In this podcast, Motley Fool senior analyst Jim Gillies and host Ricky Mulvey discuss:
- Walgreens Boots Alliance's disappointing third quarter.
- The pharmacy chain's turnaround story.
- What to look for in investor presentations.
- Why investors are cheering Brookfield's $4.3 billion bid for life insurance company American Equity.
Plus, Motley Fool personal finance expert Robert Brokamp and senior analyst Matt Argersinger discuss the fundamentals and trade-offs of owning dividend payers.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
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This video was recorded on June 27, 2023.
Ricky Mulvey: Walgreens takes its medicine, and you're listening to Motley Fool Money. Joining us now in high definition, it's Jim Gillies. Good to hear you and see you.
Jim Gillies: It's good to be heard and seen.
Ricky Mulvey: Walgreens Boots Alliance disappointed investors this morning with its third-quarter results, beat revenue expectations, but it slashed earnings guidance, the stock is down about 9-10% as of this morning. Jim, why was the market surprised that the pandemic tailwinds have worn off for this company?
Jim Gillies: Honestly, I don't know. They've worn off for everyone else at this point. You think this should have as well been already embedded in there, but you say that they disappointed investors this morning. As I prep for this show, I got my first ever attempt to look at this company ever, I've never really looked at it, and my somewhat spicy take is they've been disappointing investors for the last decade, I don't know why they're getting upset this morning.
Ricky Mulvey: I think it's been cut in half over the past five years, that includes the pandemic bounce. Well, now CEO Rosalind Brewer, is announcing a transformational, cost management program, Jim, maybe that'll get your attention. The company is expecting $800 million in savings over the next year and taking a wide approach to healthcare delivery for growth and primary care, specialty pharmacy. Are you buying the turnaround story here?
Jim Gillies: I don't think I am. Again, I am not well-versed in this company, I've just spent about an hour and a half looking at some of the things here, but I basically approached this company as I would if I would look at any other company, but I was going to recommend that in one of the services where I contribute. My starting point here is, from the Oracle of Omaha from Warren Buffett, which is the pithy turnarounds rarely turned, doesn't mean they can't, but just that they are uphill battles. In Walgreens Boots Alliance we have a stock price that's lower than it was a decade ago. Forget the pandemic rise and fall, it's lower than a decade ago. They've demonstrated that this is a company that can make a lot of cash when it wants to, and I'm talking about significantly pre-COVID. In Fiscal 18, they have an August fiscal year, so the end of August is there when we're talking about here. In fiscal 18, they did about just shy of 7 billion, about 6.9 billion in free cash flow, in the teeth of COVID, compare that to fiscal year 2021, they did about 4.2 billion, Fiscal 22, they did about 2.2 billion, this is going in the wrong direction, Ricky. The last 12 months, last four quarters, they've been negative, and there's been a lot of puts and takes, a lot of acquisitions, some divestitures. But this is a company that's got about $12 billion in debt, their dividend commitment the yield today is about 6.7, 6.8%, after the 10% drop in the market. Dividend commitments is about 1.65 billion a year. As I mentioned, they've free cash flow negative over the past four quarters, and this is a very squishy thing I look at. I looked at the earnings presentation that came along this morning, and the best word I can use to describe that presentation is busy.
Ricky Mulvey: Yeah.
Jim Gillies: They want to impress you with all the things that they've got going on it. I remember back in the dimly lit days when you're in school, they would always encourage you to make your PowerPoint presentations simple, two or three or four bullet points, and your words flesh it out. That's not how these presentations are structured. To me it's exhausting to look at this, and it just seems like they want to throw so much at you that maybe you'll be distracted by the fact that, again, this is a company where the stock price today is lower than it was a decade ago, you best like that dividend because it's probable, that's all you're going to get for a while. At $800 million cost savings per year, that might come to fruition, but you can't spend what you haven't yet delivered. As I mentioned, there's a lot of debt here, I don't imagine that's gotten cheaper over the past 15 months given the interest rate scenario we've been living through, and valuation multiples are essentially also trading at 10-year lows, some of that you would expect reflecting interest rates going up, and I think some of that's probable. You can put down to signaling investor disquiet with what's going on here. I kind of look at the presentation, I look kind of at everything they've given us, and I say, don't talk to me about strong quality of earnings, which is one of the things that they actually put in there. This feels like what I like to call a Missouri stock, you got to show me. For the last decade they just don't look they've shown anybody anything. I recognize I'm coming in cutting negative, I wish I wasn't, but I had no incentive to look at this company after today, I don't think.
Ricky Mulvey: Well, I think we can leave it there, Jim.
Jim Gillies: Sorry. [laughs]
Ricky Mulvey: Let's talk Canada a little bit. Brookfield Reinsurance, which is an arm or you may describe it as a tentacle of Brookfield Asset Management, made a cash and stock bid to buy American Equity Investment Life Holding for $4.3 billion, it is a cash and stock deal. Why does Brookfield this huge conglomerate, why do they want to pay a hefty premium for this company that sells indexed annuities in life insurance?
Jim Gillies: Well, because it's a pretty great business. I do definitely use tentacles as my analogy. With Brookfield, you've kind of got the mothership, which is Brookfield Corporation, ticker BN, and then you've got a host of satellite or tentacles, if you will, one of which is Brookfield Reinsurance, which is BNRE. The structure, they spun that out, I think in late 2020, I think they own two-thirds of it, or three-quarters of it still. The reason Brookfield does this is so you can choose to invest in which tentacle you want or you can just invest in the mothership. I own three or four of the Brookfield things at this point, [laughs] and I just kind of smile along with them, but this is the reinsurance deals. Reinsurance is already acquired, they already own about 18.5% of AEL as of the most recent proxy, they've been partners for a while, they've been I think fairly open signaling that they'd be open to acquiring the rest of the company, so I'm not very surprised by this move. What I think here is interesting though is, AEL sells indexed annuities, and what an index annuity is, is it pays out to the annuitant a specific rate based on the performance of an underlying market index, for example, so like the S&P 500. But the nice part about this is that they don't track the full gain or loss, there's usually a participation rate.
For example, if the participation rate was 80%, just to pick a number, and the annuity is indeed indexed to the S&P 500, the S&P 500 goes up, say 10%, the annuitant gets 8%, because 80% of the participation rate times 10 is eight. I don't know the specifics of AOS contracts here. But there might also be some of these things might be what's called a rate cap. Let's say the rate cap is 7%. Even if the participation rates as you should get eight, you bump up against the 7% rate cap, so you only get seven. Why do this? Well, I think it's reasonably obvious is that the companies selling these annuities can essentially invest the float coming in from annuitants into index funds, you don't even need a brilliant investment strategy because by index funds earn the index return and capture the spread between the index return and what you've rate captain participation, rate it out to your annuitants. That's just a fairly simple example at 10%, ask yourself what happens if there's a 25% year in the S&P like the S&P just goes crazy. It can be very lucrative. I think it meshes nicely with Brookfield Reinsurance when they came public, they did a couple of things. They did actually reinsurance on annuities. It's they're now taking on both sides of the risk candle here, looks to me
Ricky Mulvey: For the buyer, it can be in a very expensive hedging strategy. Some of them, they'll even pay you an upfront bonus for buying one of those annuities, Jim, which I don't know what color flag you want to put on that, but I think it deserves raising one. American Equity had some previous suitors, but for 55 bucks a share, it seems like this one's going through this morning. The stock was trading around $53, so not a whole lot of room for ARB Games here.
Jim Gillies: No. Like I said, because Brookfield Reinsurance I think they're probably the largest shareholder, not named Vanguard or BlackRock, which of course are going to be indexed participants. Brookfield probably can influence AEL's choice of suitor, shall we say? I imagine they're going, hey, why not us?
Ricky Mulvey: Then for the broader landscape, does this signal anything about mergers and acquisitions to you? This seems to be a case where finally companies with a lot of dry powder are getting ready to use it.
Jim Gillies: Yeah, I think through the pandemic, there was some dampening of a lot of mergers, especially I follow a lot of little franchising companies and what have you or restaurant companies that might like to buy concepts and there was a really big price disconnected during the pandemic. The sellers want at the price they would've gotten pre-pandemic and the perspective buyers were like, but the world's shut down, so we don't want to pay you that. A lot of the companies that I follow really cut it just sat on their hands and just husbanded cash or paid down debt. To me, this is yet another example of as the world has reopened, as it has, you start seeing companies going shopping. Again, Brookfield makes a lot of deals. While I don't believe fully that there's no limit to their dry powder as you call it. They probably got more dry powder than most or access to capitalize, Bose as the way we can better frame it. But I like to see this stuff because this is what Brookfield does through their various tentacles. I'm a fan of this one.
Ricky Mulvey: High-fidelity Jim Gillies, good to see you. I appreciate you joining me today.
Jim Gillies: {laughs] Thank you.
Ricky Mulvey: Investing doesn't have to be complex, but it usually takes a really long time to see any results. Matt Argersinger joins Robert Brokamp to talk about the power of owning dividend-paying stocks and the fundamentals of owning them. Quick note, Batty A references Bro's recent article a few times. It's called How Buffett's Secret Sauce Could Pay for Your Retirement. It's available to members of the Motley Fool Service Rule Your Retirement will include a link in the show next.
Robert Brokamp: In the most recent Berkshire Hathaway annual letter, Warren Buffett devoted several paragraphs to what he called "the secret sauce". A key ingredient in that sauce's recipe was dividends. Buffett wrote that by 1994, Berkshire had invested $1.3 billion in Coca-Cola and the same amount in American Express by 1995. In those years, Berkshire received dividends worth 75 million from Coke and 41 million from American Express. Now, you fast-forward to the end of 2022 and the dividends Berkshire received had grown to 704 million from Coke and 302 million from American Express. While the growth of data payouts from those two companies was definitely remarkable, investors and the S&P 500 also do pretty well. Here are the annualized growth rates of the dividends paid by Buffett's, two stocks as well as the dividends from the S&P 500 compared to inflation since 1994. Coke's dividend grew an annualized 8.3% a year, American Express's dividends 7.7%, the S&P 500's dividend 6% and inflation 2.6%. Matt, this may not be surprising to you since you're the advisor for a dividend-oriented service here at The Motley Fool. But give us your take on perhaps underappreciated role that dividends play in building long-term wealth.
Matthew Argersinger: Totally underappreciated, Bro, and thanks for having me on the show. I loved your article because also underappreciated, but also maybe a misconception a little bit. I think people think Warren Buffett doesn't like dividends because Berkshire Hathaway has never paid a dividend at least as long as he's been CEO. There's this feeling out there that Buffett just doesn't like dividends. But boy does he like to invest in dividends. [laughs] Not just companies that pay dividends but as your article points out, companies that grow their dividends over time and Coca-Cola and American Express are awesome examples. When that dividend growth exceeds the rate of inflation, especially that's the secret or the magic sauce to investing. It's something I focus on in our Dividend Investor Service. Dividends are truly magical if you look at data going back to the early '70s is various reports. S&P Global has got some data. Hartford Funds has done a report. You'll learn that companies that not only pay dividends but grow their dividends over many years are really the best-performing stocks. If you look at the dividend payers, for example, going back to the early '70s, they've returned about 9.6% per year. That's a full 100 basis points better than the equal-weighted S&P 500. But if you look at dividend growers, especially a couple of examples you gave, those companies have grown there by 10.7% annually on a total return basis, trouncing the rest of the market. By the way, more than double the return of companies that didn't pay dividend over time. I know Warren Buffett knows this, we know this. It's no surprise that that's where he chooses to invest. That's probably where we should be investing as well.
Robert Brokamp: That's surprising because I think over the last several years for sure people have been focusing more on growth stocks. Many of them don't pay dividends. It's probably surprising that over the long-term, companies that are able to generate that type of cash and grow it at a rate that exceeds inflation, are actually some of the best stocks to own.
Matthew Argersinger: Absolutely. It's where I wouldn't say pivoted, but I've really refocused really the core of my portfolio around dividend companies, especially dividend growth companies.
Robert Brokamp: It's nice to get paid by a company-owned. But then you have to decide what to do with it, most investors default to automatic reinvestment, which basically uses the cash to buy more shares of the dividend payer. It's really an excellent way to build wealth because you gradually accumulate more shares, which pay more dividends, which then can be used to buy even more shares and so on. I call it the dividends snowball. Let's illustrate it with some numbers from the drip standing for dividend reinvestment plan calculator found at dividendchannel.com. Let's say you invest at $10,000 into the SDR S&P 500, the ticker SPY, as many people call it. You put in that $10,000 at the beginning of 2000 and that would have bought you 68.8 shares. But if you can reinvest the dividends, your share count would have grown to 103.2 as of the end of this May. In other words, you basically grew your share count by about 50%. But over this period, the quarterly dividend paid by each share of the ETF grew more than four-fold in value but you have more shares paying that dividend. The total amount of cash that you received grew six-fold. All told your investment grew from $10,000-$42,787 in large part due to dividend reinvestment. That's the power of automatic dividend reinvestment, but you don't have to do that like you have choices. What's your take on how people should decide what to do with their dividends?
Matthew Argersinger: It's a great topic and I love your dividends snowball idea. The example that always gets me, Bro, is Altria Group. I'm sure you know this, but formerly the Philip Morris company and putting aside for a second how we feel about cigarettes or tobacco. But consider this, if you invested $100 in Altria's stock in 1972. That's just over 50 years ago. That would've turned into $18,000 today. That's a remarkable turn. However, if you invested that same $100 but reinvested the dividends along the way, that same $100, I still can't believe this would've turned into $2.8 million.
Robert Brokamp: What?
Matthew Argersinger: Yes, It is. It's mind-blowing. It's remarkable when you think about too. The rate of smoking has declined almost every year since the mid '60s, when the US surgeon general made the famous release about the dangers of cigarette smoking. Altria has not been a growth company. It's been far from it. But what it has been able to do, is pay a dividend and grow its dividend over time. That dividends snowball effect that you talk about. Now imagine finding a company, unlike Altria, that actually operates a growing business in a growing industry. Pays a dividend that grows over time. That would be a dividend snowball. But as to whether, automatically reinvested dividend. I think there's some really real strengths to just doing that, like doing a drip. Because it's simple. Just happens without you knowing about it. It takes emotion out of it. It takes decision-making out of the equation. Because you're not deciding how you need to invest that capital once you get it. I do that for a portion of my dividend stocks, mostly that I hold the retirement accounts. But personally in my taxable account, especially I tend to do what Buffett does. I like to let the dividend cash accumulate and then that pick and choose where to invest it. It probably subjects me to more mistakes. But I like being able to target, where I think I'm going to get the most growth from each incremental dollar that I invest. So I like to get the cash and then deploy it later on.
Robert Brokamp:I took an informal survey of the folks who were here at The Motley Fool, what do you do with your dividends? A large portion of them did what you did. So sometimes automatic reinvest sometimes. Be more deliberate with your dividends. But most of the people actually just automatically reinvest, which I thought was interesting. As for me, I often do it based on where I see valuations. If I think stocks are cheap, I reinvest. If I feel I want to build up more cash, I just stop reinvesting most of my stocks, not all of them.
Matthew Argersinger: There's merits of being tactical about about your investment.
Robert Brokamp:Yeah. So we've demonstrated that you can use dividend-paying stocks to build up a nice chunk of change. For most people that they're going to want to use that chunk of change to retire. So you have these stocks are paying dividends. Now you could turn off the reinvestment and use those dividends to pay your bills and retirement. But many retirees will say, I'm not comfortable with too much in my portfolio and stocks because they're so volatile. But to be more accurate, stock prices are volatile. Dividend actually can be remarkably reliable. So consider a dividend history of the S&P 500. So starting in 1958, which was the first full year for the index. There have been only nine calendar years when the dividends paid by the companies in the S&P 500 were lower, in one year than they were in the previous year. In other words, they dropped. The average decline across those nine years was just 5.3% in the dividend payouts. Figures skewed by two years when the drop was really significant. So in 1959, dividends dropped about 13%. In 2009, dividends dropped about 22% by far, the worst year for dividends since the 1950s. Most recent drop, was just recently, 2021 due to the financial fallout from the pandemic. But even that event when the global economy partially shut down, it resulted in a decline in payouts. It's just 2.6%. They rebounded pretty quickly. So Matt, what do you say to people who may be uncomfortable relying on dividend paying stocks and retirement?
Matthew Argersinger: I'd say just exactly what you just went through. It just shows that dividends are much more reliable. So you really don't have to worry if you're focused on the income that you're getting rather than the stock price fluctuation. I just loved the data you cited. I think a derivative of that, is actually you can look at how dividends stocks tend to perform during bear markets. Charles Schwab did a great study looking at every major bear markets since the 1970s. All but one of them, in the great financial crisis that you mentioned, that the really bad year for dividends. All but one of them, high-yield stocks vastly outperformed. I think the only reason they didn't hold up, in the 2007-2009 episode is a lot of those high-yielders we're, going into the crisis or banks or real estate companies. They were hit especially hard. But yeah, look at the bear market we had last year, 2022. The S&P 500 on a total return basis fell about 18%. Example, if you look at the Schwab US equity ETF dividend, for example, that's one of the larger or popular dividend ETFs. It fell only 3%. So having a good portion of your portfolio, even the core part of your portfolio in dividend stocks, can really make a difference during bear markets and periods of volatility. I don't think you have to worry about, having a large exposure if we're entering recession or bear market. Because if you just focus on the income like you said, that's going to be relatively consistent. That might fall a little bit. But it's not going to fall that much and we'll probably rebound a lot faster than stocks tend to.
Robert Brokamp: So we're talking about all the great things about dividend investing. But everything in the world of investing, there's always good things that come with the bad. So what are some of the drawbacks of dividend investing?
Matthew Argersinger: Yeah. There are few I can think of. One was the reinvestment risk I cited above. Do you choose to reinvest or not reinvest? If you don't reinvest, you have to make a decision. There's risks to that. If you do reinvest, may be you're investing dividends in a bad company over time and you're not following it because there's just automatically investing. That may be leads you astray. There's also taxes that come into play. If you hold dividend stocks in a taxable account, do you have to pay taxes. Sometimes popular dividend paying stocks like real estate investment trust rates, they don't qualify for the lower rate. So usually paying your marginal tax rate on those dividends. I think the other challenge when it comes to dividend paying companies. This is because of the nature, I think, of the sectors of the economy they come from. They going to tend to fall behind and underperform, when we have fast rising bull markets. You mentioned earlier just the tech bull run that we had those growth stocks. Well, dividends stocks did underperformed during that period of time. In fact, you can take this year as an example. We're about six months through 2023. The S&P is up about 15%. The Nasdaq 100 is up around 35%. Most dividend funds indexes I follow are pretty much flat. I think that can be discouraging if you're an investor. Sometimes it can cause you to think, to give up and think I need to start chasing the high fliers I'm falling behind. I think that's where the mistake comes in. As we discussed, over time, divided payers, dividend growers especially, can really work their magic for your portfolio. You have to stay invested in them over time.
Robert Brokamp: Yeah. I'll highlight a few things relative to what you said. First of all, I think one thing is sector diversification. The dividend payers are in a handful of sectors, generally speaking. You saw it in 2008. All you did was focused on dividend payers, you've got walloped. So you got to pay attention to that. The taxes are definitely an issue while you're working, which is why it's probably better to keep your dividend payers mostly in retirement accounts. When you retire though they're great to have because of that qualified dividend. Inflation began income, it's tax-advantaged income. That's the opposite side of that coin. But the one thing I think it's important to point out is that dividends aren't a free lunch. It basically accompany selling a piece of itself just in the form of cash. If you're a company pays out $100 million dividend, it's basically worthless now. In most cases, the stock price will adjust accordingly. So it's not like it's magical money. It's really what the dividend represents it's a company that is consistently generating cash and very comfortable that can grow that cash at a rate that exceeds inflation.
Matthew Argersinger: That's right. So you have to be aware that dividend is coming out of cash, it's coming out of the company's earnings. So you want to focus on companies that have, long-term competitive advantages. High-profit margins, generate lots of cash so that they can continue paying and growing that dividend over time. It does make you need to do that extra analysis to make sure that the company that's paying you the dividend is going to continue paying it.
Robert Brokamp: So we've hopefully gotten the audience curious about dividend investing. How do you find good dividend paying investments?
Matthew Argersinger: Oh, that's a good question. How much time do we have? It can be hard. But I think one area that investors might be familiar with is if you look at something like the dividend aristocrats or dividend achievers. Companies that have a track record of paying and growing their dividend, for many years in some cases decades. There's the dividend Kings which have remarkably raised their dividend every year for over 50 years. It's still mind-blowing to me. I think there are limitations to that though. One thing that I've come up with is a concept called the dividend knights. It uses a rule of 10. It looks at companies that have paid a dividend for 10 years, grown that dividend by a compound annual rate of at least 10% over 10 years. May be most importantly, beaten the market's total return over 10 years. So I call them the creme de la creme of dividend growth companies. Fast-growing dividend companies that, just consistently have outperformed and beaten the market. There's obviously a lot going right for these companies. Some examples include A.O. Smith, Nike, Prologis, the Home Depot, which probably everyone is familiar with. These are some of the dividend knights out there. For us in our dividend investors service, it's been a great source of ideas. As we're trying to home in on the dividend growers. But companies that really can stand the test of time. As we started the show off just really consistently outperforming inflation with their dividends. If you can find those and isolate just a few of those over your investing career. Just as we show with cash with Altria is one example. But Coca-Cola, American Express. I'm really trying to find those dividend growers of the future right there.
Ricky Mulvey: As always, people on the program may own stocks mentioned in the Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Ricky Mulvey thanks for listening. We'll be back tomorrow.
American Express is an advertising partner of The Ascent, a Motley Fool company. Jim Gillies has positions in Berkshire Hathaway, Brookfield, Brookfield Asset Management, Brookfield Reinsurance, and Nike. Matthew Argersinger has positions in A. O. Smith, Altria Group, Brookfield Asset Management, Coca-Cola, Home Depot, Nike, and Prologis and has the following options: short August 2023 $57.50 puts on Coca-Cola, short August 2023 $62.50 calls on Coca-Cola, and short July 2023 $30 puts on Brookfield Asset Management. Ricky Mulvey has positions in Home Depot. Robert Brokamp, CFP(R) has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends ARB Corporation, Berkshire Hathaway, Brookfield Asset Management, Brookfield Corporation, Brookfield Reinsurance, Home Depot, Nike, and Prologis. The Motley Fool recommends A. O. Smith, Brookfield, and Philip Morris International and recommends the following options: long January 2024 $47.50 calls on Coca-Cola and long January 2025 $47.50 calls on Nike. The Motley Fool has a disclosure policy.
