It would be an understatement to say that stocks have had an eventful festive period. Having entered technical bear market territory during one of the worst Decembers for stocks on record (including their worst ever Christmas Eve performance), they came roaring back on the day after Christmas with the Dow putting on just over 1,000 points. The last time there was such a strong one day response was back in the spring of 2009 (and right at the bottom of the financial crisis induced bear market). So far it seems to be holding up.
Anyway brief rally aside, the turmoil for shares has thrown up some good bargains (and made some already good looking bargains even better). There are two in particular that I think stand out right now: Kraft Heinz (NASDAQ: KHC) and beer giant Anheuser-Busch InBev (NYSE: BUD). As it stands the former is offering a forward earnings yield of around 8.25% and the latter around 7.25%. You can comb over the historical valuations of these stocks and you will find they rarely trade that cheap.
So what gives? There are two things at work in my opinion. The first is low growth (particularly an issue in the case of Kraft Heinz). For instance between 1957 and 2003 the H.J. Heinz company grew its per share profit at an average rate of just under 9% per annum. These days it is struggling to churn out even 3% annual earnings per share growth. It would make sense for historically low growth to go hand in hand with historically low valuations. Anheuser-Busch InBev should grow its profits at a greater clip, but then again it has a slightly higher valuation to reflect that.
The second point is the eye-wateringly high levels of debt sitting on their balance sheets. Between the two we are talking around $140 billion in net debt versus combined annual profit of around $13 billion. One of the upshots to this is that the debt adjusted valuations are not as cheap as they first appeared.
The good news is that earnings growth becomes ever less important at these depressed valuations. Take the experience of the following three companies as a good guide: Kroger, Royal Dutch Shell and Fortune Brands. There are several things that these stocks had in common. The first is that they all made Jeremy Siegel’s list of top performing stocks between 1957 and 2003. (They each delivered average annual returns of between 13.5% and 14.5% over that time frame).
The second is that they managed to do so without delivering remotely comparable rates of per share earnings growth. In fact the average earnings per share growth rate of the trio was just 6.4% per annum. So what accounts for the difference? High dividend yields reinvested at low average valuations. The trio’s average dividend yield over that time frame clocked in at 5.5% and the average earnings yield was 7.5%.
The latter figures now look somewhat familiar to what we’ve got here. The average dividend of Kraft-Heinz and Anheuser-Busch is now around 4.4%. The average earnings yield is approximately 7.75%. Granted Kraft Heinz may well end up slashing its dividend but this will free up more cash for debt reduction and earnings growth. Whichever way you slice it I don’t think the dynamic changes too much: unless earnings per share collapse there is a very good chance that these two will deliver double digit annual returns given a decent time-frame. Given we are talking about the owners of storied brands like Heinz Ketchup, Stella Artios and Budweiser it seems very much worth that risk.