For investors interested in the relationship between dividends, valuation, and blue-chip stocks, I highly encourage you to add Dr. Jeremy Siegel's The Future For Investors: Why The Tried and True Triumph Over The Bold and New to your library collection. Siegel's work is Exhibit A for demonstrating the logistics of how and why blue-chip dividend investing works, and he provides many data examples that can influence your present investment decisions.
In one of the early chapters, Siegel presents readers with a scenario that is startling. He compares the performance of IBM (NYSE:IBM) against Exxon (NYSE:XOM) from 1950 to 2003. From a purely business perspective, IBM beats Exxon by just about every metric imaginable. IBM grew earnings at a faster rate than Exxon. IBM grew dividends at a faster rate than Exxon. IBM grew revenue at a faster rate per share than Exxon. And this went on for 53 years.
But what happened to investors of both firms over that time frame? The Exxon investors achieved returns of 14.42% annually while the IBM investors achieved returns of 13.83% over that fifty-three year timespan. The reason is because, on average, shares of Exxon Mobil were almost always cheaper than shares of IBM. While IBM was trading shy of 30x earnings, Exxon usually traded in the vicinity of 10x earnings. IBM's dividend yield typically hovered around 2%. Exxon's dividend typically hovered around 5% (I know, that's hard to believe these days!). The one advantage that Exxon had over IBM that accounted for the superior performance over long time frames is this: Exxon investors had a much larger dividend that got reinvested at a much more attractive price than the IBM investors on average over the period, and to borrow a phrase from Aesop's fables, this allowed the Exxon tortoise to surpass the IBM hare over time.
I bring this up to illustrate an important point that should be of relevance to Altria (NYSE:MO) shareholders today. The reason why Exxon was able to outperform IBM was not because it had a higher growth rate, but rather, because those dividends got reinvested at depressed valuations relative to actual worth over the decades. This factor also explains why Altria was the best investment you could have made since 1926. Not only did Altria grow by double digits, but the exaggerated threats of litigation, taxation, and regulation ensured that Altria nearly always traded at a depressed valuation, and the dividends that got reinvested at the low valuation levels go a long way towards explaining Altria's phenomenal performance over the past 80 years.
The problem for current shareholders is that Altria is no longer trading at the attractive valuation that enabled past shareholders to reap excellent gains merely by clicking the reinvest button on their brokerage accounts. From 1999 to 2010, Altria traded at a P/E ratio in either the high single digits or low double digits (except for the 2005-2007 period when the P/E ratio rose up to 13 and then to 16). For the past year or so, Altria has traded at 16-17x earnings. With the exception of 2007, the company has not been this expensive since the bubble year of 1998. The analyst consensus is that Altria will eventually trade at an average P/E ratio of 12.
In 2000, Altria investors were able to take a $2.02 annual dividend and reinvest it back into the old Philip Morris at 7x earnings. And then the dividend went up by 9% the next year. It is easy to see how wealth can accumulate quickly when you're doing that: compounding high dividend growth with reinvestment at low valuations.
But that is no longer the case for Altria investors today. The conventional wisdom is likely correct in this instance that the low interest rate environment has increased the appeal of high-yielding corporate stalwarts like Altria and AT&T (NYSE:T), and this has led to valuations above historical norms (although Altria's divestiture of Philip Morris International (NYSE:PM), Kraft (NASDAQ:KRFT), and Mondelez (NASDAQ:MDLZ) have complicated the apples-to-apples comparisons). The take-home point is that the historical ability of Altria investors to reinvest their dividends at low valuations was an integral cause of the company's long-term success as an investment. That is no longer the case today, and Altria investors may want to adjust their future expectations accordingly.