Update of Portfolio: Garmin (GRMN)

Not all things are rosy in my portfolio.  I've had some losing positions over the years and this post will be on one of them.  It is the very familiar name, Garmin (Ticker: GRMN).  If you don't know what they do, they are one of the major GPS makers (alongside TomTom).

I had started my position in Garmin when I first started reading Rule #1 back in 2008.  Phil Town liked the stock and I was a Garmin user myself.  I ran some numbers and thought that the company was on solid footing.  I started buying as it fell to $40 from $120.  I thought it was an excellent price.  I continued to accumulate and had a sizeable position, with an average cost of about $37.  As the financial meltdown took its course, Garmin fell all the way to $17.  If only I had cash left at that time, I would have bought more.

Fast forward a few years, after getting paid $1.50/share in dividends and making a small amount in Garmin options, I exited the stock at around $33.50.  I bit the bullet and took a loss, because I looked at my other holdings and realized that my money was doing not much work in Garmin and the potential for growth was smaller than the others (i.e. True Religion, Google, etc.).  All in all, I lost a couple of bucks per share, but the higher costs was really the opportunity cost.

Garmin's Brief History and Current State
Let's look at how Garmin is doing these days.  If you flip through the Rule #1 analysis below, you can see that there's some missing data in MSN Money, but the data that do exist are telling.  Every was rosy until about 3 years ago.  This was when the financial crisis hit and the smartphones started to take off.

Since many people had bought a car GPS by then, the market was beginning to saturate.  Overall growth in the company became stagnant.  It also flopped on its venture into the smartphone space.  In my opinion, it failed not because it did not have a good strategy, but because of poor design choices.  The strategy of using Android as the platform was sound; HTC has become a major force in the smartphone world by adopting the Android OS, so it could be have been done.  The failure stemmed from the lackluster hardware specifications that the Garmin phones had.  Garmin's phone specs could not match those of the likes of Motorola Droid and HTC/Google Nexus One.

Figure 1: Rule #1 Analysis of Garmin (GRMN)

However, there is light at the end of the tunnel for Garmin.  As its automotive segment begins to wind down, its outdoor/fitness, aviation, and marine segments are still doing quite well and with great margins.  These segments combined already bring in more net income than the automotive segment.  Garmin will soon find its groove again if it can successfully fend off newcomers such as Nike in the outdoor/fitness segment.

The rise of China and India also presents some much needed lifeblood for the automotive segment.  So, it is not entirely dead yet.  Garmin pays a nice 5-6% dividend, has a steady cash flow, and its balance sheet is strong.  It's current P/E ratio is 11.2, which is not expensive at all.  Investors have priced it as a steady, if not declining stock.  If the stock falls below $30, it could be start to be a bargain again.

Conclusion

So, was Garmin a mistake?  Yes and no.  The mistake was exhausting my cash a little too quickly, but who would have known how low it could go back in 2008/09.  If I had only started buying a little later, I would have made some good money.  The company is not exactly a Rule #1 stock now, since it is well past its growth phase, but it could still be a value stock.  The main reason I wanted out was because I saw better opportunities out there.  Taking that loss was difficult, but it's for the better.

Rule #1 Analysis Blitz #1: Johnson & Johnson (JNJ)

The first blog post of my Rule #1 Blitz will be on Johnson and Johnson (Ticker: JNJ), the pharmaceutical/consumer products company with which pretty much everyone on this planet is familiar.  Its more well known products include Tylenol, Band-Aid, Aveeno, Neutrogena, and Johnson's Baby products.  The company has been around for over 100 years, employs more than 100,000 people worldwide, has over 230 subsidiaries, and boast of 47 consecutive years of dividend increases.  In short, this company is no joke!

Moat
So, without further ado, let's jump into our Rule #1 analysis of JNJ (download my spreadsheet here)!  Let's first look at the moat of the company, which is the first of the 3 Ms.  As I briefly stated above, JNJ is a well known company and has a tremendous brand moat.  To evaluate its moat on a quantitative basis, we look at the Big 5s and its debt.  The Big 5s include return on invested capital (ROIC), sales or revenue growth, earnings per share (EPS) growth, book value per share (BVPS) growth, and free cash flow growth.  We want all of those numbers to be 10% or greater.

From the summary chart below, we see that ROIC, BVPS growth, and free cash flow growth are green everywhere - looks good.  A few yellow and red flags are raised in sales and EPS growth.  Let's dig a little more. We see that last year's sales and EPS actually decreased from the previous year.  The year 2009 was not exactly a stellar year for the economy; so, we'll let that go.  The 5-year average numbers look a little better, with sales growth at 5.5% and EPS growth at 9.9%.  I think EPS is just fine, but sales growth seems a little sluggish.  Going back a few more years, the 9-year average for sales growth is 8.7%, which is sufficiently close to the 10%.  The time to pay back its debt with its cash flow is 0.6 years.  Anything under 3 years is fine.  So, this looks fairly good.  I'm not overly concerned about its sales and EPS growth numbers.  We just need to be a little cautious and keep our eyes open.

Moat Score: 7 / 10

Figure 1: Rule #1 Analysis of Johnson and Johnson (JNJ)

Margin of Safety

So, JNJ's moat has a conditional pass.  The remaining 3Ms are meaning, management, and margin of safety.  Meaning and management are qualitative.  Let's continue with margin of safety.  From the figure above, under Sticker Price, you will see what the intrinsic value (or sticker price) is, as calculated by the Rule #1 methodology.  The trailing-twelve-month (ttm) EPS was $4.82.  The growth number used was the lower of the estimated EPS growth and the historical BVPS growth, which was 6.3%.  The price-to-earnings (PE) ratio used was the lower of historical PE and PE estimated from EPS growth, which was 12.6.  Using these numbers, the sticker price was calculated as $27.65.  With a margin of safety of 2, the entry price is $13.83, which is 50% of $27.65.  The share price is $63.88 (at time of writing), which is more than double that of the intrinsic value!  To be fair, we used a fairly low growth number of 6.3%.  So, I went back to my spreadsheet and played with the number a little bit.  Even if we assumed 15% growth, the entry price would still be $31.81.  This stock is waaay overpriced!  If you think about it, it makes sense.  The global economy is still in shambles, and so investors will flock to defensive stocks like J&J.  Further, J&J is a well known and established company.  It will be rare that it will be undervalued by much and go unnoticed.

I'll include a blurb about Payback Time here...at 6.4% annual EPS growth, it'll take 9.6 years for the EPS to accumulate to its present share price.  I'd say it's a little on the high side for you to consider accumulating JNJ stock.

Margin of Safety Score: 1 / 10

Management
Next up is management.  How do you know management (i.e. CEO) is good?  Most of the time, you really can't tell.  However, there are some clues that help us decide.  First and foremost, how are the financials?  Let's face it, businesses exist to make money.  If the CEO can't make money for the company, there's something wrong.  From the Moat section above, he's not doing a bad job.

Second, let's look at his personal interest in the company.  We want to see vested interest, which means stock ownership.  You can find that information on Yahoo Finance easily.  Mr. Weldon owns 259,360 shares of the company stock, approximately $16 million worth.  We can also see what his recent transactions were.  In the past couple of years, Weldon had not made a single large purchase of J&J stock.  That's not a particularly bad sign, but it's not a good one either.  If I knew the company I'm running is going to make lots of money, I'm going to put more money into the company.  His most recent transaction occurred in September, where he exercised his options to purchase 238,100 shares at $50.69, and immediately after, sold it for $58.49 on the open market.  From that transaction, he made about $2 milllion.  Maybe he needed money to buy a mansion, who knows?  But it doesn't exactly give me confidence in him.  It seems like what he did was cashing out.

Management Score: 5 / 10

Meaning
Phil Town explains that a company must have meaning to an investor if he were to invest in it.  What is exactly meant by "meaning"?  It's not simply, "I like the company", type of meaning.  Rather, one needs to understand its business on a high-level and be able to identify the various issues that surrounds the business.  For example, I own First Solar (ticker: FSLR) stock.  It has meaning to me because i) I believe in renewable energy and that it will replace oil as the world's main energy source, ii) I understand First Solar's technological and business strengths compared to other solar players (i.e. its low cost thin film technology and vertically integrated business model), and iii) I am genuinely interested in this sector such that I don't mind reading up on developments on a daily or weekly basis.  It needs to interest you so that keeping up with the latest developments is not a chore.  It should be homework that you enjoy doing!  Therefore, I can't do this analysis for you.  I don't know whether J&J has any meaning to you, but for me, I think it is too diversified of a company for the typical investor to truly understand.  Unless you've worked in the industry before and have a breadth of knowledge, it may be wise to stay away from J&J.

Now, since this is a Catholic investing blog, I wanted to make this section also ethically oriented.  Is this an ethical company?  It is likely that you have heard about the drug recalls that J&J had issued in the past year.  As a result, a number of plants were shut down temporarily and millions of bottles of medication were recalled.  Drug recalls are not uncommon in the pharmaceutical industry, but the way J&J handled the recall was less than ethical.  It was discovered that J&J had hired a contractor to secretly go into retail stores and buy up all of the problematic Motrin products.  This has been dubbed as the "phantom recall".  This action, in my opinion, is absolutely unethical.  Not only were the well-being of consumers jeopardized in the first place, J&J would not assume responsibility and issue a proper recall.

Other ethical issues include i) animal testing, ii) the Propulsid case in the 90s, where hundreds of people died as a result of taking this drug, many of whom were infants, iii) the Ortho Evra "contraceptive", which is in part an abortafacient.  And the list goes on...As I've said before, most pharmaceutical companies will likely have products that, in some way, violates our ethical standards.  I'm not saying that there is no ethical pharma company out there, but it would take a long time to sort through all of them.

Meaning Score: 3 / 10

Summary
So, let's summarize the scores...

Moat Score: 7 / 10
Margin of Safety Score: 1 / 10
Management Score: 5 / 10
Meaning Score: 3 / 10
OVERALL (not an average): 2 / 10

J&J scored badly in the Meaning and Margin of Safety areas.  I believe those two alone should deter you from investing in it.  J&J's numbers aren't bad, but cannot in anyway justify your purchase of its stock!

Dividends - A Safe Way to Retire?

A Different Way to Retire: Dividends
I recently picked up, from the library, a book called, "Stop Working: Here's How You Can," by Derek Foster.  Foster is the self-proclaimed "Canada's youngest retiree" (at age 34).  He's written a few books, but this was his first.  It was a fairly easy and interesting read.  Being relatively short, I finished it in a couple of days.  It was also interesting because it was unconventional.  I'll go through the main points of his book here.  If you're interested, grab a copy from the library or Foster's website.  I've put a link on the right.

So what is the conventional way of retiring?  For most people (myself included), it's all about accumulating a large sum of money.  By having this large sum (say $1-2 million), even if you live off the interest, the money should be able to last you well into your golden years.  Since it is not easy to accumulate such an amount of money in a short time, either one has to invest aggressively in the stock market, or one accumulates wealth over a long period of time.  Either may not be the ideal routes for everybody.  Foster presents yet a third way.

Increasing Dividends During a Bear Market
Foster's book can be summarized in one sentence: accumulate stocks/income trusts with steadily increasing yields during a bear market.  Let me illustrate with one of the examples in his book.  He looked at Royal Bank of Canada (Ticker: RY).  In 1995, the stock was at $15.56 and paid a dividend of $0.59/year.  That equates to 3.8% yield per year.  Over the next 9 years, the yield steadily increased and by 2004, it had increased to $2.02/year or 13.0% yield (relative to your initial investment).

Since the stocks that you would buy would be recession-proof stocks with a long history of increasing dividends (e.g. stocks like McDonald's, Proctor & Gamble, Johnson & Johnson), the chances of dividends being cut or the stock depreciating are low.  What you are banking on is an ever increasing yield.  You also rejoice when there's a bear market, because good companies like P&G will likely not decrease dividends even during a bear market, but like most other companies, its stock value will decrease.  When this happens, the effective yield of the stock goes up (i.e. the amount of dividends remain the same while the stock price decreases).  So, for Foster, the lower the stock price goes, the better.

An Example from 2009
If you had bought Proctor and Gamble (Ticker: PG) in March 2009, you would have been able to buy it for $47 (stock price is now around $64).  The dividend paid for 2009 is $1.72 or 3.7%.  Looking at the history of the dividend increases, the dividends double every 5 year or so.  So, in 10 years, if the dividend increases follow what has occurred in the last 30 years or so, the yield would be about 14.8%.  If you had placed $100K in P&G stock in March 2009, by 2019, you would be receiving $14,800 per year in dividends.  As time passes, this amount would continue to increase, at a much faster pace than inflation.  So, you will get wealthier and wealthier!

How Much Do You Need to Retire?
Foster shows a sample portfolio in his book, which I suspect is fairly close to what his portfolio looked like.  The "sample" portfolio cost $100K and by the time of his retirement, was worth about $330K.  The dividends from this portfolio was $18,845.  There are, however, a few caveats with this method: i) you need to have paid off your mortgage, ii) you definitely can't live like a king, iii) if the stocks you own decide to cut dividends, as unlikely as it may seem, you'd be in trouble fairly quickly.

So, Does It Work?
Foster wrote his book in 2005.  As we all know, the Great Recession hit in 2008/9...so, was he able to continue his retirement?  In short, yes, but after some quick googling, I found that he had reportedly sold all of his equities in February of 2009 and had gone into the market of options (soon to be discussed in this blog).  It appears that he has done exactly the opposite of what he has advocated in his first book.  But in the end, he is still semi-retired (he works as an author now, promoting his books).

In my opinion, Foster's method is definitely a viable way of ensuring a steady income.  However, I would still try to accumulate a greater portfolio value before retiring to ensure there's some buffer if another recession hits.  While you may not need $1 million to retire, you may want to have $1 million so you have a safety net if something bad happens.

One last word: if you need to do some retirement planning in this conventional way, be sure to read my previous post on retirement.