Recent Buys: April 20th, 2015
Whenever I put new money into investments, my mind races with all of the possibilities of current and future cash flow. My portfolio produces an ever rising stream of income via annual dividend growth, and how I choose to seek and use that cash flow is increasingly important. Every dollar invested today is worth so many more in the future, and that’s especially true among all the businesses I’m invested in.
One of the main attributes I analyze in a company is their Payout Ratio. This is simply the percentage of earnings paid out in dividends to shareholders. I like to see a low payout ratio, with the bulk of earnings being used for research, development, acquisitions, mergers, and share buybacks. I aim to make sure each of my investments are looking toward the future and using their cash flow to grow earnings, revenues, and profits so they can keep sharing their wealth with me for years to come.
The ideal business is one that earns very high returns on capital and that keeps using lots of capital at those high returns. That becomes a compounding machine. So if you had your choice, if you could put a hundred million dollars into a business that earns twenty percent on that capital–twenty million–ideally, it would be able to earn twenty percent on a hundred twenty million the following year and on a hundred fourty-four million the following year and so on. You could keep redeploying capital at [those] same returns over time. But there are very, very, very few businesses like that…we can move that money around from those businesses to buy more businesses.” ~ Warren Buffett at a Berkshire Hathaway shareholder meeting when asked what the ideal business is.
Warren Buffett was a pioneer of using cash flow from one business to invest into many others which created an ever rising snowball of income. This principle works beautifully with the dividend growth investment strategy, and I’m waiting patiently for my annual dividend income to become more substantial so I can start deploying capital with even more focus.
I’ve become increasingly fond of global investment asset management company Franklin Resources (BEN). They’ve successfully used their cash flow to grow from a single location in New York to currently having offices in 35 countries and clients in more than 150. I first invested in the business in December and then averaged down in January. Today I averaged down yet again and made it the largest holding in my portfolio with a total value of just over 5k. I bought 39 shares for $51.35 each with a $6.95 commission and total transaction cost of $2,009.60. This purchase yields 1.2% and adds $23.40 to my 12-month forward dividends. As the dividends of BEN grow each year, like they have since before I was born, that smaller initial yield will grow too and inflate my yield on cost dramatically.
One of my biggest attractions to this company is their incredibly low payout ratio that typically hovers in the low teen percentages. I can’t just assume a dollar amount because the payout ratio works as a percentage, and massive mega cap companies that have a much higher percentage payout ratio can still have plenty of cash leftover to reinvest in themselves along with paying those growing dividends. The best thing to do is to dig in deeper with actual numbers and research and see where all that cash flow is going.
After dividends and share repurchases, BEN still has plenty of free cash flow for management to invest elsewhere or even give out one time “special dividends” to shareholders like they have four times since 2009.
“One of the ways that we have built Franklin Templeton’s global business is by making strategic investments in smaller, highly experienced asset management companies,” ~ Franklin Templeton CEO Greg Johnson after one of their many recent acquisitions, increasing their presence in Australia and the UK.
The company has acquired so many successful global businesses over the years by using its free cash flow responsibly. It’s no surprise BEN has trumped the S&P 500 over the last 20 years. If one had invested 10K into BEN in 1995, it would be worth almost $200K today versus the $50K of the S&P 500 including dividend reinvestment.
What’s better is that cash flow doesn’t appear to be slowing down at all when looking at a recent fast graphs chart. In fact, according to analysts, it looks like some of the best days are still ahead for this giant of an investment firm. What will they acquire next?
(For those unfamiliar with viewing cash flow via fastgraphs: The current stock price is the black line, and typically when that black line is in the darker green area below the orange line, the stock is undervalued compared to its cash flow. When the black line is below the dark blue line, the price is undervalued compared its normal Price/Cash Flow ratio. The white line toward the bottom are the dividends with their specific numbers below that. You’ll also see data such as current dividend yield, market cap, debt, and cash flow numbers with percentage changes.)
Too often, I see investors complaining when they don’t get the dividend raise they had hoped for from an investment. These investors are usually newer to the dividend growth strategy and need to remember that this is not a get rich quick scheme. Successful dividend growth investing requires decades of contributions, capital allocation, compounding, and research.
When you own a fundamentally solid company, sometimes it’s best to trust management will use cash flow to the best of their abilities in the short term. This usually provides shareholders with much better value in the long term. Paying attention to cash flow can also be a good way to recognize when management is being irresponsible and may reveal reasons to sell shares in that business.
I wanted to also mention a small purchase of Coca-Cola (KO) via my commission free Loyal3 account. I first purchased KO last month, and on 4/14 I bought 6.1914 additional shares for $40.54 each with a total cost basis of $251. The purchase added $8.17 to my 12-month forward income for a new grand total of $1,734.73.
Did you make any recent purchases? What are your thoughts on BEN and the importance of cash flow?