You Can Pay Fair Value For High-Quality Blue-Chip Stocks

Includes: BRK.B, CL, JNJ, KO, MCD, NKE
by: Tim McAleenan Jr.

One thing that I have come to appreciate recently is that some of the highest-quality dividend growth companies move from strength to strength. Take a company like Colgate-Palmolive (NYSE:CL). Shares hit a high of $67.10 in 2006, $81.30 in 2007, $82.00 in 2008, $87.40 in 2009, $86.10 in 2010, $94.90 in 2011, and $105.76 so far this year. Colgate's rising stock price has been matched by 11.5% annual earnings increase over the past five years.

Why do I mention this? Because some of the highest-quality firms in the mega-cap sphere grow earnings by 9%-11% year in and year out, and this can lead to an almost annual increase in stock price. Looking back at the numbers since 2006, Colgate hit a new high every year except between 2009 and 2010 when the country was dealing with a financial crisis. And even then, we're talking about a dollar difference.

McDonald's (NYSE:MCD) has a similar story. Since 2003, McDonald's has hit a new high every year except between 2008 and 2009 (the high was $67.00 in 2008 and the high was $64.80 in 2009).

And Nike (NYSE:NKE) fits the mold as well. Since 2005, Nike's price has hit a new high each year except during the financial crisis when the 2008 high of $70.60 was not passed by 2009's high of $66.60. Although by the time 2010 came around, Nike's price soared to a high of $92.50 and has hit new highs in the two years since then.

Heck, let's consider the context of Warren Buffett's famous Coca-Cola (NYSE:KO) investment:

In 1988, Buffett began buying shares of Coca-Cola, and soon had a sizeable position with millions of shares. This surprised some on Wall Street, especially since Coca-Cola stock had gained almost 20 percent a year for eight years, with many analysts thinking it was over-valued. But Buffett was not among them, and in fact took the opposite view. Wall Street thought "he was crazy." Yet Buffett had his own metrics. He saw Coca-Cola as a "cash cow" in 1988, a company with steady shareholder equity growth and an incredibly well-known brand, globally. Buffett believed he was buying Coke at a discount price, compared to a reasonable valuation of the company and its future prospects. Buffett began buying stock in Coca-Cola Company, eventually spending about $1 billion for seven percent of the company. By March 1989, Buffett's Berkshire held close to 22.35 million shares of Coca-Cola.

Think about that. Coke had gained about 20% per year for almost a decade when Buffett decided to pounce, and that did not stop him from reaping tremendous rewards for Berkshire Hathaway (NYSE:BRK.B) shareholders. It's hard to do an apple's to apple's comparison because Buffett also bought some more Coca-Cola stock in 1994, but his $1 billion investment could be sold for around $15.5 billion today, and that does not even take into account Coca-Cola's 24 years of growing dividends that would make these results sound much better.

Does this mean I'm advocating that investors buy Coke at $78 per share today or Colgate-Palmolive at $105? Not necessarily. I could also show you studies that point out how these companies tend to offer a very cheap entry point every six years or so, and the disciplined investor can turbo-charge his returns with blue chips by exhibiting Job-like patience. But I am saying this: the Coke's and Colgate-Palmolive's of the world move from strength to strength, generating profits in almost every currency from all corners of the globe. They sell solid products that are staples of everyday life, and they have a historical record of growing earnings by 9%-12% annually. If Johnson & Johnson (NYSE:JNJ) grows earnings and dividends by 10% for each of the next three years, what do you think is going to happen to the stock price? Well, Mr. Market might offer you a bargain, or the price might go up by a commensurate amount to reflect the earnings and dividend growth of the firm. When you're dealing with the best of the best, it shouldn't surprise you if the price of the stock keeps going up.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.