With a lot of market bubbles that crop up in various sectors, the results are usually disastrous. During the tech bubble, we saw how quickly 90% of our wealth can disappear if we chose to purchase Internet companies that are trading at 1,000x earnings (and some were even more expensive than that!). During the crash in the real estate market, we learned what happens when you overleverage assets that are about to collapse in price. But the consequences of overpaying for a high-quality blue chip stock are not nearly as harmful as the consequences of participating in some of the other recent bubbles that have shown up on the American investor's landscape in recent years.
Overpaying for an asset will always produce some kind of undesirable consequence, but the consequences of overpaying for a cash-generating company like Altria (MO) is mitigated by the fact that (1) you are receiving infusions of cash every 90 days that you can plow back into the company, increasing your overall ownership stake, and (2) the earnings are growing at an 8-12% rate over the long term, and this can provide a useful shield when the inevitable P/E compression happens.
Now that we are 12-15 years removed from the tech bubble, we can review what happened to investors who overpaid for some high-quality names during the last period of lofty prices in the market place.
(1) In 2000, Colgate-Palmolive (CL) traded at 32.7x earnings. Since then, earnings have grown from $1.70 per share to $5.00 per share. Dividends have grown from $0.63 per share to $2.72 per share. Even though Colgate has experienced P/E compression from just under 33x earnings down to 24x earnings, the growth of the firm and the 50+ dividend payments over that time frame have enabled investors to reap annual returns of 7.96%. Every $10,000 invested into Colgate 13 years ago would have turned into $26,853 today.
(2) Way back in 2000, Pepsi (PEP) traded at 27.7x earnings. Today, Pepsi trades at 21x earnings. While this price compression was happening over the past 13 years, Pepsi grew its earnings from $1.48 in 2000 to just under $4.00 today while the dividend grew from $0.56 to $2.27 today. The growth of the firm has allowed Pepsi investors to realize annual returns of 7.46% since then. This would have turned a $10,000 Pepsi investment in 2000 into $25,319 today.
(3) Procter & Gamble (PG) traded at 25.7x earnings in 2000. Since then, Procter & Gamble has grown earnings from $1.48 to a penny under $4.00. The dividend has grown from $0.64 annually to $2.41 annually. Because of this, even though the P/E ratio has fallen to 19.77x earnings, Procter & Gamble has managed to compound at 10.95% if you reinvested each and every dividend back into the company, turning a $10,000 investment into $38,207.
(4) Johnson & Johnson (JNJ) tells a similar story. Even though Johnson & Johnson traded at 26.4x earnings in 2000, the company has managed to grow earnings from $1.70 in 2000 to over $5.15 per share today (if you remove one-time items). The dividend has grown from $0.62 per share to $2.64 per share. Investors have been able to realize annual returns of 7.63% since that time, turning a $10,000 investment in Johnson & Johnson into $25,842 today.
(5) In 2000, Exxon (XOM) traded at 17x earnings, which is a very high multiple for an energy company of Exxon's size unless it is during a time of sharply declining commodity prices. Since then, Exxon's valuation multiple has fallen to below 10x earnings. Despite this, earnings have grown from $2.41 per share in 2000 to over $8.00 per share today on a normalized basis. Additionally, the dividend has grown from $0.88 per share to $2.52 per share. Although Exxon's valuation dropped sharply, an investor who dumped $10,000 into Exxon back in 2000 would have grown his investment to $29,676 today.
By the way, none of these results are examples of sound value investing. I've never heard Neff, Yacktman, Munger, or Lynch recommend doing things like pay 32.7x earnings for Colgate or pay 26.4x earnings for Johnson & Johnson. But these results do demonstrate that a blue-chip dividend stock bubble can be different from other bubbles that are built on flimsy earnings foundations. In many cases, the earnings growth of these firms acts as a countervailing force that minimizes the damages of overpaying. I do not mention this to encourage anyone to overpay for a stock, but to demonstrate that these companies can often "grow out of" overvaluation if you give them a 10- to15-year time frame to do so.