An example of how losers can become winners is found by following the investors in Thatcher Glass, a milk bottle manufacturer that was profitable in the early 1950s, during the early years of the U.S. baby boom. It is quite likely that many readers recall these bottles from when they were growing up, as Thatcher was the first milk-bottle producer and retained a dominant share of the market.
One might believe that holding on to stock in this firm would be a disaster. Births peaked in 1957 and then began to decline quickly. The baby boom turned into a baby bust. Glass milk bottles went the way of the dinosaur, soon to be replaced by waxed cardboard milk cartons, which were much cheaper, lighter, and more convenient. Today Thatcher Glass products can only be found in the memorabilia sector of eBay, going for a few dollars a bottle.
But this doesn’t mean that those who bought and held Thatcher Glass for the next forty-seven years did not do well. The glass company was bought nine years later by Rexall Drug, which became Dart Industries, which merged with Kraft in 1980 and was eventually bought by Philip Morris in 1988.1 An investor who purchased only 100 shares of that company in 1957 would now have 140,000 shares of Philip Morris stock worth over $16 million!
TABLE A1: TWENTY BEST-PERFORMING FIRMS IN TOTAL DESCENDANTS PORTFOLIO
You might exclaim how lucky that was. But such luck is not uncommon: thirteen of the twenty best-performing stocks of the original S&P 500 companies resulted from riding the coattails of other firms. Thatcher Glass was the second best-performing S&P 500 firm not because of its accomplishments alone, but also because of those of its successors.
It is most certain that in the next half century the acquiring firms will be global firms. Nearly 15 percent of the Total Descendants portfolio consists of companies that are headquartered outside the United States. Electrolux, the Swedish firm that is the world’s largest producer of household appliances, bought Emerson Radio; British Petroleum bought former Dow industrial Anaconda Copper, Atlantic Richfield, and Amoco; Australian News purchased Twentieth Century-Fox; and Diageo, a British firm and the world’s largest producer of alcoholic beverages, purchased the Liggett Group’s food and tobacco interests, to name just a few.
R.J. Reynolds Tobacco and Philip Morris: The Cultivation of Winning Firms
Thatcher Glass became the second best-performing stock in the S&P 500 because of its purchase by Philip Morris. But Thatcher Glass is not the only firm to benefit from being purchased by the leading cigarette manufacturer: fully four original S&P 500 firms made it to the top twenty because of Philip Morris and its predecessors.
The full corporate story of Philip Morris is complex, but the outstanding performance of its stock makes its history worth retelling. Because of its acquisitions, Philip Morris winds up with the primary holdings of ten separate companies from the original S&P 500. Remarkably, all ten of these original S&P 500 companies outperformed the market.
Throughout the postwar period there were two prominent U.S. tobacco manufacturers, Philip Morris and R.J. Reynolds Tobacco. Philip Morris not only made Marlboro, the world’s most successful brand, but also Parliament, Merit, Virginia Slims, and L&M (the flagship brand of Liggett and Myers, which Philip Morris bought in 1999). Reynolds Tobacco made Camel, Winston, Doral, and Salem, four of the top ten leading brands.
As smoking declined and the threat of legal actions against cigarette manufacturers increased, both firms used their plentiful cash to acquire other firms, particularly in the food industry. In 1985, Philip Morris purchased General Foods, and R.J. Reynolds Tobacco bought Nabisco Brands, forming RJR Nabisco.2 Nabisco Brands, through previous mergers and acquisitions, absorbed two other original S&P 500 firms, including Cream of Wheat in 1971 and Standard Brands in 1981. Reynolds also had purchased Penick & Ford in 1965, as well as Del Monte Foods in 1979, which had earlier purchased California packing in 1978. All six companies in the RJR lineage, including RJR itself, beat the market by more than 2 percent a year, and the top two, California Packing and Standard Brands, outperformed the S&P by over 5 percent a year.
In 1988 Philip Morris purchased Kraft for $13.5 billion. The following year RJR Nabisco was taken private by Kohlberg Kravis Roberts (KKR) in the largest leveraged buyout in history. KKR paid $29 billion for RJR Nabisco, and three years later, in 1991, sold a portion of the firm to the public in the form of RJR Nabisco Holdings.3, 4
FIGURE A1: CORPORATE EVOLUTION OF PHILIP MORRIS FROM 1957
RJR Nabisco Holdings spun off its ownership of Reynolds Tobacco to shareholders in 1999, but due to the fact that RJR was a much smaller share of Nabisco Holdings than Nabisco, shareholders still had a majority of their investment in Nabisco Holdings. Nabisco Holdings was then bought by Philip Morris in 2001.
After this purchase, Philip Morris combined General Foods, Kraft, and Nabisco Holdings into one company called Kraft. Sixteen percent of Kraft was sold from Philip Morris in an IPO in 2001 (proceeds were over $8 billion).
From the direct Philip Morris lineage, General Foods became the seventh best-performing firm of the original S&P 500 firms, giving shareholders a return of 16.85 percent per year, 6 percent better than the S&P 500. Kraft Foods, whose original parent was National Dairy Products, is the same company I cited in Chapter 1 as having the best return among the largest fifty firms in 1950. National Dairy came up number eighteen on the list of the best original S&P 500 companies.
As a result, Philip Morris is the legacy firm for ten original S&P 500 firms: the six from the RJR lineage, General Foods, Kraft, Thatcher Glass, and Philip Morris itself. All ten of these companies ended up beating the S&P 500 Index, and four are among the twenty top-performing original stocks.
The Performance of the Twenty Largest Firms in 1957
Most of the companies that reached the top twenty (Table 3.1 in Chapter 3 and Table A2) started out quite small. None of the top-twenty performing stocks from the Total Descendants portfolio ranked larger than sixty-fifth in market capitalization in 1957. Since the S&P 500 index is, like most averages, capitalization-weighted, it is important to learn how large stocks performed.
The answer, as Table A2 shows, is “very well.” The return to an equally weighted portfolio of the twenty largest companies, which constituted 47 percent of the market value of the S&P 500 in 1957, generated an 11.40 percent return for investors, identical to the performance of the Total Descendants portfolio and considerably above the return on the S&P 500 Index.
The Dominance of Oil
Nine of the twenty largest firms in 1957 were in the energy sector, which was the second largest sector after basic manufacturing (materials). It is surprising that despite the rapid shrinkage of the oil sector, the top five of the best-performing stocks from these twenty largest firms were all from the petroleum industry.
Number one was Royal Dutch Petroleum, a firm founded in the Netherlands, and one of the companies that Standard & Poor’s deleted from its index in 2002 when it purged all foreign-based firms. The second best-performing firm was Shell Oil, a U.S.-based company that was purchased by Royal Dutch in 1985. Royal Dutch gave shareholders a handsome 13.6 percent annual return over the next forty-seven years, and Shell returned 13.1 percent, both far better than the S&P 500 Index.
Shell and Royal Dutch share a long history that extends back to 1892. Shell Transport & Trading, a London-based firm, built the world’s first oil tanker, which on its maiden voyage delivered 4,000 tons of Russian kerosene to Singapore and Bangkok.
At the time, Royal Dutch was developing oil fields in Asia and commissioned an oil fleet of its own. In 1903, facing competition from the Standard Oil trust and John D. Rockefeller, the two European companies decided it would be better to merge their operations. While both Royal Dutch and Shell Transport remained independent companies, in 1907 the two companies formed the Royal Dutch Shell Group, with Royal Dutch owning 60 percent of the firm and Shell owning 40 percent.
The original oil companies that ranked third, fourth, and fifth were Socony Mobil (which first dropped the Socony [Standard Oil Co. of
NY] name and later merged with Exxon), Standard Oil of Indiana (which merged into BP Amoco), and Standard Oil of New Jersey, which changed its name to Exxon in 1972. Each of these firms outperformed the S&P 500 Index by between 2 and 3 percent per year over the next forty-six years.
Gulf Oil, Standard Oil of California, and Texas Co. (Texaco) eventually merged to form ChevronTexaco, and both outperformed the S&P 500 Index, while Phillips Petroleum, which became part of ConocoPhillips, slightly underperformed the Index.
Of the remaining eleven firms in the top 20, the basic materials and manufacturing stocks, such as Union Carbide (now part of Dow Chemical), DuPont, General Motors, and Alcoa, lagged the market significantly. U.S. Steel would have given investors an even worse return had it not purchased and transformed itself into Marathon Oil. Bethlehem Steel, once the second largest steel manufacturer in the world behind U.S. Steel, went bankrupt in 2001 and is the only one of the original twenty largest S&P 500 stocks to lose money for investors.
It might be tempting to suggest that the outperformance of the original S&P portfolios is related to the superior returns in the oil sector, which constituted almost one-quarter of the original index. But that is not the case. Even when all firms from the oil sector are removed, all the S&P 500 portfolios of original stocks would still have outperformed the S&P 500 Index.
TABLE A2: RETURNS OF THE TWENTY LARGEST COMPANIES FROM THE ORIGINAL S&P 500
THE RETURNS OF THE ORIGINAL S&P 500 FIRMS
Included in this list are the name changes, the mergers, and the year that they occurred. It is assumed that $1.00 is invested in each of the firms and that all dividends are reinvested and all spin-offs, if any, are held. If a firm goes private, the funds from privatization are assumed to be invested in the S&P 500 Index fund, with dividends reinvested. If the privatized firm goes public again, the total accumulated in the index fund is used to purchase the newly issued firm. These firms comprise the Total Descendants portfolio, as described in Chapter 2.
This list displays the breakdown of the accumulation of each dollar between the parent and spin-offs, and the percentage allocated to each. Included is the rank by market capitalization of each firm on February 28, 1957.
NOTES
2: Creative Destruction or Destruction of the Creative?
1. Richard Foster and Sarah Kaplan, Creative Destruction: Why Companies That Are Built to Last Underperform the Market, and How to Successfully Transform Them (New York: Random House, 2001), 8.
2. This undertaking would have been impossible without the superb work of my research assistant, Jeremy Schwartz.
3. Ironically, the S&P Composite Index excluded the largest stock in the world at that time, American Telephone & Telegraph, so as not to let one firm dominate the index.
4. At that time, the firms in the S&P 500 Index accounted for about 85 percent of the value of all NYSE-listed stocks.
5. From S&P’s Web site, http://www2.standardandpoors.com/spf/pdf/index/500factsheet.pdf.
6. Since 1993, new additions to the index have averaged slightly more than 5 percent of the index’s market value.
7. When a firm went private, I assumed the funds from the privatization were put into an index fund whose returns matched the updated S&P 500 Index. If a privatized firm went public again, I assumed that the firm was repurchased with the funds that were put into the index fund. Privatized firms constituted only about 3 percent of the value of these portfolios.
8. This assumes there are not enough sellers, including short sellers, to offset the automatic increase in demand.
9. In March 2004 Standard & Poor’s announced that starting in 2005 the firm would weight the stock in its index by the amount of “float,” or shares that are available to outside investors, instead of by the total number of shares. This would reduce shares in the index when shares are closely held by owners (as is the case with Wal-Mart) and may moderate the price movements in the stocks upon addition and deletion from the index.
10. See “Index Effect Redux,” Standard and Poor’s, September 8, 2004. The impact on the prices of stocks added by S&P has been reduced in recent years, but this is partly due to speculators bidding up the price of stocks before the announcement. See also Roger J. Bos, “Event Study: Quantifying the Effect of Being Added to an S&P Index,” Standard and Poor’s, September 2000.
11. The Baby Bells were Southwestern Bell, Bell South, Bell Atlantic, NYNEX, Pacific Telesis, Ameritech, and US West Communications. In 2004 the surviving firms are SBC Communications (Southwestern, Ameritech, and Pacific Telesis), Bell South, Verizon (Bell Atlantic and NYNEX), and Qwest (US West).
12. If the dividend yield on the Total Descendants portfolio is significantly higher than the other portfolios, this is a tax disadvantage, but this effect was not significant for the portfolios we analyzed.
13. There are a few cases where a stock distribution is considered a taxable event by the IRS.
3: The Tried and True: Finding Corporate El Dorados
1. Richard Foster and Sarah Kaplan, Creative Destruction, 9.
2. The firm retained its ticker symbol, MO, or “Big Mo,” as traders affectionately call Philip Morris.
3. S&P deleted this company from its index only five months after the index was launched. Although the firm was one of the smallest in the index ($6 million capitalization), inquiries to S&P have come up with no reason why the firm was deleted.
4. See the Heinz Web site, http://heinz.com/jsp/about.jsp; Associated Press, “Heinz Enters Talks to Acquire European Company,” December 20, 2000; Nikhil Deogun and Jonathan Eig, “Heinz Is Close to a Deal to Buy CSM’s Grocery Products Unit,” Wall Street Journal Europe, December 20, 2000.
5. When we add Kroger, a consumer staples firm, eighteen, or 90 percent, of the firms are in either consumer staples or health care. Chapter 4 describes the evolution of these industries.
6. Firms with zero or negative earnings were put into the high-P/E-ratio quintile. Returns were calculated from February 1 to February 1 so that investors could put actual instead of projected earnings in for the fourth quarter.
7. If the firm repurchases its shares in lieu of paying a cash dividend, the same positive effect on returns will be realized. See Chapter 9 for a discussion of share repurchases.
8. Peter Lynch with John Rothchild, One Up on Wall Street (New York: Simon & Schuster, 1989), 198–99.
9. Charles Munger. “A Lesson on Elementary, Worldly Wisdom as It Relates to Investment Management and Business,” 1994 speech at the USC business school.
10. Jeremy Siegel, “The Nifty Fifty Revisited: Do Growth Stocks Ultimately Justify Their Price?” Journal of Portfolio Management 21, 4 (1995), 8–20.
11. Peter Lynch with John Rothchild, Beating the Street (New York: Simon & Schuster, 1994), 139.
12. Warren Buffett, “Mr. Buffett on the Stock Market,” Fortune, November 22, 1999.
4: Growth Is Not Return: The Trap of Investing in High-Growth Sectors
1. Qi Zeng, “How Global Is Your Industry,” U.S. and the Americas Investment Perspectives, Morgan Stanley, New York, June 30, 2004.
2. For reference, see the weekly publication “Sector Strategy: Where to Invest Now,” Goldman Sachs Equity Research, New York.
3. Formerly stocks were classified by SIC, or Standard Industrial Classification, a system developed by the government. In 1997 the SIC codes were expanded to include firms in Canada and Mexico and renamed NAICS, North American Industrial Classification System.
4. “Oil-Gas Drilling and Services Current Analysis,” Standard and Poor’s Industry Surveys, August 14, 1980, 0103.
5. As of March 2004 only Delta and Southwest belong to the S&P 500 Index. TWA, Eastern, Pan Am, and United went bankrupt.
6. Real energy prices fell about 30 percent from 1977 through 1997 after adjusting for inflation.
5: The Bubble Trap: How to Spot and Avoid Market Euphoria
1. Alan Greenspan, opening remarks at the symposium “Rethinking Stabilization Policy,” s
ponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 29–31, 2002.
2. Robert Shiller, Irrational Exuberance, 2nd ed. (Princeton: Princeton University Press, 2005), 87.
3. Ralph C. Merkle, “Nanotechnology: What Will It Mean?” IEEE Spectrum, January 2001.
4. Gregory Zuckerman, “Nanotech Firms Turn Tiny Fundamentals into Big Stock Gains,” Wall Street Journal, January 20, 2004.
5. This and all other articles that I wrote can be accessed through http://www.jeremysiegel.com.
6. Bloomberg News mentioned that Mary Meeker, the Internet guru from Morgan Stanley, had also warned about Internet stocks in an article in the New Yorker.
7. Shorting is the strategy of selling shares you do not own by effectively “borrowing” them from someone else. The short seller hopes to make a profit by replacing the borrowed shares by buying them back at a lower price. Clearly if the stock price rises, the short seller loses.
6: Investing in the Newest of the New: Initial Public Offerings
1. About one-third of these firms survived in their current corporate form through December 31, 2003. Ifthey did not, I substituted the return on the Ibbotson small stock index (see note 2 for this chapter).
2. The small stock index consists of the smallest quintile of stock traded on the New York and Nasdaq exchanges and is reported by Ibbotson.
3. Jay Ritter, “The ‘Hot Issue’ Market of 1980,” Journal of Business 57, 2 (1984), 215–40.
4. Jay Ritter, “Big IPO Runups of 1975-September 2002,” available at http://bear.cba.ufl.edu/ritter/RUNUP750.pdf.
5. TheGlobe.com subsequently traded as low as 2 cents a share, VA Linux at 54 cents.
The Future for Investors Page 27
