There’s been plenty of ink recently spilled over Walgreen’s (WBA), a popular dividend stock. The company had been a darling for dividend investors, and up until recently had a high dividend yield. The company has been on hard times, closing stores, and had to end a 48 year streak of annual dividend increases in January 2024. It did the unthinkable – it cut dividends.
Many view Walgreen’s as a cautionary tale against investing for dividends.
On the other hand of the spectrum, many are chasing Eli Lilly (LLY), a company which seems to have found the pill formula against obesity. The stock is a top performer over the past decade, one of the largest companies in the US.
Performance of Walgreen versus Eli Lilly, 2009 - 2024
Many view Eli Lilly as a growth stock. Ironically, many view it as a cautionary tale against investing for dividends too.
Few are aware that it even pays a dividend however. The company is now a dividend achiever.
It’s fun to take a snapshot today, and measure fundamentals and popular sentiment.
It’s fun to observe how stock prices really drive investor sentiment. Everyone wishes they owned a hot high flier. Nobody wishes they ever even heard about a company that has fallen on hard times however.
Today, everyone sees Ely Lilly as a hot growth stock. Everyone sees Walgreen’s as a broken value stock.
Yet, 15 years ago or so, the roles were actually reversed.
Performance of Walgreen versus Eli Lilly, 1994 - 2009
Back in 2009 – 2010, many investors saw Walgreen’s (WBA) as a growth stock. The company was a leader in its field, it was growing store count, and it was a beneficiary of a decades long trends. Its earnings per share had been growing for decades, as had its dividend. It had delivered an amazing total return performance for its shareholders. It was a compounder that often sold at premium valuations. Check my review of Walgreen Co from 2009.
The company earned $2.02/share in 2009, which it grew to $5.02/share in 2022. Now it's projected to earn $2.85 in 2024.
Back in 2009 – 2010, many investors saw Eli Lilly (LLY) as a value stock. The company had not grown earnings over the preceding decade, it was about to halt dividend increases and sold at single digit P/E and yielded almost 6%. It’s drug pipeline looked bleak, as the company had a slew of patent expirations. Check my review of Eli Lilly from 2009.
Eli Lilly sold at a P/E of 8.80 in 2009. Today it sells at a forward P/E of 64.
While EPS did grow, there's also been a large tailwind from the expanding P/E ratio. It's possible that the company managed to grow into its multiple if it indeed grows earnings per share at the fast rate that Wallstreet is expecting it to do. But there is very little margin of safety in case those lofty projections do not get met even by a tiny bit.
As we all know, future returns are a function of fundamental returns and speculative returns.
1. Dividends
2. Earnings per share growth
3. Change in valuation
The first two items (dividends and EPS growth) are the fundamental sources of returns. The last one, change in valuation, is the speculative source of investment returns.
Today Eli Lilly investors are paying a hefty premium for future growth. Even if that growth does materialize, it is within the spectrum of possibilities that they generate low or no total returns over the next decade or so, merely because the entry valuation is so lofty.
That's because earnings per share could grow massively, but if the P/E ratio shrinks, investors would see little in price returns. For example, if earnings per share do indeed reach $57/share in 2033, but the stock is valued at 15 times earnings, that would translate into a share price of $855. This is as much as the current share price of $857.
Today, Walgreen’s is viewed as a value trap, especially after disappointing over the past 15 years.
Eli Lilly is viewed as a promising growth stock, especially after exceeding expectations over the past 15 years.
Ironically, I had a lot of readers who bought Eli Lilly about 15 years ago or so for the dividend. It offered a high yield, which was appealing. If they held on to it, they would have made out like bandits..
One could argue that the same investors who bought Eli Lilly in 2009 for the dividend probably also bought Pfizer too. And that's a fair argument. The issue of course is that your losers can only lose so much, whereas your winners can really make up for many of those losers.
Perspective is a fascinating thing, isn’t it?
15 years ago, everyone saw Walgreen’s as a promising growth stock, available at a good valuation.
15 years ago, everyone saw Eli Lilly as a value trap, which was cheap for a reason.
Yet, conventional wisdom failed.
This article is merely to point out that things can change for better or worse. It also means that the future may surprise your current expectations, for better or worse.
When you buy company at a good price, the most you can lose is the amount you invested, minus any dividends reinvested elsewhere. Hence, it is important to limit the amount of exposure per individual company when taking those signals.
The upside is that when a company really does perform to exceed expectations, the upside is unlimited. But you do need to hold on, and not sell early.
Hence it's important to have margin of safety. That means diversification, buying value at a good price, and holding though thick or thin.
While valuation is part art, part science, it is important to realize that overpaying massively for a company is the opposite of margin of safety.
