Rule #1 Finance Blog

With Investor Phil Town


People ask me a lot of questions about retirement funds and packages. Here's a letter from S____.

[Edited for length.]

Phil Town,

Most of my parents' retirement acccount is invested in BP (British Petroleum) stock. Either 50% or 100% of the portfolio. My father has 3 years to retirement – even though he'd like to retire now.

As you may be aware, BP is the only individual stock they are allowed to invest their retirement in at this date. That's how 401k's, etc. work.

One of the reasons I wanted to buy the program you offered is to make sure they can better determine when to buy and sell to maximize the growth. The last thing I want to see is for something unforseen to come up with BP stock and them lose a chunk of their portfolio due to a drop in the price.

Is there a fee a could pay you to watch this stock for my parents and educate them on what factors are effecting their stock and whether it's likely to go up or down drastically so that they can continue to maximize their 401k versus taking a potential hit?

Kind Regards,


I think the deal is that her father works for BP and is sort of forced to buy BP stock for his retirement 401(k), and it's the only stock he has.  She thinks he's 100% invested in just BP for his retirement (or maybe 50%) and she is worried.

S____, a student, is interested in finding someone who can advise her parents directly about what to do.  I'm flattered but I don't do advice or OPM investing simply because frankly, it's usually a huge pain to advise people or invest their money.  They call you.  Ughhh.  Those phone calls can interfere with golf, fishing, snowboarding, hunting and travel.  I'm learning to tango.  I don't have time for phone calls.

And everybody who is a good investor feels like that, so to make it worthwhile to take the calls, fund managers pool money in a fund, charge fees and percentages of profit, and make millions a year.  And get huge and then eventually become the arrows… get leveled to the market… and become useless — or, like Jim Cramer, get to a point where they are about to blow a fuse and quit.  (Now Jim can blow off steam on TV and we get to watch!). Or like Eddie Lampert and Bernard Madoff they just refuse to take the call, and if you bother them again they give you back your $10,000,000 and tell you to p— off.

On the other hand, it is quite a lot of fun to talk about businesses, so let's look at BP, shall we?

I always start with the Equity growth rate.  Investools shows that ten years ago the equity was at $20 billion and now it's at $80 billion — so it's doubled twice in ten.  That would indicate about 15% growth.

But MSN shows Book Value Per Share 8 years ago at $11 and today it's at $22.  Eight years to double once.  They've been selling some stock and diluting the owners (your parents) quite a bit, haven't they?  I know that without looking because it's the only way that you can have total equity growth at 15% and per share equity growth at 9%, right?

Now, curious, I check whether they've been paying dividends while they dilute the owners.  Yup.  Nice fat dividend checks going out.  That sneaky, sneaky CEO.  That means that although the pie is growing (probably through acquisitions), the CEO is selling more pieces of it so the overall effect isn't as pretty as it looks.  One double in 8 years means real equity is only growing at 9% a year, not 15%.

In effect, BP is BUYING its growth with YOUR money and then paying you a dividend to make it look like they have all this surplus going on.  Cute.  Sneaky.  Underhanded comes to mind.  To my mind (and without getting into it as much as I should before I jump to conclusions, but since you asked…) this kind of game makes BP a kind of a pretend business as far as being an owner goes.  Without looking at another thing, I already don't like this.

But that said, let's go on and see if 9% is going to be our expected rate of growth for the future.  Do EPS, Cash and Sales reflect the same thing?  And we see exactly the same thing: High revenue growth with earnings per share growing even slower than 9% because of dilution.  So this is a 9% grower at best.  And a quick glance at the analyst expectations and we can see we're right.  Zack's is estimating 8% growth.  Okay we got our growth number.  The lower of historical or Zack's.  8% is going to give us a double every (8 into 72) 9 years.

How about historical PE?  Ball park looks like 12-15 is the right multiple, and that's in the ballpark of double the growth rate (16), so let's use 14.

Okay so now we just need the current trailing twelve months EPS: $5.30.  We're going to double that in 9 years, so by then the EPS will be $10.60.  That means in 10 years we're at $11.50.  We're going to put a 14 multiple on that and get a future value in ten years of $160.  One quarter of that gives us our retail or Sticker Price if we expect a 15% return: $40.  We need a 50% margin of safety to account for our limited experience, vision, intelligence and laziness so we want to buy this at $20.

It's selling for $68.  Oh oh.

Assuming the history is predictable (and it appears to be consistent enough), and assuming the analysts are right (and they seem to be about where history takes us) and assuming we want a 15% return, we gotta buy this at $40 without any margin of safety.  But ask your parents what the three most important words of investing are:  And the answer is NOT "buy and hold".  The three most important words in investing are "Margin of Safety".  ESPECIALLY if you are retiring soon, duh!

BP is 60% above its Sticker right now.  Man, the air up there is soooo thin that I don't know if the plane can keep flying.  That would be like Microsoft at $55 (It's now at 28.)  Or Coke at 80 (it's now at $40).  Or GM at $70 (It's now at $20).  Do you think BP's price maybe got a little ahead of itself and has to go nowhere or down to get back to rational land?  Could well be.

And to think otherwise, you better be very knowledgable about BP and the oil industry and be comfortable predicting a lot more rosy future for BP than the people who cover it every day.   Nothing wrong with disagreeing with analysts, folks, but please disagree for some solid reasons — and "I just feel good about it" is NOT a solid reason.  I don't know BP but a quick look tells me no reason to think it's going to suddenly break out of its long history and blow away the predictions.  Maybe it will.  All I'm saying is if I bet on that I'd be guessing.  I don't like guessing.  I like certainty.  I like buying dollars for fifty cents.  I do NOT like buying dollars for a dollar sixty… which is what it seems is going on right now with BP.

So, S____, all you can do as a good daughter is put this kindly before your parents and hope they have a better reason for hanging their retirement all on BP than "well it went down and then went up before and we'll just stick with it".  Because I can't begin to tell you how many sob stories I've heard in the last five years from people who held that completely irrational investing philosophy and who owned businesses like Microsoft, Coke and GM, to name a few biggies which are still 50% or more below their high water marks and which have no rational reason to expect to recover any time soon.  It's not that they are bad businesses.  They just got overpriced.  BP looks that way to me right now.

So now you tell me, S____:  If this is all you owned for your retirement do you want to keep it or sell it and buy something else?  (Notice I don't have any problem with them owning one thing.  But if they own one thing don't you think they should really understand what they own and what it's worth?  Warren Buffett says that diversification is for the ignorant — meaning that if your parents are ignorant investors, they should diversify.  My view is they should stop being ignorant and stay focused, but focused on a wonderful business that they can buy at an attractive price.)

In all fairness to BP, I haven't even begun to look at its Meaning, its Moat or its Management.  This was just a quick MOS look.  Maybe if I really got into it I'd love it and think the analysts are completely stupid.  Maybe.  But I really HATE it when businesses are diluting me while they pay me dividends unless I know why and like the reason.  It makes me feel like the CEO is playing me.  And that makes me feel like I'm not being treated like the owner … and you know how I feel about that.

Now go play!

Phil Town