It is always exciting to chase the current hot stock with a share price racing higher by the day. The problem with those stocks is that the price will, at some point, correct and return to a more reasonable valuation. A more pressing problem with these stocks is that nobody can really know with any degree of certainty when that correction will occur. History shows it will happen when it is least expected and that it will happen with great suddenness. We also know from history that the end will be quite unpleasant for a large number of investors. But, it will certainly be an exciting ride for them.
If I want an exciting ride, I can buy a ticket to Six Flags and ride the latest roller coaster. When it comes to my investment capital, I am looking to build lasting wealth in a steady and reliable approach by taking advantage of the miracle of mathematical compounding over the long term. Following this path will afford me the means to purchase all of the exciting entertainment I could ever want and still have my money kept safe and sound. When it comes to investing, safe and boring is a far better choice than fast and furious.
Buy Businesses That Produce Products We Have To Have
I have long believed that owning businesses that produce products our society requires today and will need more of tomorrow provides a moat of safety around my investment that offers tremendous value. If these products are also obscure in some way where they don't really get noticed, I like the business even better. High visibility attracts attention, and attention attracts competition. Competition is not normally good for profits.
So, I need a product almost everyone must have that almost nobody ever thinks about except when they use it. Oh yes, it should wear out as quickly as possible and, even better, it should be expected to wear out quickly. Do you think a product that fits each of these measures would be hard to find? If so, you would be wrong. Just look in your garage, or better yet, your trash, and pull out a cardboard box. Never noticed until we need it. Completely disposable after only one or two uses, and who would ever think of a cardboard box as a wealth-building machine?
I would, that's who. The best opportunities are the ones right in front of our faces that nobody sees because they are so obvious. Everywhere we turn, we hear or read about the death of traditional retail and how everything in the future will move more and more to online shopping and delivery to our door step. And what is it you will find in your mailbox or on your doorstep? A cardboard box with your merchandise inside. If you think you might need the box soon, you might just save it. Otherwise, into the trash it goes. And, best of all, if you own shares of Packaging Corporation of America (NYSE:PKG), every time that trash can lid closes on another cardboard box, the cash register rings again. Nice thought, the sooner the product gets thrown away, the more money investors make.
As more and more of the products we buy are shipped directly to us in cardboard packaging, the packaging industry is positioned for explosive growth, and has become so while completely escaping the notice of most investors. The fundamental numbers for Packaging Corp. clearly reveal the opportunity with which investors are being presented today. What they don't reveal is the hidden potential in the business, as shipping resulting from the explosive growth in online shopping drives the need for cardboard packaging materials through the roof. Sometimes, you just have to think outside the box in order to see the need to buy some.
The Layer Of Protection For Our Capital
As with any good, safe packaging or investment, the product must provide an excellent layer of protection for the cargo being contained, in this case, our investment capital. The layer of protection to which I now refer is the current conservative valuation of this business, given its enormous upside potential. I suppose that says something about being early to the party; the advance tickets are always cheaper.
Speaking of cheap, Packaging Corp. is currently trading at a very reasonable price-to-earnings multiples of only 14.93 times 2014 earnings and 12.93 times 2015 estimated earnings. With a five-year projected annual earnings growth rate of 15%, it only needs to maintain its current multiples to deliver annual returns on capital in the 15% range. Over the past five years, the business has averaged annualized returns on equity, assets and capital of 25.4%, 9.5% and 13.3% respectively. One of my favorite valuation methodologies is to take the average of these three numbers and multiply them by the current year's consensus earnings estimate to provide an estimated current fair value for the share price. This calculation produces a current fair value of $73.44/share; 7.1% higher than the current price of $68.55.
With what I believe to be a conservative projected growth rate of 15% for future earnings and a 2.33% dividend yield, this stock is cheap enough to provide investors solid downside protection in an aging bull market where most assets prices are showing signs of becoming extended. A boring packaging products business is quite out of style right now; that perception will change quickly at the first signs of any type of correction. Safe and boring start to look pretty attractive when compared to the fear and panic of a serious correction.
Final Thoughts And Actionable Suggestions
The demand for packaging materials will always be with us as long as we are moving products and property from one place to another. The demand should grow substantially along with the increase in online commerce that continues to drive the decline of traditional retail. Taking advantage of a business that is irreplaceable in this trend and trading at a bargain price is not a difficult decision. Packaging Corporation of America is a screaming "buy" at the current level. The only real question is how to best open a position.
Passive investors can simply buy the shares and wait for the price to continue marching higher over the next several years. This is a trend that should continue until someone comes up with a cheaper and better alternative to cardboard. Don't hold your breath waiting for this to happen; but certainly hold this stock while you wait.
Truly cheap investors (like myself) who simply can't bring themselves to purchase anything that is not discounted might wish to consider selling the August 16, 2014 expiration put options with a strike price of $67.50 for $1.40/share. Selling these options will obligate the seller contract to purchase 100 shares of the stock for each contract sold, should it be trading below $67.50 on August 16th. The $1.40/share premium represents an immediate return of 2.07% against the strike price of the options and, over the 35-day life of the contract, would produce an annualized return of 21.28%, should the options expire worthless. Should the shares be trading below $67.50/share on August 16th, the options seller would be required to buy 100 shares for every contract sold and would have an entry price into the stock of $66.10 ($67.50-$1.40), representing a 3.57% discount to the current price.
For those aggressive investors with a solid focus on generating income, the prospect of buying the shares and simultaneously selling the August 16, 2014 expiration covered calls could be just the ticket. For each 100 shares purchased, the holder would sell one call option contract for a premium of $1.25, for an immediate return on capital of 1.8% or 19% annualized over the 35-day life of the option contract. If shares of PKG are selling below $70 on August 16th, you will keep the premium collected and the shares as well. Should the stock be higher than $70 at contract expiration, the buyer of the options will take the shares from you, and you will be left with a capital gain of $1.45/share on the stock plus the $1.25 premium collected for selling the option and have a total gain of $2.70 (3.94%) on the capital required to purchase the shares, which will result in an annualized return of 41.09% over the 35-day life of the trade.
Whether you simply buy it and hold it, insist on a discount to the current price or buy it and squeeze a little income out right away, be sure to package up some profits for your portfolio with Packaging Corporation of America.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.