Buying Dow for a Better Deal than Warren Buffett Got

So, after the news of the past couple days, I have added to the position in Dow Chemical (DOW). At prices averaging $32, even we tripled the position in Dow yesterday and today.

Current yield, 5.25% and rock solid safe. Think about it: Berkshire Hathaway's (BRK.A) Warren Buffett only got 8.5% on his $3 billion convertible and it is underwater if shares are under $41 and change (28% higher than today) in 5 years ($41 is the conversion price).

Now, Warren's 8.5% is stagnant. My dividend will grow and I will also gain the additional 28% price appreciation of the shares if they sit at $41 when Warren converts at no gain other than the interest he has received.

Dow has increased the dividend 18% over the past three years. Assuming a consistent growth, three years from now the dividend will be $1.94 for a yield on my investment of 6%. Again given the same growth, I will get $2.17 a share when Warren converts his shares and I will be yielding 6.8% on my initial investment.

The dividend growth enjoyed by shareholders may just turn out to be a conservative growth rate that I am using for comps. The reality may very well be far better than that, but is very unlikely to be anything less than the current yield given the company's history. Even were the dividend to stay flat for 5 years (again, very unlikely scenario), the common at these prices offers superior appreciation prospects.

When you add the 28% share price growth I will get in order for shares to get to $41, right now, common share buyers today are getting a better deal than Warren. He will receive interest totaling a 42.5% over the five years and if the dividend on the common stays the same for 5 five years, I will receive 26.25% plus the 28% appreciation in the shares for a total return of 54.25%. Should the dividend grow as is has, the return on my invested cash goes to 58% plus.

Chances do not come around very often to get a better deal than Warren....grab it.

Disclosure ("none" means no position):Long DOW, None

Comments

[najdorf:]

Dow common may or may not be a good investment, but you're ignoring the advantages of Buffett's preferred investment that are not available to the average investor. First, an 8.5% dividend from a large, stable company is really, really good in today's climate. You can get that from financial companies, but you're taking on a big default risk. And you might say there's not much difference between 5.25% and 8.5%, but the difference is enormous. You could have gotten the 5.25% on a long treasury or CD last year. 8.5 may well be better than the total return of the stock market for quite a while.

Also, Buffett is in no way "underwater" based on any future common share price. The preferred is perpetual and is convertible entirely at his discretion. It's just an option on the common stock for him - the real point is the yield, since 8.5% is about all he expects to make in today's climate. He can collect 8.5% indefinitely (barring Dow bankruptcy or extreme crisis) while he waits for the share price to appreciate. You can collect 5.25% for as long as they feel like and are able to pay you (the company doesn't guarantee the regular dividend in the same way that they guarantee the preferred) while you hope for the share price to appreciate enough to make your investment better than his. Advantage: Buffett. Famous investors with 3 billion cash in a liquidity-starved environment get better terms than amateurs.

2008 Jul 12 03:23 PM

[Jim Hawthorne:]

I was trying to remember when and if I ever saw a dog sicker than this one get better. I can't; and my whiskers are pretty much all grey now.
Todd, can you give us a good technical indicator for a buy here? No? Okay, how about a good fundamental one?
Don't need to hurry... I can wait...

2008 Jul 12 03:45 PM

[Brahm:]

I am a long term (plus 10 years) investor in DOW, and consider my investment in it (appreciation + dividend of plus 4%) a good investment, since the risk has been low. Following the announcement of the acquisition of ROH, I added up more DOW to my current position. I intend to add more to the position next week.

I had been considering adding to my position in DOW, especially after the announcement of the foreign joint-ventures, for the last few weeks. The primary reasons have been the intended transformation of DOW to a specialty chemical company, the commodity chemicals joint-ventures with raw material suppliers abroad (Middle East, North Africa and Russia), and the partial spin-offs of some bulk chemical operations in the US through joint-ventures with parties in the Middle East, and the gradual evolution also of the company into a strong agricultural (and bio-food seed) player.

There is tremendous vision on the part of management to transform this company into new growth areas (specialty chemicals, bio-foods, and agricultural chemicals). Its traditional areas in commodity chemicals manufacuring also will grow significantly using the joint-ventures abroad. The benefits provided by joint-venture partners will be formidable in terms of raw material costs. As the costs of energy remain high or even increase, the benefits of the joint-venture with raw material suppliers will have very high pay-offs in future.

I expect earnings for DOW to increase significantly, probably more than double, in three to five years. I believe that as DOW gradually transforms itself it will merit a much higher P/E than it has had as a predominantly commodity chemicals company.

Who has the better deal? I believe short term it is Buffet. In the intertmediate term (3 to 5 years) it is shareholders, especially those who are significantly increasing their positions in DOW. Long term, it is almost even for both shareholders oand Buffet. However, we must remind ourselves that without Buffet or someone like him the deal would not have been easy to happen. Capital is hard to come by in the prevalent atmosphere.

2008 Jul 12 04:54 PM

[bozak:]

What about the rising cost of natural gas? Isn't Dow the biggest user of natural gas in the world? Natural gas prices represent a significant headwind for DOW. If you want a better deal than Buffet buy KMX 40% lower than Buffet's latest buy.

2008 Jul 12 07:28 PM

[Urbane Gori...:]

I agree with 'bozak'... Why buy it here when even the CEO of DOW has been parading around every TV screen he can get on stating that they are taking a big hit with NatGas prices, that they have to raise their prices to buyers, but don't feel they can, that the economy is bad and getting worse?

I was kinda hoping to get a real reason to buy the stock rather than just the fact that Warren Buffett may or may not have paid too much for it.

Why not look at something like CRDN which provides the disposable crucibles for smelting aluminum (after the Olympics as aluminun smelting is presently reduced in China till August due to smog and electric demands etc... ) or GTI which produces graphite rods for smelting ... There are also other profitable multifaceted chemical companies that are actually rebounding right now, not to mention the possibility of buying some integrated oil companies that have chemical production as sideline and would benefit from a pullback in oil prices, but should do OK even if oil doesn't as they pump their own base materials?

Whew! Sorry about that! jegan ;-)

2008 Jul 12 08:18 PM

[E Nuff Sed:]

This argument is pointless. Since you cannot get the deal Buffet got - the next best thing is to buy the stock. Given the Dividend and growth prospects I agree with Todd that this is good value.

2008 Jul 12 08:19 PM

[VennData:]

"...Assuming a consistent growth..."

Don't

2008 Jul 12 10:15 PM

[VennData:]

"...Assuming a consistent growth..."

Don't

2008 Jul 12 10:15 PM

[Ames Tiedeman:]

Yippie, you beat Buffet, this time.

2008 Jul 12 10:51 PM

[truthinvesting:]

Buffett has locked in a place to park money with NO RISK.he does NOT have to convert in 5 years. Im not saying Dow is a bad investment ,just saying Buffett has a cant lose deal and his dividends are 70% tax free giving him a much better deal than T bill. Just my 2 cents.peace

2008 Jul 13 10:29 AM

[ArtfulDodger:]

Thanks for the article on DOW. However, I'm not sure anything is much worth buying right now except for gold, until the Israeli/Iran craziness is solved.

Moreover, regarding some of the comments, I simply could not take a stock recommendation seriously from someone who doesn't know a past participle from a fried egg.

I value literacy. But that's just me. Perhaps someone who can't write a complete sentence can indeed pick stocks. Who knows?

2008 Jul 13 12:42 PM

[Jake2:]

I don't know who RONJSQ

2008 Jul 13 01:59 PM

[QED:]

Re Ronjsq and Truthinvesting

It would be good if comments and/or suggestions were kept relevant to the article of the author only. That way we would not have to read lots of unsolicited and often irrelevant comment. If we want general investment advice we can always subscribe for a newsletter.

2008 Jul 13 07:28 PM

[ArtfulDodger:]

Not speaking of Todd Sullivan, whose article made some good points, but regarding some of the commentators: no wonder so many people go broke listening to stock touts, if this is the type of education they have.

God help us!

2008 Jul 13 11:07 PM

[Todd Sullivan:]

najdorf

the convertable convert sat dow's discretion after 5 years. they can also opt to pay him the interest in cash, shares, or more convertible.

2008 Jul 14 02:05 PM

[Todd Sullivan:]

bozak,

nat. gas. when dow goes online in SA they will be paying 40% LESS than marlet prices for nat. gas.

they are also talking to gazprom about a JV

2008 Jul 14 02:08 PM

[Todd Sullivan:]

jim,

technical? no...

fundmantal? i have posted over 50 times on dow giving a multitude of reasons.

read them and if you have any counter arguments, i'd love to hear them

2008 Jul 14 02:09 PM

[trackdoc:]

Buffet is limited to only huge investments to make a dent in his holdings ($3 billion) and there very very few good huge investments out there. If you are an individual investor with under $500,000 to invest, your options should be much better than Buffet's and you don't have to follow what he does. If Berkshire were small right and just starting out now, Buffet would be looking for a much better deal than DOW, but he is limited by his huge size.

2008 Jul 15 10:28 AM