Dear Fellow Investors:
Many years ago, United Airlines had the slogan, “Fly the Friendly Skies.” At Smead Capital Management, we like to own companies for a long time which are “friendly” to their public shareholders. In this missive, we will define what it means in our eyes to be shareholder friendly and give a company specific example of this friendliness.
In our view, shareholder friendliness among publicly-traded common stocks includes the following:
- A well-cast long-term vision of the future for the company and the effort to communicate that vision and other company matters openly and honestly to all shareholders.
- Outside directors who are engaged, passionate and invested in the company.
- Judicious use of the free cash flow generated by the business, including but not limited to the following: a) wise acquisitions which build on core businesses and strengths, b) improvement in the company balance sheet and/or maintenance of existing balance sheet strength, c) stock buybacks, and d) dividend payments and dividend growth.
- Significant insider ownership.
The best way to learn our view of the risk limiting and wealth creating nature of our sixth criteria is to look at Amgen (AMGN). From 2009 to 2011, we sat with a sizable position in this biotech/Pharma company. As the economy rebounded from the financial meltdown and the healthcare industry stared toward political and regulatory upheaval, Amgen traded around $50-52 per share. Investors questioned whether the company’s research pipeline would be there in the future as cash cow blockbusters like Enbrel and Epogen would ultimately lose their patent protection.
Then a series of shareholder friendly activities emanated from their strong balance sheet and huge free cash flow generated by their existing products. Amgen announced their first dividend of $.28 per share per quarter. It meant that Amgen’s first dividend was greater than 2% of the stock price on an annual basis. It also meant that the stock was going to pay more than the ten-year US Treasury bond. In my entire career, I’d never seen a company start a dividend and the return was immediately competitive with prevailing interest rates.
It was also accompanied by a massive stock buyback announcement. Amgen has raised the dividend consistently since then and bought back a great deal more of their shares. It currently trades around $118 per share. Despite the current enthusiasm for smaller biotech stocks, we are very excited about the long-term prospects for this shareholder friendly and high-quality common stock. Amgen has nearly $20 billion in cash sitting on their balance sheet and is generating over $6 billion in free-cash flow yearly. Their R&D averaged 20% of sales over the last year, which means that they were even more profitable than meets the eye and are pursuing their long-term vision.
At the end of 2003, Amgen had 1,280,000,000 shares outstanding and Value Line estimates that at the end of this calendar year they will have 740 million shares left outstanding. Value Line is estimating $9 per share of free-cash flow and $8.20 of earrings per share. They estimate the dividend to be $2.44 per share in 2014 and grow to $3.20 in four years based on a modest 30% payout ratio! Records showed in 2011 that over the last twenty to fifty years, dividend payouts on the S&P 500 index had ranged from an average of 46% over the prior twenty years to over 52% the prior 50 years on average. There appears to be a great deal of long-term upside in Amgen’s dividend payments if historical payout ratios come back in the future.
Amgen has demonstrated shareholder friendliness by wise use of free cash flow via dividends and stock buybacks, maintenance of a strong balance sheet and continued commitment to long term research at the detriment of short-run profits. We are pleased to be affiliated with companies which fit our sixth criteria and fit the other seven as well.
The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.
This Missive and others are available at smeadcap.com