It's often the case that even the best businesses go through periods of transition as they adjust to structural changes in their business. While it can be tempting to cut your losses and move on as you observe a static share price year after year, the reality is that it can be worth your while to hang onto exceptional businesses with wide moats that are in the midst of transition as these businesses have proven track records and years of earnings increases that can suggest they can get their businesses on track. If these businesses happen to be dividend-paying businesses, you are actually getting paid to wait for these transformations to be completed and generating significant total return in the process.
Johnson and Johnson (JNJ) has been battling a number of patent expirations with some core drugs in its pharmaceutical business including Aciphex, Concerta as well as the upcoming expiration of Remicade. With the acquisition of Synthes, the company is very much in the transition to having a significant contribution from medical devices and is diversifying the business away from pharmaceuticals.
The impact of this transition uncertainty has been reflected to some extent in the Johnson & Johnson stock price. An investor in Johnson & Johnson five years ago would have seen a stock price of around $63. While Johnson & Johnson stock has shown some strong price recovery in the last year, moving up to a current share price of $75, an investor who had invested $10,000 in Johnson & Johnson stock would have only seen their stock appreciate to approximately $12,000 for an annual return of approximately 4% per annum.
This ignores the fact that Johnson & Johnson has also been paying a healthy dividend for many years. Not only has Johnson & Johnson been paying a dividend, its also had a strong track record of increasing this dividend for many years, something which it was also able to do over the last few years. With an effective annual dividend of close to 3.5% per year a $10,000 investment in Johnson & Johnson would actually be closer in value to $14,000. With the inclusion of dividends an investor's return in Johnson & Johnson is actually almost double what it would appear from share price appreciation alone, and worked out to almost 8% per annum over the last five years.
In order to consider the question of whether it could be worth it to persevere with good businesses in transition, one only has to look at the track record of Johnson & Johnson in building wealth over an extended period of time. In 1987, Johnson & Johnson stock was about $3.00 and the stock paid out about $0.10 in dividends for a 3.3% yield. Fast forward to 2012 and Johnson & Johnson pays out about $2.45 in dividends. Its stock price? $70.00. Not only have Johnson & Johnson investors been handsomely rewarded with consistent income being paid out to them over time, they have got much greater net worth to show for their troubles.
Thus while the market may be taking a wait and see approach with Johnson & Johnson while it works through some transitional issues in the core business, Johnson & Johnson has actually been paying investors handsomely to maintain the faith.
Many dominant, successful companies have had to manage challenges in their core businesses. One of the examples of such a successful company transition in my view is McDonald's (MCD). McDonald's was one of the companies caught in the wave of a change in consumer preferences toward healthier food choices. McDonald's has managed to successfully reposition its business as one that is focused on healthier choices through the inclusion of fruit selections, detailed calorie information and smaller portion sizes. Even through the ups and downs of market concerns about the effects of changing consumer choices, and the ability of McDonald's to respond to such changes, investors continued to get rewarded via dividends paid by McDonald's through the last 10 years as McDonald's found a way to successfully reposition its business.
The Coca-Cola Company (KO) is another that was able to manage through changes in consumer preferences of wanting lower calorie drinks through the introduction of such options such as Coke Zero. While Coca-Cola continues to face threats of periodic backlash by various groups concerned with sugary drinks, investors continue to get paid to ride out these issues, irrespective of any negative view that the market may take on Coca-Cola's future prospects and the impact that threats or actions on soft drink bans may have on the stock. Given Coca-Cola found a way to transition its products through the major change of reducing calorie content, it's entirely likely that management will be able to manage through recent threats of action in relation to the sugar content in its drinks.
At some point in time, it's likely that successful businesses will go through periods of market uncertainly and depressed share price performance as they have to deal with changes and disruptions in their core businesses or changes in consumer preferences. While the markets may negatively appraise the stock during such times of uncertainty, dividend-paying businesses can actually make it worth your while to see these transitions through.