Yes, I admit it: I've sounded almost purely bearish in my articles the past few months.
First, perhaps foolishly, I disagreed with Ray Dalio about the "beautiful deleveraging" that he sees happening currently, demonstrating that, on the contrary, debt growth has continued at a rapid clip in almost all areas since the Great Recession.
Then I discussed seven significant ways that American consumers are worse off today than decades ago, concluding that the confluence of these factors will ultimately lead to a slowdown of GDP growth.
Most recently, I explored some spooky similarities between the 1920s and the 2010s, resolving that though history doesn't repeat, it may very well end up rhyming.
These are strange and unique times. We are nearing the end of a long-term, central bank-driven debt cycle. Much of the stock market's success over the past handful of decades has been due to the Greenspan/Bernanke/Yellen/Powell put, accommodative monetary policies which fueled earnings growth through progressively cheaper cost of capital. Having exhausted almost all room at the lower bound of interest rates, we are entering into a new age in which quantitative easing will be central banks' primary lever of further accommodation.
But monetary policy isn't the only way that the financial world is changing. The rapid rise of the Chinese economy heralds a new age of international trade and geopolitics. The crumbling foundations upon which European prosperity has been based since the end of the second World War bodes poorly for the Continent. And though the United States remains the shiniest tool in the toolshed, we, too, have our problems: slowing growth, political polarity, and many signs of a peaking market.
How does one invest in such an uncertain environment?
The purpose of the Equities for Alpha series is to identify certain qualities or subsets of stocks that are positioned to outperform the market over the long-term.
We start today with one of particular interest to me: Family businesses.
My grandfather founded a cable company in Texas, which expanded into several other states and was eventually acquired (at a generous multiple) by a communications conglomerate during the cable TV frenzy in the late 1990s. The real estate company that owned some of the land under the cable company's buildings, however, remained in the family. My father took over that company and expanded it into a well-oiled commercial real estate cash flow machine. I am currently a real estate agent working at a residential investment and management company (also family-owned and operated, though not by my family), and I hope to play some part in my family's business someday.
Needless to say, I have a soft spot for family businesses.
Why Family Businesses Outperform
McKinsey & Co. defines a family business as “one in which a family owns a significant share and can influence important decisions, such as the election of a chief executive.”
Publicly traded family businesses typically take one of two forms: single share class or dual share class. Some companies have a single common share class in which family members own a significant enough portion to effectively control the direction of the company (or at least appoint its decision-makers). Other companies have dual share classes in which the family may own little of the non-voting class but a much larger portion of the voting or supervoting class.
A common perception of family businesses is what takes place in the show Arrested Development. In the farcical comedy, the Bluth Company's founder is removed from control after going to prison for a white collar crime, leaving his materialistic, spoiled, and self-absorbed family to run it. Michael Bluth, the only competent scion of the founder, has to share management responsibilities with his totally incompetent and petty siblings.
Indeed, the idea of a "family business" often brings rampant nepotism to mind for many people. It seems intuitive to many that, once the innovative and hard-working founder of a company passes on, his or her inevitably less capable heirs will run it into the ground. We've all heard some version of the pithy platitude about generational wealth: the first generation earns it, the second generation enjoys it, the third generation depletes it.
Perhaps this is true of many family businesses, but certainly not all. The ones that successfully make it past the succession of the founder and to the initial public offering (IPO) phase tend to perform quite well.
Credit Suisse found in a 2017 report that family businesses tend to outperform the market by 400 basis points annually, even (and especially) during recessions. They have stronger revenue and EBITDA growth as well as higher margins and better cash flow returns. This holds true for both smaller and larger companies.
According to ValueWalk, “Companies in which founders and their families hold controlling stakes have the rare ability to maintain a long-term view. That can be a huge advantage, particularly when it comes to capital allocation.”
The ability to maintain a long-term view may be the single biggest factor in family business outperformance.
“When I ask owners whom do they work for, they answer ‘for my kids and their kids,'” says Justin Craig of the Kellogg School of Management.
In my view, this is why family business stocks, as we will see, make such steady dividend payers. A dividend cut might produce some financial blowback for the company, but it's nothing like the distress of telling family members that their income is being decreased. Imagine the head of a company having to call her grandfather, who also ran the company in his day, to give the news that his retirement income would soon be curtailed.
This multigenerational perspective frees up the company's management team, whether they're family members or not, to maintain prudence and discipline when it comes to capital allocation decisions.
From ValueWalk: “A 2016 BCG [Boston Consulting Group] study found that the financial leverage of family-controlled businesses was 27% lower on average than that of comparable peers.”
Contrast this prudence and investment discipline with the short-termist behavior exhibited by many other publicly traded companies. Family-owned businesses have the ability to invest in opportunities that may yield no immediate returns but will position them well in the future. They also have the option to refrain from investing if no compelling opportunities present themselves. Contrary to stocks with a more diffuse ownership which tend to focus only on the next few quarters, family businesses have the freedom to look out into the next few years or decades. The more emphasis and resources corporate executives devote to short-term stock price, the less emphasis and resources can be allotted to long-term value creation.
The largest share of allocated capital for executives of diffusely owned corporations is M&A, but the value creation for these deals tends to lie not in the acquiring company but in the target company since the acquirer typically pays a ~30% premium to secure the deal. Shareholders of the target company enjoy a nice, immediate return, but shareholders of the acquiring company typically do not see nearly the same returns.
Family businesses certainly do engage in some M&A, but when they do, they tend to pay lower multiples than their non-family controlled counterparts.
This capital discipline does have a slight downside. Researchers from Harvard Business School
show that during good economic times, family-run companies don’t earn as much money as companies with a more dispersed ownership structure. But when the economy slumps, family firms far outshine their peers. And when we looked across business cycles from 1997 to 2009, we found that the average long-term financial performance was higher for family businesses than for nonfamily businesses in every country we examined.
Since family business leaders have a long-term focus, they don’t react as strongly to the ups and downs of the market. “The market may be heating up, but family firms will put their cash away,” says Justin Craig. “They know the market will come down, and that’s when they step in. They ride the cycle differently.”
Researchers from Boston Consulting Group concur with their Harvard colleagues' findings:
...we’ve conducted a study of over 400 companies in seven countries. What we found consistently is that family businesses tend to outperform their nonfamily business peers in periods of recession, but they also underperform, slightly, in periods of expansion. They tend to be prudent.
And they do a number of things to get to this result. First of all, they tend to be more frugal. They are more cost conscious in both good times and bad times. They have lower debt. They are quite cautious with acquisitions. They like diversification, both in terms of sector and geographies.
This does not hold true, however, for family businesses in emerging markets:
What we found in emerging markets was that the family businesses always grew faster than the nonfamily businesses—in good times or bad times. And we also found that they were actually less profitable in good times or bad times. They were actually willing to spend their profits to invest toward growth.
Keith Baldwin and Andrew Steen identify seven primary traits of family business operations that contribute to their outperformance:
- Better Scrutiny of Capital Expenditures
- An Aversion to Debt
- Fewer (and Smaller) Acquisitions
- International Presence
- Retention of Talent
Perhaps as a result of these traits, family businesses tend to be more trusted than their non-family peers. In a 2017 Edelman survey, 75% of respondents trust family businesses over non-family businesses. When it comes to public trust in general, The Economist reports that 66% of people trust family businesses, versus 52% who trust in other public non-family businesses and 46% who trust state-owned companies.
Unfortunately, the number of family-controlled businesses is shrinking. According to Baldwin and Steen, “The number of publicly-listed companies in the US has declined precipitously over the past 20 years and currently sits at just half of the all-time high reached in 1996.”
This makes identifying these high-quality family businesses a more challenging task, to which we turn next.
Twelve Family Business Stocks
1. J.M. Smucker (SJM)
J.M. Smucker is one of the oldest family businesses around, having been founded in 1897 and currently in its fifth generation of family leadership.
Mark (President & CEO), Richard (Executive Chairman), and Timothy Smucker (Chairman Emeritus) together own a little over 3.6% of the company, around $440 million worth of SJM stock. These three alone have a substantial amount of their own wealth tied up in the company.
Mark Smucker is the fifth generation of his surname to lead the company. His father, Tim, and uncle, Richard, were co-CEOs before him. Richard Smucker is chairman of the board. His great, great grandfather, Jerome Monroe Smucker, founded the company by selling apple butter out the back of a wooden cart.
That means the current CEO of the company is the great, great, great grandson of the founder.
Growing up, the siblings and cousins of Mark's generation all worked at the company, performing tasks as menial as janitorial work and as consequential as marking and sales. (When the family business is real estate, as it was in my case, the menial work is much more laborious: painting exterior buildings, cleaning out clogged gutters, trimming hedges, etc.)
It is a longstanding tradition that at Smucker’s, employees are treated like family. In 2016, J.M. Smucker placed 6th on Indeed.com’s top ten best places to work list. As such, it is the most favored food company to work for in the United States.
SJM has raised its dividend for 18 years in a row. Over the past 20 years, the stock has drastically outperformed the market:
2. Franklin Resources (BEN)
The company was founded by Rupert Johnson in 1947 as a retail brokerage firm, and the Johnson family still owns about 35% of the company. The second generation leaders of the company, Charles and Rupert Jr., ran the business for many decades. Currently, Charles' son Gregory and daughter Jennifer are CEO and COO, respectively.
Interestingly, Charles Johnson also owns a large stake in the San Francisco Giants.
But considering that, in my view, we will likely see another round of QE in the future, benefiting from QE (and being hurt by QT) isn't necessarily a downside to owning the stock.
BEN is a dividend aristocrat, having paid a rising dividend over the past 37 years. With special dividends, the company pays out close to 100% of FCF. Without special dividends, it pays out only about a quarter of FCF. Thus, the current $1.04/year dividend appears safe.
Like SJM, BEN has handsomely outperformed the market over the last 20 years:
3. Urstadt Biddle Properties (UBA)
Coming from a commercial real estate family myself, this one bears a certain familiarity to it, though focused in a different region of the United States.
UBA owns high-quality shopping centers, typically grocery anchored, geographically confined to the tri-state area of New York, New Jersey, and Connecticut. Some might say this geographic concentration is a weakness of the company. I disagree. Clustering properties relatively closely as UBA does gives management the ability to visit property sites in person within a day's drive.
UBA's properties are also located in areas with limited developable land and restrictive zoning laws, which limits overbuilding.
Their properties have a strong demographic profile, boasting the highest median income in a 3-mile radius ($95,400) of any shopping center REIT (even higher than ultra-high quality Federal Realty Investment Trust (FRT)). They can also claim the third highest rent per square foot in the shopping center REIT space.
Their tenants are overwhelmingly e-commerce- and recession-resistant (a similar focus of tenants in my father's business). Occupancy has never fallen below 91%, which is fantastic for a shopping center REIT.
Urstadt-Biddle has dual share classes: one that is more liquid, primarily held by institutions, and pays a 10% higher dividend (UBA); and another that is primarily held by insiders and has supervoting rights (UBP).
As pointed out by SA author Risk Hunter, insiders (family members) own ~20% of common and supervoting shares and, as such, will prefer non-dilutive methods of growing. Plus the family ownership is a natural buffer against dividend cuts. UBA has upped its dividend for the past 25 years, making it a newly minted dividend aristocrat.
UBA joins the ranks of those family businesses that have outperformed over the past 20 years:
4. Adams Resources (AE)
Diversified oil and natural gas company, Adams Resources, was founded by "Bud" Adams in 1947 as the "ADA Oil Company" and later went public in 1974. Insiders (including non-family management) own approximately half the company.
It's noteworthy that AE has zero debt and nearly $28 per share of cash in the bank. Of course, the company needs a large amount of cash to operate its oil buying and selling (marketing) business, but much of their cash is excess. Most of their earnings come from marketing operations.
Unless the Green New Deal somehow becomes the law of the land, the United States has many years (decades, even) of oil and natural gas production to look forward to, and that production will need transportation, which Adams also provides.
The founder, Bud Adams, also owns the Tennessee Titans (you'll notice a theme of family business leaders owning sports teams).
Once again, the family business outperforms:
Brown-Forman is a producer of American whiskeys, such as Jack Daniels, Old Forester, and Woodford Reserve.
It was founded by pharmaceuticals salesman George Garvin Brown in 1870 (perhaps whiskey was the original cough syrup?) and is now overseen by his great-grandson, George Garvin Brown IV, the current Chairman of the Board. The family retains 51% ownership of the company, and that ownership is shared among at least 25 of the founder's descendants.
Like Urstadt-Biddle, Brown-Forman has a dual share structure. Class A shares are owned primarily by the family and are scarcely traded, while Class B shares are highly liquid but have no voting rights. The yield is the same for both.
Brown-Forman is currently being hurt by the international trade war, as tariffs on US products have taken a $125 million bite out of net sales. Sixty percent of sales come from non-US countries, while 40% comes from within the US. That international exposure is evenly split between developed and emerging markets.
While the dividend yield is minimal at 1.31%, the company has grown its dividend for 34 years and pays out a little less than 40% of its earnings to shareholders. It has outperformed in the last 20 years quite comfortably:
6. Comcast Corporation (CMCSA)
Communications and entertainment conglomerate, Comcast, owns Xfinity, several cable channels (including MSNBC, CNBC, and the USA Network), film studio Universal Studios, as well as Universal Parks & Resorts.
Brian Roberts, son of the founder, Ralph Roberts, owns about 1% of all Comcast common shares but all of the Class B shares, which are supervoting. This gives him a fixed 33% voting power over the company, more than enough to exert control.
It’s interesting to note that Comcast had no negative years during the Great Recession in terms of revenue and only one mildly down year (2008) in terms of net income.
Thanks to a strong bull run since the Great Recession, Comcast joins the ranks of family business outperformers:
7. Enterprise Products Partners (EPD)
Dan Duncan founded the midstream energy company in 1968 with $10,000 and two propane trucks. He took the company public in 1998, and EPD has been paying a steadily rising distribution every year since. The company is now a $61 billion pipeline behemoth in the midstream energy landscape.
When Duncan died in 2010, his majority stake in Enterprise was left to his four children, who each inherited about $3 billion worth of EPD stock. The four siblings still exert considerable control of the company and have enjoyed the wealth compounding effect of a generous dividend and rising stock price in the years since their father’s death. The founder’s daughter, Randa Duncan Williams, is currently the Chairman of the Board. The other three siblings are not actively involved in the business.
The Duncans are fortunate. Their family business has utterly obliterated the market over the past 20 years:
8. Ford Motors (F)
Ford Motors needs no introduction. I think of it as the all-American car manufacturer that didn't take taxpayer stimulus money during the Great Recession. Good for them.
Currently, the largest shareholder is William Clay Ford, Jr., great-grandson of founder Henry Ford. With ownership of 6.8 million shares and having spent five years as CEO and many more years as Executive Chairman, “Bill” Ford has taken as active a role as any in the family business. Ford’s descendants own only 2% of the common shares but retain 40% of the voting rights through ownership of Class B shares. They still meet regularly to discuss the operations of the business and its direction.
Unfortunately, the company has drastically underperformed the market over the last 20 years, but if one had bought in the doldrums of the Great Recession, one would have enjoyed many years of outperformance since:
9. Nordstrom (JWN)
The well-known retailer has been family-owned since its founding in 1901. The family currently owns a little over 30% of the company.
John Nordstrom, one of the original founders, built a successful shoe store in Seattle, handing it down to his children, who expanded into women’s clothing. The third generation Nordstroms added men’s and children’s apparel in the 1960s, opened department stores, and took the company public in 1971. The fourth generation were early adopters of the Internet, taking Nordstrom online in 1998.
Unfortunately, Blake Nordstrom, who had been working in the family business for most of his life, rising up from the stockroom at the age of 11 all the way to co-president, died unexpectedly on January 2nd of this year at the age of 58. He had been diagnosed with lymphoma just a month before his death.
The family has tried to take the company private multiple times, which to me, is a good sign. They see the company’s value and would like to be its sole owners.
While JWN's dividend has remained flat since 2015, the company has been paying and generally raising its dividend since 1988, not once cutting or suspending it. Even in the midst of the retail apocalypse, Nordstrom has outperformed over the last 20 years:
10. Rogers Communications (RCI)
The Canadian communications corporation was founded by Ted Rogers in 1960 as a single FM radio station. It has since expanded into a diversified conglomerate, mainly focused on communications services such as Internet, TV, and cell phones.
The founder died in 2008, but two of his four children, who were active in the business, have taken up leadership roles, although not executive roles.
The Rogers family, who happen to be the 4th richest in Canada, still exert considerable control of the company through Class B supervoting shares. They also, interestingly, own several sports teams based in Toronto, including the Blue Jays.
RCI's outperformance has been strong in the past 20 years:
11. Shaw Communications (SJR)
Another Canadian communications corporation (and competitor to RCI), SJR was founded by J.R. Shaw in 1966 as a cable TV provider. It has since expanded into many of the same areas as Rogers Communications, including cell phones, Internet, and TV.
The family owns about 78% of the Class A (voting) shares through a living trust.
SJR has also outperformed in the last 20 years, but not as handily as RCI:
12. Walmart Inc. (WMT)
Here is another company that needs no introduction.
Walmart was founded in 1950 by Sam Walton as a Five & Dime store in Bentonville, Arkansas. The first true Walmart (“Walton Market”) store opened in 1962. After he died, Walton left his huge stake in the company to his family, who still own a little over half of the retail giant.
Walton Enterprises LLC is the vehicle in which most of the family ownership lies (in the staggering amount of 1.415 billion shares), having been established before Sam Walton’s death as a way to keep ownership of the business in the family while avoiding taxation as much as possible.
Jim Walton, the founder’s youngest son and CEO of Arvest Bank, owns the most direct shares in the company — 10.5 million as of July 2018. Alice Walton, the founder’s only daughter and a finance businesswoman, is the second largest shareholder, with 6.7 million shares. Samuel Robson Walton, the founder’s eldest son and a lawyer by trade, is the third largest shareholder, with 3.34 million shares. The fourth largest shareholder is another insider: Marc Lore, the former CEO of jet.com and current CEO of Walmart’s eCommerce division, owning 3.3 million shares.
Walmart boasts 46 consecutive years of dividend growth, making it one of the most aristocratic of dividend aristocrats.
The company pays out only 35% of its free cash flow and actually saw its earnings rise during the Great Recession, counting it as one of the few anti-cyclical stocks. It appears that Walmart is positioned to continue growing its dividend for many years to come.
The stock has just barely underperformed the market in the last 20 years, faring much better in bear markets than bull markets:
Any I Missed?
What do you think? Are there any publicly traded family businesses that I've neglected? (Especially ones that pay dividends.) Let me know in the comments!
Disclosure: I am/we are long SJM, EPD. 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.