As I've been expecting for years, investors are flocking toward "legacy assets".
Legacy Assets is a term I use to describe timeless businesses that you can own for decades. In the past, most investors were focused on trying to "hit it big" on the next hot tech startup. Impressing strangers at cocktail parties was more important than building wealth.
This approach, though, is going by the wayside. Oh sure, there's still some get rich quick mentality around. But more and more people are dumping riskier investments like junk bonds and junior mining companies.
Instead, they're pouring funds into dependable dividend payers. The stock market has been shaky over the past few months. Legacy assets like Clorox (NYSE:CLX), Exxon Mobil (NYSE:XOM), and Union Pacific (NYSE:UNP), though, have held up just fine.
It's about time. As I've been trying to explain to friends and family for years, these stocks are some of the best investments out there. They stand out head and shoulders from the rest of the pack.
If there is one skill every investor should know, it would be how to pick out a legacy asset. No, they won't impress your colleagues around the water cooler. But these companies are the best way - that I know of anyway - to build wealth in the stock market.
Starbucks Corporation (NASDAQ:SBUX) is a textbook example.
1 "Legacy Asset" to Own Forever
The first sign of a legacy asset is a widening competitive advantage. We're not only looking for firms with an edge over rivals. We're looking for companies that are increasing their advantage over competitors, which allows them to produce outsized returns over the next 10 years or so.
Starbucks' new loyalty program is one such example. This idea goes far beyond a 10-drink punchcard. The company is building up a huge repository of customer data, allowing them to design a personalized marketing campaign for each customer.
Starbucks could very well become the "Google" of coffee shops. Google (NASDAQ:GOOG) (NASDAQ:GOOGL) is the No. 1 search engine because it returns the best results. Google returns the best results because the most people use it. It's a positive feedback loop that keeps the company at the top of the pack.
With so many customers around the world, Starbucks has an information edge over rivals. The company's uber-geeks can comb through this data, looking for patterns to exploit. Your indie-shop on the corner has no idea why their customers are going elsewhere.
Most investors haven't even begun to understand this advantage, which provides room for outsized returns in SBUX stock for the next decade or so.
The second sign of a Legacy Asset are expanding margins. Expanding margins are the ultimate sign of a healthy business. More money flowing to the bottom line is also a catalyst for a higher share price and growing dividends.
In 2010, Starbucks generated 14 cents in operating profits for every dollar generated in sales. Today, this number is approaching 20 cents. This margin expansion, though, is just getting started.
To boost profits, the café giant raised the price of some items as much as 30 cents this summer. Given how much people love their pumpkin spiced lattes, coughing up some extra dough at the checkout is no big deal. And as the company continues to grow, raw scale has allowed management to squeeze suppliers for lower prices.
Other cost cutting measures could also boost margins. At the Goldman Sachs Global Retail Conference last month, CFO Scott Maw said the company is looking to cut hundreds of millions of dollars in expenses over the next four years. New technologies are also allowing Starbucks to operate stores with few employees, boosting profits further.
The final sign of a legacy asset is a long history of paying dividends. Wonderful businesses put shareholders first. They often have histories of paying growing distributions stretching back decades and even centuries.
In this respect, Starbucks falls a bit short. The company has only been paying a dividend for five years. Hardly an impressive figure when we're talking about "generational wealth".
But what Starbucks lacks in history, it more than makes up for in growth. Since the company's started paying a distribution, management has hiked the payout between 20% and 25% every single year. This dividend trickle is starting to turn into a gushing river of cash flow.
I expect the company to hike its payout later this month. Another 20% to 25% dividend bump is likely, given this is how fast profits are growing. And with the payout increasing so quickly, Starbucks stock could become a target for an entirely new group of people: income investors. Once again, a potentially huge catalyst for shares over the next decade or so few people are talking about.
Starbucks, of course, is no sure thing.
The company uses tons of raw commodities like milk, sugar, and coffee. Labor costs are also rising, with the push for a $15.00 minimum wage. A spike in input prices or a serious labor dispute could eat into margins (and by extension shareholders' dividends).
And for a dividend stock, Starbuck's yield is hardly impressive. Based on their current payout, shares only yield 1.5%. Not bad, but hardly enough to knock your socks off.
This focus on yield alone, though, is a tad misleading. In addition to paying out dividends, Starbucks also has a ravenous appetite for its own stock. If you include share buybacks, SBUX stock has a total "shareholder yield" of 4.0%. That's far better than you'll earn on Treasury bonds.
And with a little patience, today's meager dividend could become an impressive payout. Assume the company continues to hike its distribution by 20% annually over the next decade (a modest pace given the company's low payout ratio and soaring profits). By 2026, current shareholders will be earning a yield on cost of 10.7%.
The Bottom Line on Starbucks
Bottomline, identifying a legacy asset is the best skill you can develop. While income investors have known about these companies for years, everyone else is finally catching up. And in the case of Starbucks, these traits have allowed the stock to beat the market for the past 10 years… and probably the next 10 years, too.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.