Today we conclude our three-part series examining the companies
with the biggest bank accounts, and whether they are worthwhile
investments for the upcoming New Year.
In Part One, we studied
General Electric (
and Warren Buffett's
Berkshire Hathaway (NYSE: BRK-A)
. Part II gave us the opportunity to delve into
Oracle (Nasdaq: ORCL)
We'll look at four companies today, all of which are household
names. Computer giant
Dell (Nasdaq: DELL)
, search pioneer
Google (Nasdaq: GOOG)
, drug maker
Johnson & Johnson (
and petroleum titan
Exxon Mobil (
, which holds the distinction of being the most profitable company
in the United States.
Dell Inc. (Nasdaq: DELL)
, $12.8 billion
Selling computers is a tough racket.
Computer manufacturers must deal either with finicky consumer
tastes or with corporate customers whose technology budgets are
dependent on a fickle economy. Neither group is easy to plan for.
Both demand the latest technology and shop almost entirely on
price. As if those business conditions didn't add up to low enough
margins, the whole enchilada rests squarely on continual and
expensive ad campaigns. The result is that Dell, the No. 2 computer
maker, takes in scads of revenue -- about $60 billion a year -- but
gets to keep relatively little of it.
No company can afford to rest long, but the technology sector is
known for especially intense, NBA-like competition. In the fight to
sell computers, Dell can't even afford to blink. Hewlett-Packard is
a relentless opponent. Upstart competitor Acer constantly nips at
Dell's heels. And then Asustek came along and had the idea of
making computers even cheaper with its stripped-down netbook, an
idea that totally remade the industry almost overnight.
Dell makes decent computers and sells them cheap, but its investors
never get anywhere. That's clear from the static shareholder equity
line. Ideally, a company should maintain a reasonable cash position
and use some of its free cash flow to reduce debt over time. Dell
simply can't do this for one simple reason: It doesn't have enough
money. Its cost of goods and operating expenses mean a razor thin
operating profit of just 5.2%.
Apple (Nasdaq: AAPL)
, whose consumers do not shop on price, maintains a 21.0% operating
margin. And, surprise, the company's balance sheet is not only
devoid of any long-term debt, its shareholder equity line
continually grows. Dell will never be able to match Apple's model.
That's the cost of competing on price.
Dell is fairly valued and looks poised to deliver lackluster
earnings of $0.97 in the year ended Jan. 31, 2010, about 50 cents
per share less than its recent good years. At 14 times earnings,
Dell's current valuation exceeds its two-year average. Going
forward, the consensus estimate of $1.21 seems to err on the side
of optimism for an economic recovery, and even if it is dead-on it
implies only a modest +7.4% upside at its historical valuation.
Cash is great if it can be used to generate significant profits.
Dell can't do this and, importantly, it never will be able to. I
think investors should look elsewhere.
ExxonMobil Corp. (
, $12.5 billion
ExxonMobil is worth $354.9 billion. Last year's revenue, at $460
by a wide margin. Exxon posted net earnings of $4.7 billion last
quarter alone -- enough to buy Hasbro outright -- and $13.3 billion
in the first nine months of this year, which would add two aircraft
carriers to the Navy's Pacific Fleet.
The most surprising thing about Exxon, given these humongous
numbers, is that it doesn't have more cash. After all, its cash
line is roughly equal to this year's profits. So investors, when
looking at Exxon's books, need to ask one critical question:
The answer lies in management's laser-like focus on the future.
Now, don't worry. I'm not going to launch into some diatribe about
how the world's biggest oil company is spending gazillions on
harnessing tidal energy to bring about cheap power and world
peace. While Exxon certainly invests substantial sums in
"green" energy -- it recently committed $600 million to an
algae-based biofuel program -- its main focus remains on finding
more crude and acquiring the rights to it.
This is the first and most important thing this company does, so
it's not surprising that it's the first topic of the annual report.
Here is what the company said as it reported its 2008
results: "By 2030 global energy demand is expected to
increase by about 30 percent from today's level, even assuming
significant gains in energy efficiency. Oil and natural gas will
remain the world's primary energy sources, meeting close to 60% of
the demand. ExxonMobil plans to invest more than $125 billion over
the next five years developing future energy supplies."
It is this investment that will be the future of the company.
That's where most of its cash goes, and that's what every investor
must focus on -- not the price of oil, not the current state of
global petroleum demand. What matters is not what it's selling
today, but what it will sell five years from now.
"Upstream" earnings (refineries and gas stations are "downstream")
accounted for $35.4 billion of Exxon's $45.2 billion in 2008
earnings. If Exxon were to begin to deplete its reserves,
then it would become a vanishing asset. This is not the case,
though: The company succeeded in replacing 103% of its production,
adding 1.5 billion barrels of oil equivalent to its
reserves. Here's how Exxon uses its cash: To buy reserves that
will generate more cash. Last year it spent $26.1 billion on
capital expenditures and exploration. It currently has 72 billion
barrels of reserve capacity. These upstream assets require a lot of
cash, but that cash earns a remarkable return -- 54% in 2008 and an
average 44% during the past five years.
The earnings potential is the bottom line, and the most important
thing for investors to keep in mind. I know of no other company
that gets more bang for its buck. Because of this, I consider Exxon
to be an outstanding long-term investment.
Google Inc. (Nasdaq: GOOG)
, $12.1 billion
If I had to pick the worst business decisions ever made, taking
Google public would be near the top of my list. It's not like the
company ever had any trouble raising capital:
Sun Microsystems (Nasdaq: JAVA)
co-founder Andy Bechtolsheim wrote Larry Page and Sergey Brin a
check for $100,000 to get the entity going even before it had been
incorporated. Sequoia Capital and Kleiner Perkins came through with
$25 million about a year later. In 2004, the company sold 19.6
million shares for $85 each in a $1.7 billion IPO.
The company is now worth $180 billion. Page and Brin, had they kept
the company private, likely would be No. 1 and No. 2 on the list of
the richest people in the world, with a net worth of perhaps $80
billion each, instead of sharing 11th place, at (a paltry) $13.3
Google derives 96.8% of its revenue from advertising. And today the
shares hit a 52-week high, which seems to indicate a rosy outlook
for advertising. Wall Street was pleased to see that the revised
unemployment figures came in lower than were previously estimated,
which the market evidently interpreted as a sign the economy is
turning around and that advertising will pick up.
Google is the most richly valued company of the stocks on our list.
Investors are willing to pay 5.5 times net assets (or "book value")
for the shares, a significant premium to the 2.2 times book value
that the overall S&P 500 commands. The reason Google's
price-to-book ratio is so high is the same reason its P/E ratio is
high: Investors expect Google to continue to increase its earnings.
And they are willing to pay $5.50 for every dollar of assets. To
put that number into perspective, investors only pay $1.20 for
every dollar of Berkshire Hathaway's assets, which means, at least
mathematically, that Warren Buffett is only worth 20 cents to Wall
Even at such a high valuation, Google looks like an awfully
tempting buy. Its 2010 revenue is estimated at $26.19 per share,
and even a relatively low earnings multiple of 30 implies a
fair-market price of $785.70. That's about +35% above today's
prices, and it's an exceedingly low estimate: These shares
routinely are worth 40 times earnings, not 30.
Investors can rest assured that Google will use its cash to
continue to build its business. It certainly doesn't need to use it
to service debt, as the company doesn't have any. Google's primary
focus going forward will be in expanding the reach of its
advertising in the United States and in developing its presence in
the rest of the world.
Investors who aren't afraid of tech likely would be pleased with
these shares, and they won't need to commit to the long term. In
the next year, these shares should roughly triple the long-term
average return of the S&P 500. If you buy them, however, please
hold them for at least 366 days. Not to give my prediction more
time to come true, but to help you avoid some capital-gains taxes.
Johnson & Johnson (
, $11.9 billion
More years ago than I care to remember, I -- a young copy editor --
walked into the deputy managing editor's office at The Star-Ledger,
the largest newspaper in New Jersey and one of the best papers in
the country. As much as it pains me to admit it, the guy was
brilliant (he's now the executive editor) and he oversaw a great
sports department and a business section that broke news in a tough
market, where our competitors were
The New York Times
The Wall Street Journal
. I can't remember what we were initially talking about -- I
suspect it was rank insubordination -- but I wound up betting him
that Johnson & Johnson would miss earnings.
A few days later, I paid up on the modest wager, which was probably
bad Chinese food from across the street, and I heard a bit of
advice from my boss's boss's boss: "Don't ever bet against Johnson
& Johnson. Just don't do it."
It has become one of the commandments I live my life by, along
with: Never bet on a horse named after a blonde, never draw to an
inside straight and never eat at place called Mom's.
Good rules, all.
Johnson & Johnson is one of the most looked-up-to companies in
the world. According to the Reputation Institute, Forbes reports,
J&J is the company that Americans esteem, admire and respect
the most. Its composite score of 83.6 on a 100-point scale was 2.5
times higher than
, which took a distant second in the ranking. (Oil-field service
scored lowest out of the 153 companies ranked, and that's a bum
rap. HAL's a great company. It's also up +53% so far this year.)
As I learned from my ill-fated wager, Johnson & Johnson can be
counted on to deliver results. It's posted an annual earnings
increase since at least 1998 and has beat Wall Street expectations
for the past 15 quarters. Its earnings did not slip in the
recession, which suggests an uncommon resiliency. And yet it is not
a juggernaut by any stretch of the imagination: For the past four
years, J&J's revenue has posted a modest +6.0% compound rate of
growth. Its net earnings have fared somewhat better: They've grown
at a compound rate of +6.5%. Given its immense revenues -- some $60
billion a year, this feat is not only laudable but impressive. The
company maintains a 25.4% operating margin.
Johnson & Johnson makes hundreds of health-care related
products, including scores of medical devices like heart stents,
diagnostic tools and about two dozen prescription drugs. Its
consumer line-up includes such ubiquitous products as Band-Aids and
the baby powder and No More Tears shampoo that all moms use.
As Johnson & Johnson moves forward, it will deploy its cash in
acquiring companies to add to its product line, which currently has
only five products in late-stage clinical trials. As Big Pharma
goes through a wave of mergers -- the Pfizer-Wyeth deal, Merck's
acquisition of Schering-Plough -- a takeover seems ever more
likely, though it might be more natural for J&J to focus on
devices or diagnostics than pharmaceuticals.
Frankly, J&J needs a deal. J&J has a great reputation as a
company everyone loves and it makes products we all use, but
investors are ho-hum about the company's prospects. A deal might
add some excitement, the sale of a division might unlock the value
of a particularly dynamic business unit.
I learned my lesson, and I'm not going to bet against its earnings,
but I'm not wild about J&J's stock, either. If 2010 delivers
the consensus earnings estimate of $4.92, the company's fair-market
value is only about $69, not much of a premium from today's $64.36.
It may have a vast cash hoard, but it doesn't look like a
particularly compelling buy for the New Year.
Editor, Government-Driven Investing
Disclosure: Andy Obermueller does not own shares of any security
mentioned in this article.