A Couple Of Lessons From Hawaii Electric

| About: Hawaiian Electric (HE)
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Summary

Hawaii Electric Industries recently announced a combination with NextEra Energy.

As a result, the stock price for Hawaii Electric jumped significantly.

This article looks at a couple of lessons that can be learned from reviewing the company.

Tracing its roots back to 1881 the Hawaii Electric Company claims to be the only electric utility in the United States - and perhaps the world - inspired to go into business at the request of a king. Today the company is known as Hawaii Electric Industries (NYSE:HE) and is comprised of two parts: the long-standing utility business and banking.

Roughly two-thirds of the business is a dominant trio of utilities: Hawaiian Electric, Maui Electric and Hawai'i Electric Light. Collectively these businesses operate on five separate grids, with 100% market share for 95% of the state. The other third of the business is American Savings Bank, the third largest bank in Hawaii with $5 billion in assets and 57 branches across the state.

On December 3, Hawaii Electric announced that it would be combining forces with NextEra Energy (NYSE:NEE) - with HE shareholders receiving NEE shares, cash and newly spun-off American Savings Bank shares. The combined deal is valued at approximately $33.50 per HE share, representing a solid premium over the previous close. As such, the share price jumped 14% on the news and the price now sits just below the $33.50 mark.

In reviewing this information, there are a couple of lessons that can be gleaned. Let's start with the recent price movement.

Market Capitalization Doesn't Tell The Whole Story

When you see a company's market capitalization, it appears reasonable enough. You take two known things - the price at which shares recently traded and the total number of shares outstanding - then you multiply them together. It's a practical "best guess" as to what others might be willing to pay for the entire company. However, it certainly is not perfect.

The average trading volume for a company like Hawaii Electric is one million shares per day. That sounds like a lot, but it only represents about 1% of the total outstanding shares. So when you come up with a total value, you're doing so based only on what 1% of the shareholders are willing to negotiate. This has important ramifications. Obviously the other 99% of shareholders aren't holding out for lower prices - they could just sell out today for a higher price. Instead the majority of stakeholders either believe the shares are worth more than the going rate or simply have no interest in selling.

Given this information, if you want to take a company private, this is why you have to do it at a premium. In turn, you might find that the market value of equity holdings regularly trades at a "discount" to what the business might be worth. This "liquidity discount" gives you the ability to trade your shares anytime you want, but at a lower price. This alone seems like a sensible reason to consider yourself a long-term shareholder. The market price of a given security is routinely going to be below what a private buyer might be willing to pay. Likewise, your valuation of the entire company might very well be consistently higher than the going market rate.

The business of Hawaii Electric didn't improve by 14% in a single day. What changed was the price others were willing to pay.

The Difference Between A Stock Chart And Total Returns

In a recent article I elaborated on John Neff's concept of "dividend hors d'oeuvres" - receiving an above average yield while you wait for the main meal of capital appreciation. I used BP (NYSE:BP) as an example, but really Hawaii Electric might have been an even better representation.

At the beginning of 2002 shares of Hawaii Electric were exchanging hands around $20 per share. As recent as a few months ago, shares closed in the $23-$24 range. That's an annual rate of just over 1% per year. Moreover, the earnings per share have been effectively stagnant. In 2002 the company earned $1.62 per share. In 2013 the company also earned $1.62 per share. It is true that the shares outstanding have been increasing such that this represents more total earnings, but it's clear that the price and earnings of the company haven't done much over the last dozen or so years. More pertinently, if you were to look at a stock chart it would appear that a Hawaii Electric investment was a disappointment.

Yet this wasn't the case. The dividends paid during this time are not readily observable in the squiggly stock price line. Hawaii Electric has been paying the same $0.31 quarterly dividend since the late 1990s. This translates to a $1.24 annual payout or over 6% of your original capital returned each and every year. By holding the security for 12 years you would have received over 70% of your initial investment back in the form of dividends. All of a sudden that 1% capital appreciation turns into 6%-plus annual returns - beating the S&P 500 index (NYSEARCA:SPY) over the same time period. Moreover, this effect just compounds as you reinvest the dividends. In addition, the Hawaii Electric shareholder eventually received further capital appreciation after snacking on dividend hors d'oeuvres for the last decade.

Reviewing the history of a company like Hawaii Electric can bring about important insights to keep in the back of your investing mind. If you were to simply look at the stock chart, you probably won't be impressed. Yet hidden inside this low to no growth story is the ability to receive reasonable or even market-beating returns. The long-term HE shareholder was eventually "rewarded" in that others were willing to pay a higher price. A value that long-term shareholders always knew was there. But even if this wasn't the case, there's a great advantage in being able to differentiate between finicky price movements and long-term returns.

Disclosure: The author is long BP.

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.