, Ameriprise Financial, Anheuser-Busch, Coca-Cola, M&T Bank Corporation, Moody’s, Petrochina “H Shares”, Procter & Gamble, Wal-Mart, The Washington Post Company, Wells Fargo & Company, and White Mountain Insurance.

By the time 2013 came around, the reported list of stock holdings contained some familiar faces, but some changes as well: American Express, Coca-Cola, DirecTV, Exxon-Mobil, Goldman Sachs, IBM, Moody’s, Munich Re, Phillips 66, Procter & Gamble, Sanofi, Tesco, U.S. Bancorp, Wal-Mart, and Wells Fargo & Company. I put in bold the names that remained consistent between the 2005 and 2013 list.

What I find worth noting today is the extent to which Buffett has consistently, and quietly, been discarding of the company’s stake in the legendary household product company Procter & Gamble. In fact, Warren Buffett never really bought shares of Procter & Gamble in the first place—he invested in Gillette in 1989, and endorsed its merger into the Procter & Gamble conglomerate in 2005, at which point his Gillette ownership position transitioned into 100,000,000 shares of Procter & Gamble. From 2005 through 2014, Buffett methodically reduced Berkshire’s P&G stake each year, taking it down to 52.4 million shares as of this calendar year.

Then, he announced this past week that he is trading the remaining 52.4 million shares of Procter & Gamble from Berkshire’s portfolio of investments in exchange for ownership over Duracell batteries plus the $1.8 billion in cash that had been on Duracell’s balance sheet. This is nothing short of brilliant tax magic on Buffett’s part—by making a P&G stock for Duracell + cash swap, he is able to avoid paying north of $900 million in taxes to the U.S. government on the transaction (you have to remember that these shares of P&G on Berkshire’s balance sheet had been accumulating for a long time).

This partially explains why Berkshire is such a superior compounder over time—not only are the individual investments and operating companies wisely chosen, but the transactions and nature of the changes to Berkshire’s holdings over time have always been done in a way that keeps the tax payouts to an absolute minimum (this is also an important reason why I favor buy-and-hold forever investing on this site because it lets you go through life without 15% or more capital gains haircuts on your invested capital).

Of course, some of you who own Procter & Gamble may be wondering whether you should contemplate selling the stock. After all, Buffett doesn’t want the stock. The profits have been increasing in the mid-single digits lately. And it is likely that the stock is 15-20% overvalued, and the current P/E valuation of nearly 25x profits will work its way towards 20x profits over the long term. While the latter might be a good reason to abstain from adding shares of Procter & Gamble at this point in time, it does not seem wise to sell.

A few things to keep in mind:

Just because Warren Buffett sells a blue-chip business does not mean that the company has ceased being excellent. Buffett sold out of Disney in the 1960s, and the stock compounded at 13% annually in the five decades since then. For a more recent example, he sold McDonald’s over a decade ago, and the stock went on to compound at almost 11% annually after the point at which he made his sale. He often deals in excellent companies, and they don’t cease to be excellent companies when he relinquishes his ownership position. Heck, he sold Johnson & Johnson a few years ago in the $60s, and the business results have been excellent since then, taking the stock into the $100s.

And secondly, you need to beware of recency bias when you extrapolate recent bad news and project it indefinitely into the future. For much of the 2010s, investors were ragging on Pepsi became it was having trouble growing profits. Now, earnings per share growth is back on track as last year’s profits of $4.37 are expected to give way to $5 in profits next year. Shareholders got a nice 15% dividend hike as a catch-up from the previous year’s hike of only 5%. Procter & Gamble is in a similar position, where the 3.0% earnings per share growth of the past five years can quickly give way to 7-8% earnings per share growth in a hurry as sales of its main divisions are growing at 5% which usually translates into 8-9% earnings per share growth while P&G is in the process if selling off its slower growing divisions. The company also has $10 billion in cash on its balance sheet (about 2.5x the usual amount) and it may make an acquisition in the not-too-distant future.

P&G has been raising its dividend for 50+ years. It hasn’t missed a dividend payout since going public in the 1890s. It increased its dividend during parts of WWII, for heaven’s sake. In bad years, the dividend payout still increases at a rate twice inflation, and in good years, the payout increases around triple the inflation rate. These are the kind of assets you want to hold for a lifetime. Even the company works through the inevitable periods of slow growth, you get paid a growing amount each year while you wait. It’s a nice stock to have in the background, incessantly compounding, while you locate your fresh cash towards more attractively valued and faster growing opportunities.

Yum Brands. Diageo. Nestle. Wal-Mart. Coca-Cola. If you ever develop the urge to invest in Africa, look to buy stock in those five companies which are currently investing throughout the continent to mixed results, although Nestle is once again proving that it has the business model to make money anywhere.

I was reading through the T. Rowe Price Africa & Middle East Fund (ticker symbol TRAMX), and I was reminded of the statistic that there has never been an African-focused fund open to American retail investors that has beaten the S&P 500 because it is extraordinarily difficult to successfully predict African firms that would serve as suitable long-term investments.

Since its inception in 2007, the T Rowe Price Africa & Middle East Fund has returned only 3.16% per year. And to make matters worse, you got charged a 1.47% expense ratio while you achieved those returns.

What does that mean with someone who had $10,000 in September 2007 and decided to buy T. Rowe Price’s Africa & Middle East Fund on opening day? On a pre-fee basis, the investment performance would have only grown the investment to $12,433. But you would have had to pay $1,115 in fees to get that, so your returns would be $11,318. And if that investment was in a taxable account well, you wouldn’t even be able to walk away with all of that $1,318 after 7-8 years.

This isn’t to make fun of T. Rowe Price but rather to demonstrate that investing specifically in Africa is hard. Having broad notions such as “it’s easier for an African country to double its GDP than the United States to double its GDP” won’t do it—in this case, you need the specific companies like Emaar Properties, Samba Financial, Jarir Marketing, and Naspar to do well in order to profit. That’s tricky, to say the least.

Meanwhile, investing in large multinationals that have operations in Africa and the Middle East seems like a safer bet that, in this case, also tends to deliver superior returns.

What if, instead of buying T. Rowe Price’s Africa & Middle East Fund in September 2007 when it opened up shop, you instead invested in large companies that have African and Middle Eastern operations?

If you bought Yum Brands, you would have achieved 13.83% annual returns. Diageo? 8.51% annual returns. Nestle would have given you 11.61% annual returns. Wal-Mart would have given you 10.41% annual returns. And Coca-Cola would have given you 8.66% annual returns. Each large multinational working in Africa would have done significantly better, and plus, there’s no 1.47% fee eating at your returns. You pay your $8 in one-time brokerage fees to buy the stock, and then the only cost you have to pay after that would be dividend taxes if held in a non-retirement or charity account.

Some diversification away from American, British, and Swiss multinationals can make sense. Buying an international total world stock index fund or international small cap index, or even a U.S. small-cap index can provide intelligent diversification without turning it into an exercise in diworsification.

But when you feel the need to own an Africa & Middle East Fund outright in the name of diversification, you’ve probably crossed over into “too niche” territory. It’s hard picking winners, and the fees are usually so large that you don’t have much of a hedge if the pick doesn’t work out.

Meanwhile, assume that Coca-Cola had trouble growing in South Africa, Nigeria, Egypt, and/or Qatar. Fine, you lose a bit or don’t get to explore that avenue of growth, but shareholders of the parent company are still going to get their 8% earnings per share and dividend growth. And if it does work, great, your profits are higher than what you’d otherwise get. In other words, the consequences of failure or negligible to owners. The consequences of failure are not negligible to Africa & Middle East fund-holders, as you only see your money compound at 3% and you have to deal with paying out almost half your returns in fees.

This isn’t meant as a criticism of T. Rowe Price. Some of their funds, historically the Capital Appreciation and New Horizons Fund, have been excellent long-term holds that helped build the firm’s reputation. Instead, it’s a criticism of deliberately allocating a percentage of your portfolio to Africa & Middle East Funds. It can’t be done in a low cost way, and the ways that cost money haven’t proven superior performance to just owning the plain-old multinational firms that we usually discuss. Why overcomplicate things?

View the T. Rowe Price Africa & Middle East Fund (TRAMX) here.

Colgate-Palmolive is probably one of my favorite businesses—if someone said I had to make a decision today to only own eight stocks for the rest of my life, and the list could never be changed, it would occupy one of the eight slots (with Nestle, Coca-Cola, PepsiCo, General Electric, Johnson & Johnson, Procter & Gamble, and ExxonMobil occupying the others).

You’re already familiar with its product line—Colgate toothpaste, Hill’s petfood, Irish Spring soap—and the fact that the company has been growing dividends for 50+ years (and, like Procter & Gamble, has been paying dividends in uninterrupted quarters dating back to the 1890s). Not only is it a blue-chip with a long history, but its recent growth has been good as well: In the past ten years, revenues have grown by 7.5% annually and dividends have grown by 12.5% annually. That means the company has meaningful top-line growth, and not only do you get the safety inherent in a durable business model with a very long track record, but you are receiving growth in your income at a substantial rate as well.

I would have a few concerns about buying the stock right now:

The company has covered up slow foreign market growth in recent years by giving shareholders dividend raises above actual growth in profits. Throughout the 1990s and until 2003, Colgate was paying out 30-40% of its profits in the form of a dividend. The payout ratio has increased in recent years, as Colgate experienced a year decline in 2013 as profits dipped to $2.38 from $2.58 in 2012 (and should come in around $2.60 this year). This drop was due to negative currency translations, which is generally irrelevant background noise over the long-term, but also lower than-expected revenue growth (Colgate only grew its revenue from $17 billion in 2012 to $17.4 billion in 2013, and it’s expected to be somewhere around $17.6 billion this year).

Because of this slow near-term growth, the $0.36 quarterly dividend amounts to $1.44/$2.60=55% of the company’s profits. The dividend constituted a higher percentage of Colgate’s profits during 2013 and 2014 than at any point in the past twenty years. The company has covered up some of the stagnating growth by taking on debt to retire 10% of the company’s outstanding stock since 2008.

Are these near-term problems that should dissipate in the coming years? Absolutely. The company has indicated that it plans to grow revenues by 7% in Asia and Latin America, and 2% in the United States and other developed markets over the coming five years. That can doably translate into 8.5% or so earnings per share growth, and if the company continues with its buyback program, it can achieve long-term growth in the 9-11% range.

My concern about buying here has to do with valuation. Just check out Colgate’s typical P/E ratio over the past ten years: 21.8x earnings in 2004, 19.7x earnings in 2005, 20.6x earnings in 2006, 20.5x earnings in 2007, 19.8x earnings in 2008, 16.1x earnings in 2009, 18.6x earnings in 2010, 17.3x earnings in 2011, and 19.6x earnings in 2012. Last year, people were willing to pay 25x earnings for Colgate. Now, with a stock price of $67 per share and $2.60 in earnings, the stock is trading at 25.7x earnings.

This is loosely analogous to what happened to the stocks trading in the 1990s, when the company traded at a little over 30x earnings. If you bought the stock in the summer of 1999, you paid 31x profits for it. You received 8.5% annual returns since then, which is nice in an absolute sense given the quality of the company, but it is also frustrating knowing that Colgate grew profits per share by 12.5% from 1999 through 2014, and shareholders had to suffer impaired returns because of their starting valuation (and considering it is my contention that the stock is overpriced right now, the long-term returns would be even worse than that 8.5% annually if company were fairly priced right now).

Is 25x profits as bad as 30x profits in 1999? No, it’s not. But it is enough overvaluation that someone buying now will probably see their total returns lag the growth of the business by 2.5 percentage points or so. If the business grows at 10%, you’ll get 7.5% returns. If it grows at 7%, you’ll get 4.5% returns. You need things to go quite well to earn above average returns, and if the company encounters any pro-longed setback, as occasionally happens to great companies (see Coca-Cola’s troubles to grow revenue right now for a reference point on that) then you will be disappointed by your long-term returns as you would simultaneously have to deal with lower earnings growth and a compressing P/E ratio at the same time.

If someone were dollar-cost-averaging a small amount into Colgate among a bunch of other companies, it probably wouldn’t be a big deal to your overall strategy—the point of dollar-cost averaging is that you buy through the highs, fair pricing, and the lows to eventually receive returns that mirror the growth of the business. But if you are making a one-time lump sum investment, and you have any kind of bent towards value investing, then now is not the season to buy the stock, as its dividend payout ratio is about fifteen percentage points higher than historically, and the valuation these past two years is the highest since 2001.

If you want to be a good growth-at-a-reasonable price investor, then you should insist on a price below 21x earnings, or the $54-$55 range. If you want to take value investing seriously, and apply it to even the best-of-breed companies, then I would look for a price below 17x earnings, or $44 per share (you would have been able to do this for good chunks of 2008 and 2009, and briefly in 2010 and 2011, but it generally requires significant patience to get a price where Colgate is actually cheap). It’s a wonderful long-term hold in the portfolio—how many places in the world can reliably give you 8-11% annual dividend increases for the next twenty years?—but this isn’t the right season to start a large position.

In 2002, Otter Tail made $1.79 per share in profits on behalf of its owners. For those of you unfamiliar with the company, it is a small, $1 billion-sized northern electric company with 2,300 employees. It has 130,000 costumers, and provides power to half of Minnesota and a little less than half of North Dakota. It has a small footprint in South Dakota as well. The earnings don’t grow all that much, as the company spends about 13% of its revenues on fuel costs alone. Plus, it has an extensive dividend commitment that prevents the company from retaining profits and growing significantly over the long term.

In fact, profits haven’t grown at all since 2002, as it only makes $1.75 per share in profits over the course of 2014. From a growth in business perspective, it has treaded water these past twelve years—in fact, it’s actually making a little bit less in profit now than it used to in 2002. The dividend rarely grows; however, it doesn’t decline. In 2002, the dividend payout was $1.06 per share. Now, it’s $1.21 per share. From 2008 through 2013, the dividend was frozen at $1.19 before finally going up to $0.3025 quarterly in 2014. The profits didn’t even cover the dividend in 2008, 2009, 2010, 2011, and 2012, as the company had to borrow funds in order to avoid a dividend cut. This year has finally been a breakout year, and with profits at $1.75, the payout ratio is now at a more comfortable 69% of profits (it’s been in the 60%, 70%, 80%, and over 100% range throughout the past twelve years).

It’s not a company I talk about often because the profits don’t grow, and the dividend hardly ever grows. If you had to make a list of only 25 to 30 stocks, and the condition was that you had to hold the company and hitch your personal fortunes to that of the wagon of the companies you select, it is highly unlikely that Otter Tail would make money people’s lists (though perhaps some folks in the Dakotas and Minnesota, all too aware of their monthly payment, would differ).

And yet, it wouldn’t be some terrible hardship to have to hold this stock. For someone who held the stock for the past twenty years, your money would have compounded at 5.7% annually, almost three percentage points below the wealth you would create by purchasing an S&P 500 Index Fund and collecting you 8.6% annual returns over that time frame. If you did reinvest the dividends, your yield-on-cost improved dramatically, as you were receiving a significant (though static) chunk of income that was able to compound upon itself on eighty different occasions from 2004 through 2014. This boosted your compounding rate to 7.6% annually.

What I find so interesting is the growth in annual income that would have happened, even though the dividend payment didn’t really grow all that much (Otter Tail paid out $0.88 in 1994, and pays out $1.21 today). The reinvested dividends almost tripled your share count—a $10,000 investment would have increased 600 shares of Otter Tail to 1,472 shares of Otter Tail. That catches my interest that a company with a negligibly growing dividend could increase your annual income from $528 in 1994 to $1,781 in 2014. A low dividend growth rate, and the power of reinvesting a high dividend payout, gave you 237% total income growth over the past twenty years. No TV networks will talk about this, the stock is only trading $3 above its 2002 highs right now—and no analyst will recommend it because the company has trouble demonstrating sustainable long-term earnings power (though Bill Gates’ private investment vehicle, Cascade Investments LLC, has been a shareholder). And yet, despite this complete lack of fanciness, the company has been able to deliver returns within one percentage point of the S&P 500 (without dividends reinvested) if you had taken the Otter Tail dividends and reinvested them along the way. If you make an apples-to-apples comparison and reinvested the S&P 500 dividends as well, the gap becomes two percentage points.

To me, that’s crazy—I wouldn’t have intuitively guessed that a very moderate low growth business could come close to keeping pace with the S&P 500 through the sheer power of a high value of dividend reinvestment.

The take-home message from this article isn’t that you’re supposed to go out and buy Otter Tail. Rather, the lesson is two-pronged. On one hand, those high-yielders with limited growth like AT&T and GlaxoSmithKline deserve your respect and attention, because the accumulation of reinvested dividends over time will become significant. And secondly, it’s a reminder not to freak-out when a company you own doesn’t “beat” analyst expectations on Wall Street. A lot of times, people get upset and panic sell McDonald’s, BP, or IBM simply because a quarterly report didn’t meet expectations. These businesses are actually growing profits, just not a rate that pleases Wall Street. They’re not going anywhere; they’re just growing a little bit slower than some might hope. Avoid the inducement to sell low. Even if the low growth hangs around for a while, you can still receive adequate positive returns. And, more likely, when the growth per share resumes, you’ll receive a commensurate (justified) price hike as well that will make you glad you didn’t knee-jerk upon encountering bumps in the path.

The best argument in favor of the reinvestment of dividends—particularly pertaining to companies that you know will be bigger and stronger ten years from now—is that your money immediately is put to productive use. If you choose to pool dividends together for a separate investment at a later date while sitting on cash, you miss out on the dividends (and price appreciation, if any) that occur before you get a chance to put your cash to use.

The classic Benjamin Graham quote on this topic is this:

“It is far from certain that the typical investor should regularly hold off buying until low market levels appear, because this may involve a long wait, very likely the loss of income, and the possible missing of investment opportunities. On the whole it may be better for the investor to do his stock buying whenever he has money to put in stocks, except when the general market level is much higher than can be justified by well-established standards of value.”

I was looking at Emerson Electric’s history as an investment when I had this in mind. Emerson Electric is essentially a smaller General Electric without the financial operations, and has been raising its dividend every year dating back to the 1950s. Over the past twenty years, the dividend has grown by an average rate of slightly above 8%. If you were collecting $0.11 per share annually in 1995, you’d be collecting $1.72 in 2014.

Someone who bought $25,000 worth of the stock two decades ago would have collected $29,700 in dividends and seen appreciation in the price of the stock of $104,000. In other words, you’d be sitting on $133,700 today, with $104,000 of it in Emerson Electric stock and $29,700 sitting there as a cash balance.

Had those dividends been automatically reinvested, your share count would have grown from putting those $29,700 in dividends to work. You would have ended up collecting $40,400 in dividends over the period due to putting your money in additional Emerson Electric shares, and because they have a market value of their own as well as generating more dividend income, you’d be looking at $122,000 worth of capital appreciation on your investment.

In exchange for dutifully reinvesting your dividends for two decades, you’d reach a point where your investment would be achieving a 17.1% yield-on-cost, producing $4,275 in annual income on your $25,000 despite collecting a little less than $800 in the initial year.

The reinvestment of dividends, in this case, added $10,700 in total dividend income that went your way because of your decision to reinvestment, and because those got plowed into new shares, you also saw $18,000 in additional wealth get created because the new shares purchased with reinvested dividends have a market capitalization of their own as well.

It should be mentioned, of course, that you wouldn’t let $29,700 in cash build up from your Emerson Electric dividend payouts over the past two decades. You wouldn’t just sit there with $800 in dividend income from 1994/1995 dividends and never touch again for two decades, so if you wanted to properly calculate the opportunity cost, you’d have to compare the results of your Emerson Electric reinvestment against any other investment you would have made with your Emerson Electric dividend income, and that’s the hypothetical question that would vary by investor.

Instead, knowledge of the power of reinvested dividends adds some insurance to the investing experience because they are never usually addressed in the total return figures you see reported with most companies—the current standard practice of reporting historical returns is to combine the capital appreciation with the dividends generated from a stock. So, if a $5 stock paid out $2.50 in total dividends and the price rose to $7.50 over a specific period, you would hear that the total returns were 100%. However, if you put those $2.50 back into more shares, the reality of your situation will actually be better than that 100%.

Someone who bought McDonald’s stock and collected the dividends as cash to spend over the past two decades would have achieved 11.2% annual returns, which is very nice. But if those dividends got reinvested into more shares, the total returns would have been 12.1%. A full percentage point adds up to a lot over two decades. It’s the difference between turning $100,000 into $794,000 or $937,000.

For someone who owned $10,000 worth of Chevron and collected the dividends as cash to spend, the total returns would have been somewhere around 10.8%, becoming just under $75,000. The reinvestment button would have made it $107,000 (the substantial difference is due to the fact that Chevron tends to offer both a reasonably high starting yield so the amount of income getting plowed into new shares is high, and it is also has a high growth rate such that the reinvested shares bought in the early years have an outsized effect on growth). Learning about the effects of dividend reinvestment with oil stocks is probably one of the best Aces a long-term, buy-and-hold investor can have up his sleeves.

Even though the results of reinvestment can be quite nice for a portfolio’s end result, the conclusion shouldn’t necessarily be that you must reinvest your dividends in all cases. The purpose of money is to delay gratification so that you can live a better life later, and there does come a point at which you say, “I need to reap some benefits.” Instead, I provide reinvestment information so you can make a better decision about how to allocate capital, and realize that you get some insurance returns that add a percentage point or two to the results you actually experience compared to the figures that get reported.

I don’t think people realize how difficult it is to deliver annual returns in the 10% range once you reach a certain size. In the case of Wal-Mart, it is almost incomprehensible how huge this company is. In terms of revenue, it generates about $487 billion per year. They sell about $1.3 billion worth of goods every single day. It wouldn’t surprise me if, within the next fifteen years, Wal-Mart comes closing to moving $1 trillion worth of merchandise in a given year. In terms of profits, Wal-Mart makes about $16 billion in a year. That’s a little bit less than in 2012 when Wal-Mart made just shy of $17 billion per year.

It doesn’t get a lot of attention these days, because its yield is 2.31%, its natural earnings per share growth rate has been somewhat low in the past few years, and the P/E ratio in the 17-18x earnings range likely means that the stock is trading at a price towards the high end of what you’d consider fair.

Yet, I continue to admire Wal-Mart’s stewardship of shareholder capital. It has delivered 6% annual returns over the past ten years, which I find commendable under the circumstances: In 2004, Wal-Mart was trading at 23x profits, as investor expectations for the stock had gotten higher than justified (based on current known factors, I consider Wal-Mart’s fair value to be between 14 and 18x profits. If it gets cheaper than 14x earnings, you’re buying the stock on sale. Once you hit 19x earnings or so, you start to approach the territory where your total returns lag the earnings per share growth of the business.

In terms of business performance, Wal-Mart’s management team has turned in an excellent decade. They’ve grown profits per share by 10.5%. That’s all you have a right to expect with a company of that size. The management did their job. As investors, if we bought in 2004, we overpaid. No, it’s not some terrible hardship—you still increased your purchasing power at a rate that is double inflation, so it’s nothing to lament. However, if you are constantly seeking to improve your investing skills, then it is important to recognize that large, mega-cap retailers shouldn’t be bought when the starting earnings yield is below 5%.

If you want to approach a Wal-Mart with a value investing mindset, than you insist on a price below 14x earnings, or $67 per share. You could have gotten that kind of valuation at some point in the calendar years 2007, 2009, 2010, 2011, and 2012. If you want to be a growth-at-a-reasonable-price investor in which you just want total returns that mirror the growth of Wal-Mart the business but do not demand the accelerator of P/E expansion as well, then you should consider purchasing shares anytime the price of the stock is in the $67 to $84 range. As your price rises above that, it becomes increasingly likely that your long-term returns will lag the growth of the business (as was the experience of those Wal-Mart owners that established their position in 2004).

What I find commendable about Wal-Mart’s management team is that they have not “reached for” profits by raising prices to pad the bottom line during a period of slower store rollouts. It could be very tempting to try and raise the profit margins to something like 5% so that they could report higher short-term profits, but it would be at the expense of ceding market share to Amazon, Target, and a few others as Wal-Mart would be diminishing its competitive advantage which is low industry prices.

When I study Wal-Mart, I am reminded of Warren Buffett’s thoughts on GEICO from when he sent a letter to George Young at National Indemnity back in 1976. Buffett wrote at the time, “I have always been attracted to the low-cost operator in any business and, when you can find a combination of (1) an extremely large business, (2) a more or less homogenous product, and (3) a very large gap in operating costs between the low cost operator and all of the other companies in the industry, you have a really attractive investment situation. That situation prevailed twenty-five years ago when I first became interested in the company, and it still prevails.”

Wal-Mart makes a profit of 3.5% on all its goods; ten years ago, the figure was 3.6%. Wal-Mart management has refused to reach for extra profit by raising its profit margins, and in the process, surrendering its low-cost advantage of its peers. I find this strategy praiseworthy, as it keeps long-term competitive advantages in mind when making short-term decisions.

The stock has been relatively cheap since 2006. Wal-Mart has been using its free cash flow (the dividend typically consumes only 25-33% of cash flow, compared to Target which is currently dedicating 60% of cash flow to the dividend) to repurchase very large amounts of stock. In 2006, Wal-Mart had 4.1 billion shares outstanding. That has been reduced to 3.2 billion in 2014, for a reduction in shares outstanding of 22%.

The reason why Wal-Mart trades at the high end of a fair price now (while a lot of other blue-chips are 15% or 25% overvalued) is because analysts had been concerned by Wal-Mart’s decision to slow down store rollouts as it determines whether it wants to expand primarily through new supercenters or the smaller, more focused neighborhood stores that have become more popular (just look at the explosion in the profits at the dollar stores to see what I mean). I find this concern more than more trivial but manageable: Wal-Mart is still going to expand its 11,000 store count by 600 in the next year, and it’s going to be retiring 90 million shares of stock in the next year as it has more cash flow available from slowed down store expansion.

Wal-Mart seems on pace to be making around $7.50 per share in profits five years from now. If you figure the stock will be valued around 16x profits at that time, we are looking at a fair price of around $120 per share. You also get a 2.3% dividend yield that should grow somewhere around 8% annually over that time frame. My conclusion is that the stock is at the high end of what you’d want to pay, and it’s probably worth being patient, but you probably will receive satisfactory high single-digit total returns if you buy at this current valuation.

If you are a close follower of IBM’s stock, you know what has been the general story for the company over the past several years: IBM has been having trouble transitioning to the cloud and growing revenues because operations are so immense, but because the dividend only accounts for a little more than a fifth of profits, IBM is able to retire significant blocks of stock and increase earnings per share due to buybacks with only a soft reliance on what we would consider old-fashioned growth, at this point in time.

Because IBM is getting 9% annual growth due to lowering costs and buying back stock rather than increasing revenues at the top line, a lot of analysts have been poking fun at the stock and touting it as a bad investment.

What I find bemusing is that, over this time period, Warren Buffett has nicely benefitting from his ownership stake in IBM, despite the concerns expressed about the company in the press.

He purchased 63.9 million shares of IBM in time for his letter to shareholders in 2011, and although he increased the position to 68.1 million shares by the time of the most recent report, we will take a look at what those 63.9 million shares are doing for Buffett and Berkshire Hathaway shareholders.

In 2011, IBM was paying out $0.75 per share in dividends, which worked out to $3.00 over a twelve-month period (IBM actually has the habit of raising its dividend in May).

Those 63.9 million shares were generating $191 million in immediate dividends for Buffett to take and deploy elsewhere.

By 2012, those dividends had become $0.85 quarterly, or an annual rate of $3.40. At this point, $217 million was getting sent Buffett’s way.

Last year, IBM raised its dividend to $0.95 per share ($3.80 annually). That gave Buffett $242 million in dividends to make new investments for Berkshire.

And now, that quarterly dividend has grown to $1.10 per share, or $4.40 annually. Now, he’s collecting $281 million over the current twelve-month stretch that we find ourselves in.

Obviously, Buffett’s working with a whole lot more capital than the rest of us, but the general principles hold: The amount of money that Buffett is receiving from IBM has increased 47% since he made his initial investment in 2011. That’s what makes the fundamental performance of the business at such a disconnect from the headline risk—it’s what you saw happen to McDonald’s in the early 2000s and Johnson & Johnson in the late 2000s—the stock fell out of favor with investors while growing profits and raising the dividend significantly.

For someone not concerned with the share price and just checking in each year to make sure that the profit figures are doing all right while also collecting his dividend checks to spend, the ride has been great. How many areas of life can you achieve 47% growth in income over four years without doing anything? You could have mailed in a check for some IBM shares, completely gone through life while ignoring it and paying the taxes if not held in a retirement account, and the raises kept coming. That’s what makes this stuff fun.

It is also highlights the role that stocks like Disney, Visa, Becton Dickinson, and here, IBM, play in a portfolio. A lot of times, income investors ignore these kinds of companies because the starting dividend yield is too low. That’s understandable, but look at what lies ahead if you have the patience to wait for a couple years of dividend increases to show up.

Just between 2011 and 2014, IBM increased its payout from $3 to $4.40 while having a tough business environment. If you bought 100 shares at $150 each, you would have collecting $300 initially for a 2% yield on your invested amount. Now, you’d be collecting $440 for a 2.93% annual return on your money (you’d be across the 3% threshold if you’d been reinvesting back into additional IBM shares). In a few years, the IBM yield-on-cost will start to shift from the paltry to the respectable, and you get something for waiting for that income to rise: a nice capital gain in the form of higher share prices that will sit on their on your household’s balance sheet.

It seems the best way to handle low starting dividend yields from particular investments is to pair a low-yielder with a high-yielder. Make a Visa and BP investment simultaneously, or buy shares of GlaxoSmithKline and IBM together. That way, they give you a blended yield that works. A stock like BP gives you more immediate income than you’d otherwise expect, and a stock like Visa would provide a higher growth rate than you’d otherwise expect. It makes for a nice balanced attack. Ying. Yang.

Lately, I’ve been studying the opportunities that showed up during the 2008-2009 financial crisis to get clues about what would be the most intelligent behavior during the next time the once-in-a-generation financial crisis arrives.

Although it seems very counterintuitive, the long-term wealth maximization decision is not necessarily buying the high-quality blue chips that I frequently discuss here: Yes, they get cheap and provide a platform for 12-15% annual returns even when you are dealing with high-caliber businesses that will only be growing at 10% because you were able to lock in prices at such a cheap rate. Perhaps if you invest $40,000 over the course of a recession, blue-chips should occupy $30,000 of that investable capital.

What interests me is this: buying energy MLPs during times of crisis. I’m studying the energy MLPs that traded at over $5 billion in valuation before the crisis, and I can only find two that failed catastrophically. All the others survived and prospered substantially.

I’ll use Vanguard Natural Resources to serve as a representative example of what could have happened if you created ten $1,000 slots for energy MLP investments. Assume two go completely go completely bankrupt. The other eight go into a collection of energy MLPs that survive and prosper a la Vanguard Natural resources.

Here’s what it would have looked like: the $8,000 used to buy shares of Vanguard Natural Resources would have netted you 1,600 shares at $5 each. The company was in the midst of exhibiting its financial health, raising the quarterly payout from $0.445 to $0.50 per share. That’s about as much of clear signal as you can ask for, if you remember what 2008 was like.

The amount of distribution income those 1,600 shares of Vanguard Natural Resources would have generated is obscene. Even if you lived off every distribution provided since then, you’d still be in the interesting situation today of having 1,600 shares of VNR pump out $0.21 per share (errr, unit) monthly. That’s $336 per month, giving you a yield of 50.4% on the amount invested, or 40.3% on your total amount of invested capital when you include the two that went kablooey.

If you reinvested throughout the financial crisis—crazy things would have happened as you had very high distribution payouts mixing together with a very depressed valuation. Distributions reinvested from 2009 through 2014 would have you sitting on 2,607 shares paying out $0.21 each month, giving you $547 each month, or $6,564. It’s another year or three of reinvestments mixed with distribution growth away from crossing the hallowed “I am collecting more in cash from this investment than I put in” ground.

Speculation is at its most lucrative during times of financial crisis because blue-chip stocks get beaten by 20% or 35% while the third-tier and fourth-tier quality companies get beaten down 75-80%. Therein lies an opportunity if you are the kind of person who can survey the wreckage and think, “I’m going to place a small collection of diversified bets on this very high income sector, and we’ll see what’s standing in five years. Meanwhile, I’ll reinvest the dividends.”

Most of this post is just me thinking out loud—there’s a lot to be said about doing something like buying $10,000 worth of Coca-Cola at the split-adjusted price of $22 per share. That would have got you 441 shares then, which, if you’d been reinvesting dividends, would have grown to 515 shares now. You’d be receiving $628 in dividends from the highest-quality company in the world (although I’m open to arguments it’s tied with Nestle and Johnson & Johnson), giving you a 6.28% yield-on-cost just six years later. You won’t have to do any more thinking or maneuvering—you would just sit back and watch it grow.

I’m not done studying the financial crisis yet, and I’m sure I’ll update with more posts, but my current inclination is to think something along the lines of this: “The best approach for an income investor during a severe economic crisis is to allocate 75% of investable capital to very high-quality blue chip stocks and permit the other 25% to go towards a small collection of income-rich energy MLPs as part of a broad basket of investments.” It combines the desire to make lifetime investments with the desire to act shrewd; the current yields-on-cost for the energy MLPs that survived is mouthwatering if you like receiving $5,000 dividend checks on $10,000 investments within six years, and I’m still thinking about what to do with that knowledge.

I recently heard from a reader who mentioned that his wife had over 2,700 shares of AT&T stock sitting in an individual retirement account (IRA), and was seeking my input on whether such a heavy concentration in one stock was wise (this constituted almost the entirety of the IRA assets, in addition to a plain old bond index fund).

I posed the same question to him to rely on to his spouse that I pose to everyone wondering about proper portfolio risk management, “If something super weird happened and this stock went bankrupt, could you deal with it? Would it wreck your life? Would it set back your standard of living substantially?” If your answer is, “Yeah, it would cause me a whole lot of harm”, then there is no reason why you should stay super concentrated. You can reduce the risk substantially by dividing that money into Coca-Cola, Procter & Gamble, Johnson & Johnson, Disney, Nestle, Exxon Mobil, Chevron, PepsiCo, Colgate-Palmolive, McDonald’s,  and Wells Fargo. The only sacrifice would be a reduction in income, but the diversification acquired by such a maneuver would be substantial.

Or, you could treat that AT&T stock as a giant mother goose that would create its own blue-chip dividend portfolio over time. Even though the reader mentions that his wife is sitting on 2,700 shares of AT&T stock now, let’s pretend that I got this e-mail in 2004 so I can use real, hard numbers for illustrative purposes.

If you owned 2,700 shares of AT&T, you would have received $3,375 in AT&T income. Had you taken that $3,375 and put it into Coca-Cola stock, you would now be sitting on $7,300 worth of Coca-Cola.

In 2005, AT&T raised its dividend to $1.29, generating $3,483 in annual income. If that check got put into Procter & Gamble, it would have grown to a little over $6,600.

By 2006, the AT&T dividend grew to $1.42 per share. This would have created a $3,834 dividend check, that if put into Johnson & Johnson, would have grown to a little over $8,000.

In 2008, AT&T jacked up its dividend to $1.60 per share, and then raised the quarterly dividend by a penny per share every year since then. If you would have repeated the process in the order of the stocks I mentioned above, you’d have ended up with: $11,000 worth of Disney, $8,600 worth of Nestle, $7,300 worth of ExxonMobil, $9,000 worth of Chevron, $6,600 worth of Pepsi, $6,500 worth of Colgate-Palmolive, $5,500 worth of McDonald’s, and $4,400 worth of Wells Fargo.

Over a ten-year stretch, you just built a blue-chip stock portfolio solely from AT&T dividends. In 2004, those 2,700 shares of AT&T would have been worth $62,000. Someone just taking a cursory look at a stock chart would have noticed a $10 or so price gain, and a dividend that grew from $1.25 per share to $1.84 per share. Yes, it’s super nice seeing that $3,375 dividend check grow to $4,968 each year.

But look at what you did: In 2004, you essentially had a $62,000 portfolio that was 100% AT&T stock. Now, you have those AT&T shares worth somewhere between $90,000-$100,000, depending on the market fluctuations of the day. But you also created your own blue-chip portfolio that is worth over $80,000 in its own right, generating about $2,000 in dividends of its own. Now, AT&T is only 55% of your portfolio, and you’ve been gradually diversifying without selling any shares. And that is only with ten years of this strategy under your belt. Imagine what you could create if you spent 25 years replicating the strategy of using AT&T dividends to create your own blue-chip dividend portfolio.

Of course, that could be too slow for some, and if your allocation would make you miserable in the event that you stopped receiving dividend income from a single company—I don’t care which company—then it makes sense to scale back. But you can also use time and selective deployment of dividends to diversify a portfolio, so you can continue to receive ongoing benefits from the original cash cow while opening yourself up to new streams of high-quality revenue coming your way each year.

If you were able to make fresh investments from your job, you could further dilute the AT&T influence even faster.

For investors starting out, I’ve often discussed how nice it is to get a block of Coca-Cola, Nestle, Johnson & Johnson, or Colgate-Palmolive under your belt at an early age, because you know the company will be around for decades and you will always have some money coming your way each year.

But that’s not the only way to do it—there’s also something to be said about getting your hands on a couple hundred shares of something like AT&T, BP, Royal Dutch Shell, Conoco Phillips, Philip Morris International, Altria, or GlaxoSmithKline at an age in which you could spend decades taking their dividends and using them to create a mini blue-chip dividend portfolio from them alone. Using cash cows as the base of creating another blue-chip portfolio is an underrated, autopilot way to diversify your way into high-quality wealth.

One of the reasons why I have chosen blue-chip investing as the medium of choice to advocate is because there is so much downside protection—absent falling demand due to technology change or a lack of liquidity and a super-leveraged balance sheet like you saw at Wachovia, it’s almost impossible to take down a $100 billion company.

Anyway, I was checking the numbers on what has happened to General Electric stockholders over the past decade, and they’re officially in the black: if they dutifully reinvested and let their GE shares run on autopilot, they would have grown their position from 322 shares outstanding to 460 shares, and giving them total annual returns in the 1.5-2% range.

No, those aren’t returns to aim for at the moment of contemplation, but think about the conditions that existed and surrounded a GE investment over the past decade: the company was trading at 22x profits (modest overvaluation), and was about to experience a devastating dividend cut down to $0.10 per share because if a low Tier 1 Capital Ratio and a disastrous real estate loan portfolio that consisted of largely non-performing assets when the worst of the financial crisis hit. By that time, GE Capital was responsible for half of GE’s total profits, and the finance division’s non-performing assets and low liquidity to weather the storm caused profits to plummet from $22 billion to a little over $11 billion (note: that’s the part that’s never talked about—even in the worst of the crisis, GE was generating almost $1 billion in profits each month for shareholders).

By a show of hands, how many people out there can say they slightly overpaid for a stock that exploded during the financial crisis and then had left you at the breakeven point or so, once you adjust for inflation? That steadily growing share count you see in the picture is a buffer of sorts—every time additional shares get added to your account, the share price can fall by a little bit more—each dividend payment builds additional downside protection into your investment.

I expect that several years from now, the returns will even get better as General Electric continues to improve (over 75% of its profits now come from an industrial segment growing at 8% annually while the other 25% come from GE Capital that consists of much higher-quality finance divisions that are better capitalized than where GE was before the crisis). In 2020 or so, GE will be paying out a $0.40 quarterly dividend, and the recovery decade of 2010-2020 will perk up the experience for those who purchased their shares before the financial crisis.

As long as the company stays alive (e.g. avoiding the fate of General Motors), time can do a lot of healing. The investor community frequently rags on companies like General Electric and BP, usually to advance the argument that you can’t hold the same stock for a long period anymore. What I find interesting is that, for those who stick with the company, the curse of picking the wrong stock at the wrong time is usually five to ten years of dead money time, as opposed to a 100% loss of investment.

GE investors have collected a third of their investment back in the form of dividends over the past decade, and that includes the brutal dividend cut during the financial crisis. But by reinvesting dividends, you were able to increase your share count in GE by 42% over the past ten years. That plays an important role in the recovery process that is easy to ignore when all you hear is that the dividend declined to $0.10 per share in 2009.

Some of you have written in to me asking why certain blue-chip stocks don’t get mentioned, or only get mentioned in passing, here on the site. I can’t speak for everything, but often it has to do with valuation or my own estimates of future growth.

For instance, I would love to talk about Nike, Brown Forman, Hershey, and Colgate-Palmolive all the time. They are absolutely extraordinary businesses, as they possess both durable earnings quality that can make profits in all conditions AND they also have very strong earnings growth supported by sales figures that increase year in and year out.

My problem? Valuation. It is highly likely that anyone making a lump-sum investment in any of these companies right now will achieve long-term returns that trail the growth of the businesses themselves by an amount that you will find frustrating.

Take Nike, for example. This is a company that almost always trades between 17x earnings and 21x earnings. The only exception prior to the dotcom era has been the years 2012, 2013, and 2014. The price of the stock has been advancing very significantly compared to the growth of the business lately, such that the price of the stock is now sitting in the $97-$98 range even though the business only generated $2.97 per share.

If you care at all about the margin of safety principle before making a large investment, and you are contemplating Nike as your choice, this should bother you a lot: The current valuation of the company is just a shade under 33x earnings. Even though the business is performing excellently, and even though there is a reasonably good chance that the company can grow profits 10-12% annually in the coming ten years, that valuation should still be alarming.

Let’s run two scenarios about the next decade: One in which Nike does well and grows profits at 12% annually, and one in which Nike disappoints investor expectations and only grows at 5% annually.

Under a 12% growth assumption, Nike will be making $9.80 per share in profits in 2024. Under a 5% growth assumption, Nike would be making $4.89 per share in profits in 2024 (by the way, you should note that I find these low assumptions highly unlikely, but I’m modeling it anyway to show you what might happen if you receive positive growth that significantly lags expectations). When the P/E ratio comes down to 20, the stock would trade at $196 under the 12% assumption and at $97.80 under a 5% assumption.

Think about that for a moment—if the stock grows at 5% annually for the next ten years, but the P/E ratio comes down to 20, you will receive no capital appreciation. You will only collect the dividend. The current price offers you no leeway for a couple of years of mediocre performance. If, on the other hand, you receive 12% annual growth and the company trades at 20x earnings a decade from now, you would get a share price of $196 plus whatever dividends are paid out in return. That’s a compound annual growth rate of 7.29% (though the dividends would make this higher).

That’s why I don’t recommend that people holding this stock sell—you can still get the same return with Nike from here that you might get with a slow-growing utility or telecommunications company, and the dividend growth that you will receive should also be significant (although you’re starting out with a very low yield). But still, from the perspective of initiating a significant long-term investment in Nike, I wouldn’t do it here—there will be a spread of about five percentage points between what the business will do and the returns you will receive.

In short, valuation is the reason why some excellent businesses don’t get much coverage here right now. There’s nothing wrong with the business, but the price at which you buy the business is setting you up for somewhat disappointing returns going forward because the premium to initiate a business has gotten quite high (though the overvaluation of Colgate-Palmolive is not as bad as Hershey, Nike, and Brown Forman).

Other businesses don’t get much coverage here because I believe they will have a low earnings growth rate going forward. One of those companies is Campbell Soup. My personal predictions are that earnings per share will increase around 3-4% per year and you get a dividend of 2.8%. For someone buying the stock over the next ten years, I would anticipate that you get total returns around 5.8% and 6.8%. The earnings quality is great—soup will be around for a long time, and it’s a nice stock to have around for the reliability of the current profits and income (e.g. profits grew from $2.09 in 2008 to $2.15 in 2009, and inch upwards year after year for decades).

But why would Campbell Soup ever be the best option at a given point in time? Heck, ExxonMobil pays out a 2.9% dividends, and repurchases 4-5% of its stock per year, and plus it benefits from growing production and commodity prices that tend to rise over time. 2.9% dividend+4-5% repurchases+4% organic growth= 10.9%-11.9% long-term total returns. Given that Exxon has a higher credit rating and more financial strength than Campbell Soup, and given that it should deliver higher rates of compounding by four or five percentage points over time, why not spent an inordinate amount of time focusing on the blue-chip stocks that have the best combination of growth profiles and earnings quality, rather than pretending that the first element doesn’t exist?