Peter Lynch once offered a rhetorical question that investors should ask themselves when considering a stock, "Is this firm so profitable that even an idiot could run it? Because someday, one will." Warren Buffett offered a similar quote that showed up in Alice Schroeder's book "The Snowball: Warren Buffett and the Business of Life":
"'I always used to tell Gates that a ham sandwich could run Coca-Cola (KO). And it was a damn good thing, too, because we had a period there a couple years ago where, if it hadn't been that great of a business, it might not have survived."
That's a great quote that touches upon the importance of investing in companies with sound moats-something that is at the center of a successful strategy for long-term investors. If you plan on holding any stock for the next twenty years, there is a decent chance that at some point during that stretch, your company will be run by someone who makes Bobby Valentine of the Boston Red Sox look like the "Manager of the Year."
To use a relevant example today, most people seem to be quite critical of Indra Nooyi's management at Pepsi (PEP), and many people have been quite critical of Johnson & Johnson's (JNJ) outgoing CEO, William Weldon. During Nooyi's tenure, critics have complained that Coca-Cola has been building on its upper hand in the "Cola Wars", as Pepsi has fallen to third in market share, behind both Coke and Diet Coke. Anytime a Board of Directors has to release statements to the Wall Street Journal (click here) declaring confidence in the CEO, it's probably not a sign of superior management. And in the case of William Weldon, the outgoing chief at Johnson & Johnson, the company has endured a lot of bad press and a stagnant stock price over the past five years due to a seemingly endless stream of product recalls that have called into question the firm's safety measures. If you want to look at a list of Johnson & Johnson product recalls, be sure to check this link out.
Needless to say, no one has been mistaking Nooyi and Weldon for former General Electric (GE) CEO Jack Welch over these past five years. Some people consider the unimpressive performance of these CEOs to be a reason to sell the stock, but I tend to take the opposite view-each company's persistent annual and dividend growth reinforces just how strong the underlying brands of each firm are.
Here is a list of Pepsi and Johnson & Johnson's earnings and dividends over the past five years:
For every year during this time frame, both companies managed to earn more money and pay out more in dividends than the previous one. I see this as proof of how strong the brands are-brands such as Pepsi (the drink) and Tylenol are so strong that they can continue to do the heavy lifting when it seems like the management team is out taking a smoke break. If both Pepsi and Johnson & Johnson can continue to grow annual earnings by 7-8% when they're not being run by particularly impressive people, I'll take it-that sounds like the presence of strong brands, economies of scale, and competitive advantages to me.
We often talk about buying shares of companies that have "high-quality" earnings. We all have our different definitions of what that might mean, but for me, I like to look for companies that don't need the "smartest guys in the room" types at the top in order to be a success. I agree with the folks who complain about Johnson & Johnson's handling of its recalls, but I disagree with those who consider it an opportunity to sell the stock. In spite of all these things going wrong, Johnson & Johnson is still making more money, and that carries a lot of weight in my book. If we fill our portfolios with companies that fall into the "their products sell themselves" category, then we can build a margin of safety wherein subpar management leads to slowing earnings and dividends, not the elimination of them.