“Should I continue to hold this stock as it just hit an all-time high?”
I’ve been faced time and time again with this question, and while providing short-term insight is beyond my intended scope here — this is up to any reader’s specific financial situation — I wanted to elaborate more on how I think about stocks that have hit all-time highs.
Stocks represent a claim on the company’s stream of earnings. If the earnings (per share) grow, the share price likely will follow sooner or later. It is possible to see the EPS of a company grow diagrammatically and see the shares decline dramatically, but in my experience, this is much less relevant for long-term investors.
One of the most extreme examples I have encountered is Baidu (NASDAQ:BIDU), which from year-end 2007 to year-end 2008 grew EPS from $18.11 to $30.19 (pre-split) — a 66.7% increase — yet the shares declined from $389 to $130 (pre-split) in the same period — a 66.5% decline.
A 66% EPS increase is almost never followed by a 66% share price drop, so you can mark that one for the record books as “a 100-year storm.” Companies that grow earnings faster than their respective industries and the market tend to outperform over time than the relevant industry or stock market benchmark index.
Sometimes, rapidly growing companies will see their share prices get ahead of themselves, and their stock will bounce in a trading range for a long time until the earnings catch up with the share price. But if EPS keep growing, in my experience, the share price tends to react positively sooner or later.
A Take on Current High-Fliers
When I looked at the four, Lorillard stuck out like a sore thumb. I tend to follow the other three pretty closely in the course of my regular work, but I had somehow missed Lorillard. I thought it was an “interest rate” thing, but there is more to it.
(Since the Fed has chased income investors from the Treasury market by suppressing interest rates, income investors are hiding in high-dividend paying groups like utilities, MLPs, pharmaceuticals and — of course — tobacco stocks, pushing their dividend yields 20% or more below their five-year averages. The same goes for junk bonds.)
The reason for my surprise to see Lorillard in the high-fliers group was the overall state of the U.S. tobacco market. Other U.S. tobacco stocks are at or close to all-time highs, but generally they are not earnings stories. U.S. cigarette volumes peaked in 1981 and have been falling with smoker rates despite positive population growth. In this situation, most U.S. tobacco companies have been paying healthy dividends and cutting costs to boost payouts; Lorillard is doing all of the above, but it also is growing EPS and revenues, which most of its American competitors have not been able to do.
For the latest reported quarter, adjusted diluted earnings per share increased 26.4% versus last year to $2.20, and annual adjusted diluted EPS increased 16.2% versus last year to $7.88 — both record amounts. Net sales in the fourth quarter increased 8.9% from last year to $1.618 billion. Annual net sales increased 9% versus last year to $6.466 billion. (In the tobacco industry, I had become accustomed to seeing erratic earnings and flattish revenues, which clearly is not the case here.)
It appears Lorillard is aggressively taking away market share in a stagnant market. Lorillard’s domestic retail market share once again posted gains in the fourth quarter of 2011, increasing 0.8 share points to a market share of 14%. This is due to the popularity of its menthol brands like Newport (and non-menthol products under the same name) as well as increasing popularity of its discount brands thanks to constantly rising prices in the industry.