I've had a lot of time to sit around and reflect on 2014 these last few weeks. I've realized that I have made one fundamental mistake that I don't intend repeating again, which is selling too early during brief periods of stock over valuation. In my case, this mistake occurred in the context of my ownership of Colgate (NYSE:CL).
There is arguably no better defensive business in the world than Colgate. Colgate is a company that I had been wanting to own for years. When I think of consumer staples, and building defensive positions in companies with great brands and wide moats, Colgate is often the first company that comes to mind.
Why do I like the Colgate business so much? When you think of oral hygiene you think Colgate. The other reason I really like the Colgate business from a defensive perspective is that its products aren't ones that are easily substituted. I'm not going to take the inferior brand toothpaste just because it costs less if it tastes terrible.
But owning Colgate is just better than just playing defense. It's defensive growth. And that's best kind of business. That's the reason I own companies like Resmed (NYSE:RMD), and others. They have a stable product demand profile, coupled with exceptionally solid growth. Colgate's revenues have close to doubled over the last decade while dividends have grown at a rate of 12% p.a over the same time.
The power of Colgate's business can be seen in the return on capital that the business is able to generate. Colgate has achieved a return on equity in the range of 30%+ for most of the last decade. Defensive product characteristics, with strong revenue growth and high returns on invested capital makes for a strong business.
I saw my opportunity to pounce in mid-2013. Colgate has never really traded cheaply, but it at least appeared fairly value, so I moved in and bought a stake. I managed to pick up Colgate in the low- to mid-$50 range. However Colgate's share price drove consistently higher through 2013 and into 2014, touch close to $70 today. The business current trades at a P/E multiple of close to 30x trailing earnings.
In any case, I surmised, and I think correctly, that the company was overvalued at the current point in time and I sold. Arguably the rational decision to take, but ultimately, I realized it was the wrong one. Why so? I underestimated my holding period. See, if one has a holding period of one to two years, arguably you can free up excess capital and chase something else that is undervalued and ride that higher.
I don't have a one- to two-year holding period. In fact, my holding period is as long as I need my dividend income to last, which arguably could be as long as 50 years. In this case, selling out and chasing something else with better valuation underestimates what Colgate is likely to do over my 50-year holding period.
Why is this? 50 years is a pretty long time. The world as we know it could look completely different over the course of that time. However people will still be taking care of their teeth in some fashion or other, unless we invent other ways to do so. And even if we do invent other ways than brushing our teeth, its likely Colgate will be at the forefront of that innovation as the category leader in oral care.
There is considerable investment obsolescence risk over such a long period. Businesses in technology and even retail may not exist in the way we know them today over such a long period. So making capital allocation decisions biased toward another category of investment that is less stable increases holding period risk. It's the risk that my alternate investment could fold within the time of my 50 year holding period. I would argue that the risk of oral care becoming an irrelevant category is very much reduced, compared to other types of industry verticals and stocks.
Also, over this next 50 years, Colgate is going to continue generating higher and higher profits. As it does so, its intrinsic valuation is going to keep incrementally increasing. As its intrinsic valuation increases, so will its share price. The longer the company can grow profits at a rate in excess of general economic growth then the faster its share price will rise.
With all the growth opportunities for advanced oral care in Asia and Latin America, this looks like being a pretty long runway of opportunity. In focusing on a 10-20% near term overvaluation, I missed the forest from the trees. In all likelihood, when I'm done with my accumulation, Colgate will be many multiples higher in price than what it is today.
So what did I learn from all this? You need to cut some valuation slack for really great businesses. Remember what the end game is and what your true holding period is. Don't shortchange yourself out of a multibagger in return, because of brief period of overvaluation. I'm back in Colgate again, by way of my dividend accumulation index. I intend to stay the distance this time, irrespective of short-term valuation movements.
Disclosure: The author is long CL.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.