If you own some of the largest blue-chip companies in the world, it can be reasonable to wonder as part of your risk management inquiries whether the "law of large numbers" will kick in and put an informal lid on the growth of your companies going forward.
As we stand here today, Exxon Mobil (XOM) makes between $17-$35 billion per year (depending on the fluctuations in the underlying commodities) across 40 different countries.
Coca-Cola (KO) makes $10 billion in annual profit across 210 different countries.
Procter & Gamble (PG) currently has a product in 398 out of 400 American households.
General Electric (GE) now operates in more than 100 countries, and generates $147 billion in annual revenues.
Wal-Mart (WMT) now has over 1 billion square feet of store space.
Johnson & Johnson (JNJ) has over two dozen brands that conduct $1 billion in sales each.
Over the past thirty years, the total returns of those companies have been nothing short of life-changing for investors who chose to truly become long-term owners rather than short-term renters of ticker symbols.
Since November 1983, Exxon has compounded at 14.44% annually, turning a $10,000 investment into $575,000. Coca-Cola has compounded at 15.14% since then, turning a $10,000 investment into $692,000. Procter & Gamble has compounded at 13.98%, turning a $10,000 investment into $510,000. General Electric has compounded at 11.64%, turning a $10,000 investment into $273,000. Wal-Mart has compounded at 15.82%, turning $10,000 into $825,000. And Johnson & Johnson has compounded at 15.04% since that time, turning $10,000 into $673,000.
Those histories have been fantastic, but the terms of the investment in those companies today are a bit different. During the past thirty years, each of those companies listed above went from being primarily American companies to conquering the rest of the world with their products, and that explains the eye-popping growth. Now that they have crossed the threshold from big to mammoth, it's worth inquiring: What is the next frontier that will deliver gains to shareholders?
With companies like those mentioned above, future growth in earnings per share metrics will come from these sources:
(1) Population growth. Right now, Coca-Cola has a stable of over 500 drinking brands sold to customers across 210 countries. Anytime someone is born, a new potential Coca-Cola customer is born if he ever regularly purchases Coke, Diet Coke, Sprite, Fanta, Powerade, Dasani water, Minutemaid, Fresca, Fanta, and so on. As the world population grows, so will the profits for a company like Coca-Cola because drinking is a universal need, and Coca-Cola has an incredibly diversified array of beverage items that can create long-term, profitable consumers.
(2) Stock Buybacks. In 2003, Wal-Mart made $8.86 billion in net profits. By the end of 2013, that number is expected to be $17.00 billion. That might lead you to think that shareholders experienced total growth of 91% over that time period. Not so. Wal-Mart relentlessly repurchases and retires its own stock. In 2003, the Wal-Mart company's profits had to be split up into 4,311,232,322 pieces. Now, the company's profit is only split up into 3,255,456,108 pieces.
Because of the fewer shares outstanding over the course of the decade, the earnings per share actually increased from $2.03 in 2003 to $5.20 by the end of this year. Although the company only grew profits by 91% on a companywide basis, shareholder profits actually grew by 256% over the past ten years because the company was simultaneously growing total profits while also eliminating 1.056 billion shares from existence. A well-run buyback program, like we see at Wal-Mart, turns moderate overall profit growth into excellent profit growth when it is adjusted for the individual shareholders.
(3) Productivity Gains. When Benjamin Graham wrote about stocks, it was common enough to buy excellent companies with P/E ratios below 10. By the mid-1970s and 1980s, valuations of many companies in the S&P 500 crept upwards towards 15. Nowadays, there are certain excellent companies that deserve valuations of 20x earnings. Are we getting dumber and overpaying, or is there a rationale for that? One potential reason is that it takes much less capital to generate the same amount of profits, and this allows owners to remove more profits from the company, thus warranting the higher valuation.
General Electric is a classic example of this phenomenon. Factories that used to require hundreds of employees to create light bulbs now only require the labor of a dozen different people. This trend is unfortunate for those seeking or desiring to maintain employment, but it benefits the owners that seek to draw out large profits from their ownership stakes. On the industrial side, we are starting to see the company eke out $0.11 of profit on every dollar of manpower employed, compared to $0.08 ten years ago. Those kinds of increases in productivity result in lower ongoing costs, which is one of the two levers that can increase overall profitability.
(4) Acquisitions. With companies like Johnson & Johnson and Exxon Mobil, it is easy to see how the gradual addition of smaller companies can lead to increases in profitability. In the case of Exxon, the company was able to acquire XTO energy in 2010. The bottom-line growth has not yet produced its intended results because of the lower-than-expected natural gas prices that we have seen since that, but this is the kind of move that can and eventually should push the needle forward.
In the case of Johnson & Johnson, the company benefits from having a Consumer, Pharmaceutical, and Medical Device Divisions. When you are involved in skin care, oral care, dermatology, circulatory disease management, babycare, contraceptives, antipsychotics, and so on, you have a permanent demand for $2-$5 billion acquisitions.
While the next thirty years may not bring the same success to these blue-chips as the last thirty, there are avenues for future success. When you are a truly global company, population growth means that a new customer is born every minute. With the rapid increases in technology, companies are finding ways to generate the same amount of profit at a lower cost. Stock buybacks can allow the earnings per share growth rate to be several percentage points above the actual growth rate of the firm. And the ever-present opportunity to engage in bolt-on acquisitions is another way to expand the empire. These four factors likely represent the next frontier for the biggest blue-chip stocks that make up the bulk of conservatively oriented stock portfolios.