No. of Recommendations: 23
I've been thinking about how best to capitalize on the investment opportunities before us. One issue is timing: Very low prices are here now for many quality names. They may go much lower. They may not -- once the panic subsides, prices on the very best names, the ones we want, may go back up and never trade as low again. This may be the best opportunity we’ll ever have. Or, it may be surpassed by much better opportunities, perhaps around March of 2009, as has been suggested on this board, or perhaps in 2010 after a terrible rout reminiscent of the Great Depression. Or the best opportunities may be gone for good after they are generally recognized as safe or the money simply starts coming back. There is no way to know.

I've decided to pretty much stop selling puts to open. The trades take up quite of bit of capital and deny me the opportunity to invest those funds elsewhere should much better opportunities arise. Worse, sometimes the stock falls below my strike price, but my puts are never bought, leaving me waiting. Most of the time I will probably use limit orders. I might make an exception if AAPL goes down hard and fast again -- the put money is good, and I would love to own the stock if the option were to be executed. Less volatile names, such as JNJ for example, just don't seem to offer the payoff even in this volatile market.

So, what to buy, at what price, and when?

As for when, I've resolved to break my funds into deciles, investing 1 decile any day now (I'm currently 100% cash), reserve 2 deciles each for the first half of 2009, the second half of 2009, and for the whole of 2010, leaving 3 deciles for trading opportunities as they arise. Of course, if the market normalizes before the end of 2010 I'll roll up this plan. But so far, this is my plan going forward.

As for what to buy and at what price, I've been looking at candidates that I believe will survive this crisis in spite of the possibilities of a global financial meltdown, exploding pension fund obligations, and the collapse of entire economies. I have long said that some companies are safer than US Gov't Bonds. I can imagine the US Gov't going bankrupt in my lifetime -- but JNJ and other well-run multinationals will certainly be going concerns in one form or another long after I'm gone.

As the opportunities we are presented with are quite unique, it bears the most careful consideration which to buy and why. Which companies would you hold for 5 or 10 or 20 years if you could get them at low enough a price that the dividends would repay you for your wisdom over and over and over?

Well, first, what do the dividends do for you? I've tried to work that out. Here's what I've come up with -- but beware, I'm no math genius:

First of all, I've looked at the growth of dividends in several companies since 1992, taken that 16 year average and cut it in half to adjust for the rotten times ahead, and looked at where their dividends might be in 10 years. Here's what that looks like:

92 Div 08 Div Gr Rt Div In 10 Years at 1/2 Growth Rate
HMC $0.06 $0.82 17.8% 3.5% 8.2%
TM $0.30 $1.50 10.6% 4.2% 7.0%
JNJ $0.22 $1.80 14.0% 3.1% 6.1%
PG $0.26 $1.45 11.3% 2.5% 4.3%
MMM $0.80 $2.00 5.9% 3.1% 4.1%
KO $0.28 $1.52 11.2% 3.3% 5.7%
PEP $0.26 $1.52 11.7% 3.1% 5.5%
GE $0.19 $1.24 12.4% 6.7% 12.2%

HMC and TM don't really grab me. I know, I know, extraordinarily low stock price and all that -- but we're still headed into an ever-deeper recession, so I think I'll just wait and see where they go over the next couple of quarters. But I was surprised at their excellent dividend growth over the years.

GE, of course, will not be raising their dividend till at least after 2009, and that's if they are able to keep it at all, so my number there isn't properly in line with the rest. Besides, would you really be surprised to see them cut it in half at some point in the next 18 months? I wouldn't. Their recent trouble makes me wonder what sort of future the company has, and how much their numbers have been the result of GE Capital all along. So never mind.

PG and MMM I worry about. PG because white labels will eat away at PG's market share for perhaps years to come, and MMM because they just don't grow their dividend very well, making them a less attractive long-term prospect. KO and PEP have similar issues. None of them are as financially strong as JNJ.

So JNJ gets the nod. I doesn't appear to have the financial time bombs many other companies do, whether due to pension fund obligations or just plain debt, and it has excellent management on board. Perhaps Big Pharma will have some trouble in the new administration's term(s), but it may not be as bad as all that -- it's all happened before without slowing JNJ over long holds -- and besides, JNJ is only 40% Pharma -- PFE, for example, sold their wonderful consumer brand portfolio to JNJ. When the economy recovers, those brands will still be there, attached to a company with a better dividend and history of dividend growth than PG. Companies with great brands outperform handily over long holds, as does Pharma. JNJ is both.

So one thing I'm hoping to hear from you about is why JNJ is not such a great idea, and what you think would be better and why.

So for the sake of my example we've got when and what, but not price. How much should one be willing to pay for JNJ now? To answer that question I'm going to look at only one angle: what might the reward look like for buying JNJ over time?

How volatile the market is and how long it remains depressed bear strongly on that answer. All possible outcomes cannot be appreciated. So I'm going to simplify, and make some absurd assumptions in the hope of getting some idea, however loose, on what buying JNJ at different prices could mean.

My assumptions: $100,000 invested in a tax-free account. Dividends reinvested, dividends growing at 7% every year (half the rate since 1992). Stock price of JNJ grows at 3.5% every year starting at today's close of 60 (it won't; this is a simplification that attempts to capture inflation and other factors, see below), so that in 5 years JNJ trades at 71, and in 10 years at 84.5. Given all of that, how does a purchase of JNJ look at today's price -- and lower, if we can get it?

Price 5 Years 10 Years Return Dividends As Cash, 5 and 10 Years:
50 $222,997 $445,955 16.1% $11,510 $32,283
51 $217,864 $434,177 15.8% $11,024 $30,814
52 $212,960 $422,984 15.5% $10,569 $29,443
53 $208,269 $412,335 15.2% $10,141 $28,160
54 $203,778 $402,192 14.9% $9,739 $26,958
55 $199,475 $392,520 14.7% $9,360 $25,832
56 $195,347 $383,288 14.4% $9,002 $24,774
57 $191,385 $374,467 14.1% $8,665 $23,779
58 $187,579 $366,032 13.9% $8,346 $22,843
59 $183,919 $357,957 13.6% $8,045 $21,960
60 $180,399 $350,221 13.4% $7,759 $21,127

Given these assumptions, JNJ trades for so little today, with consequently so large a dividend, that at half of historical dividend growth rates and a rate of growth of its stock of 3.5%, in 10 years a $100,000 investment would throw off over $21,000 every year in perpetuity regardless of what the stock price did. If you caught it at 55, that figure becomes almost $26,000. Not bad, considering I tried to account for inflation.

I figured that JNJ might in reality grow its stock price at a rate of at least Siegel's Constant -- maybe 6.5%. Strip out 2.2% for its dividend average since 1992, give inflation a check at 2-3% versus the deflation of the stock price, and I figure 3.5% growth in today's dollars is something maybe close to fair. You may protest that 3.5% plus 7% dividend growth yields a 10.5% return, and that's hardly market normal, and that's true. It's not normal. It's somewhat exceptional. But remember, JNJ was the only company of the Nifty Fifty to come out ahead. Wyeth and Procter & Gamble both beat 14% returns from 1957-2003, and JNJ as just as good as both ever were put together. It's a great company, not an also-ran, great enough that my figures may prove to be conservative. Not only that, but the price, like the economy, has been knocked down, so future returns are likely to be greater, not average. It's an extraordinary company at an extraordinary price, yielding an extraordinary dividend opportunity. Of course the numbers are wrong -- an extended downturn in price would be much better as dividends piled in to buy the stock on the cheap -- but they might look something like this, might give us some idea what a buy might look like at different buy points 10 years from now.

What do you think?

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