In basketball parlance, the "triple threat" is a position where the offensive player has three basic options: dribble, pass or shoot. It's the "sweet spot" of being ready for whatever opportunity that comes about. The investing world, I would contend, has its own "triple threat" position. Instead of basketball actions, I like to think about the possibility for earnings growth, a solid dividend payout and the potential for a higher earnings multiple in the future as being in the "sweet spot."
For this particular article, I'd like to highlight international automotive dealer Penske Automotive (NYSE:PAG), which currently possesses many of these attributes. Let's start with some history.
Here's a look at the operating and security results for Penske Automotive from 2006 through 2015:
On the top line, Penske put in solid results, growing revenues from about $11 billion in 2006 all the way up to $19 billion last year. Moreover, the quality of those sales have been improving as measured by the net profit margin. Put together, Penske the business was able to grow company-wide earnings by over 11% annually. The number of common shares outstanding declined a bit, resulting in earnings per share growth of 12% per annum.
If the beginning and ending earnings multiples were to remain the same, you'd see share price appreciation on par with earnings per share growth. However, that was not the case with Penske. Instead, the P/E ratio went from about 18 down to 12, resulting in yearly share price appreciation of "just" 6.7% per annum.
Finally, you can see the effect of the dividend as the payout ratio went from 20% of earnings up to 26%. In total, an investor in Penske from 2006 through 2015 would have seen 7.6% total annualized average compound gains. To give that number some context, that's the sort of thing that would turn a $10,000 starting investment into $19,000 or so after nine years.
Reviewing the operating and security history of a company can help you think about that investment moving forward. With Penske, you had very strong company-wide revenue and earnings growth, coupled with P/E compression and a fast-growing, but low-yielding dividend. The net result was reasonable but not exceptional returns.
Let's use this framework to think about the future.
Triple Threat #1 = Earnings Growth
It depends on where you look, but I've seen intermediate-term growth rate estimates for Penske of around 9% per year. Naturally there are concerns - for instance, over a third of the company's business is attributable to the U.K., which stands to be affected by the Brexit - but this sort of thing can also be mitigated by the structure of the company's offerings (namely higher-end brands).
In the past, the company grew earnings per share by 12% annually. Looking forward, something closer to 9% per year is expected. Let's use 6% per annum to bake in a bit of caution. At this rate, you might anticipate a future EPS number near $4.90 or thereabouts after half a decade. Indeed, I've seen estimates well above $5 per share during this period, so that doesn't appear to be an especially outlandish anticipation. Naturally, something much better or worse can happen, but the idea is to generate a starting baseline.
Triple Threat #2 = Dividend Growth
Penske has an interesting dividend history that isn't quite captured in the above table. The company was paying a dividend from 2003 through 2008 before suspending its payout during the start of the recession. Instantly, a good deal of investors would look elsewhere, but as we observed above, the long-term returns have still worked out fine.
The payout was reinstated in 2011 and has been picking up steam ever since. Penske reinstated the dividend at $0.07 per quarter in 2011, but has now increased it by a penny every quarter. From a $0.07 starting mark to $0.08 in July 2011, $0.09 in November 2011, $0.10 in January 2012 and so on all the way up to $0.28 in July 2016. Usually, we talk about yearly dividend increase streaks. Here's an instance of 21 straight quarterly dividend increases.
So you could say that the "annualized" mark sits at $1.12, but that could very well understate what may actually occur.
Moreover, the $1.12 "annualized" dividend represents an estimated forward payout ratio in the 25-30% range. Management has indicated its intention to eventually get the payout ratio up to 30% or 35%, highlighting the idea that the dividend could very well grow faster than earnings in the coming years.
If Penske were to grow earnings by 6% annually and eventually pay out, say, 32.5% of its earnings in the form of cash dividends, you might anticipate a 5-year dividend growth rate of over 7%. Expressed differently, you might expect to collect $7 or so in dividend payments over the next half decade.
Triple Threat #3 = Multiple Expansion
On a trailing basis, shares of Penske are presently trading around 10.5 earnings. Should this multiple hold in the future, you'd have a future share price near $51 (10.5 times $4.90). Once you add in the dividends, you come to an expected value of about $58 as compared to a current price under $40. This represents an annualized gain of about 7.8%, which, incidentally, is quite close to the annual rate investors saw over the past decade.
Of course, the company's average historical multiple has been a bit higher than the present one. Shares have more regularly (before the last year or so) traded with an earnings multiple in the 13-14 range. Should investors instead be willing to pay say 12 times earnings for shares, your anticipated price would be closer to $59, resulting in a total anticipated annualized gain of over 10%.
With just a few differences - an expanding rather than contracting multiple and a higher dividend - suddenly your anticipated returns go from reasonable to quite solid.
Of course, none of this has to occur. You should always contemplate your own expectations and see how those mesh with what the market happens to be offering. However, the idea is that the possibility for reasonable or better returns is certainly there. In the past, you had a very strong business that had a valuation drag and low starting yield. Today, you might not anticipate that the business can continue to grow as quickly as it had, but you have some potential "boosts" in the way of a lower valuation and much higher beginning dividend yield.
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.