Now that we have established some of the methodology for Star List investing, I wanted to take you through a case study of how investing in quality companies, buying and holding for many years, might work. So, I selected a portfolio of 4 quality companies from March of 1985. The date was selected at random and also because earlier data gets harder to come by, and I don’t exactly have access to a Bloomberg terminal, so I researched this based on openly available information. These 4 companies were selected because they were from a list of the bluest of blue chip stocks – the Nifty Fifty. For those who don’t know, the Nifty Fifty were a list of the supposed best blue chip stocks. This list was popular in the 1950’s – 1980’s. I deliberately chose 4 quality stocks that all experienced significant problems after the date that I selected. The return for each is calculated using March 1985 – May 2024 as the investment period.
Imagine that, after saving, scraping and scrounging for years, you manage to put together $40,000 to invest, spread equally amongst these 4 stocks – $10,000 in each, having chosen them for what you believed was their extremely high quality and durable returns on capital. For the purposes of this exercise, we will assume 3 scenarios, given in the table below: 1) that the dividends are immediately spent without further investment, 2) that the dividends were reinvested in 30 year treasury bonds at the long-term average yield for 30 year bonds, which is 4.74%, or 3) that the dividends were reinvested back into the company (or the index) that paid the dividend at the average dividend yield of the company over the 39 years from March 1985 to May 2024. The stocks were Coca Cola, GE, Phillip Morris, and Kodak. If you bought in March of 1985 and held through today, all 4 would have experienced significant troubles.
Coca Cola, just one month after you bought in April of 1985, would introduce the disastrous campaign for New Coke. They took their beloved classic Coke off the market and made the New Coke flavor the only one available, much to the chagrin of their loyal customers.
GE would continue to experience growth and profits for a couple decades more, but then would run into trouble with managing their overly complex and sprawling conglomerate. They would make bad bets on offering expensive long-term care insurance at too low of a price, and they would encounter difficulties due to their financial and management practices, leading to a collapse in the share price just a few years ago from which they are only now starting to turn things around.
Phillip Morris was just beginning to encounter the start of a flurry of lawsuits against cigarette manufacturers, culminating in the 90’s and mid 2000’s with large settlements. In addition, cigarette sales declined over the past few decades as social norms changed, anti-smoking laws were implemented, and the full extent of the negative health effects of smoking became apparent.
Finally, Kodak, founded almost 100 years earlier, was about to enter a slow decline due to fierce competition from Fujifilm Corporation in Japan. The advent of the digital camera, and its growing popularity compounded with the invention of the smartphone with ever better cameras also helped it along on its decline. All of this was despite Kodak having invented the first handheld digital camera way back in 1975. With all of the troubles facing them proving insurmountable by management, Kodak eventually declared bankruptcy in 2012.
Further, lest you think that I am cherry-picking extremely undervalued stocks, let’s look at the valuation of our 4 companies relative to the S&P 500. In March of 1985, the S&P 500 had a P/E ratio of 11.0 based on 1984 earnings. The P/E ratio of our 4 companies, based on 1984 earnings, were: 12.6 (GE), 10.5 (Kodak), 11.1 (Phillip Morris), and 15.5 (Coke). The average P/E of our 4 stocks is decidedly above the market average, so valuation is somewhat richer than the S&P500 when the initial $40,000 investment is made. We will get no help from under-valuation contributing to excess returns.
So how, might you ask, did such a portfolio of troubled quality stocks fair? To truly understand the total returns, you must take into account not just the stock price, but also all of the dividends and spinoffs in which you were granted shares, as well as any other special situations (special dividends, other rights granted which could be sold such as warrants and preferred shares, etc.). So let’s examine each stock and see how they did.
At the bottom of the return pile was Kodak. Now you might think that bankruptcy means you lost everything, but you would be terribly wrong. If you invested in $10,000 in Kodak in March of 1985 and held until May of 2023, you would have received $49.7k of dividends from Kodak and its spinoff company, Eastman Chemical. In addition, you would still own 280 shares of Eastman chemical that continue to pay a dividend and have opportunity to grow. In total, your return would be $77,906 if you did not reinvest the dividends, spending them instead. Your total annualized return in Kodak had you held the entire 39 years was 5.4%. This one fared the worst of all, but still not a total loss by a long shot – your return was positive. See Table 1 below for several scenarios exploring re-investment of dividends.
| Total return ($) for scenario: | K | GE | KO | MO |
| Spend the dividends | 77,906 | 267,880 | 663,685 | 1,312,965 |
| Invest the dividends in 30 year treasury bonds at 4.74% | 179,467 | 451,742 | 1,079,551 | 2,757,537 |
| Reinvest the dividends back into the stock | 108,140 | 649,737 | 1,632,594 | 5,079,222 |
The next worst returning stock was GE. Had you invested $10k in GE in March of 1985, you would have made $90.0k in dividends, and you would own 800 shares of GE, 166 shares of GE Healthcare, 159.6 shares of GE Vernova, and 20.6 shares of Westinghouse Air Brakes for a total return of $267,880 without dividends reinvested at all. This translates to a return of 8.8% annualized. Had you reinvested dividends in GE you would be coming in just shy of the return on the S&P500 with dividends reinvested.
The runner up for best return was Coca Cola. $10k invested in Coke would have returned $203.5k in dividends plus some small amount of proceeds from the sale of Columbia Pictures to Sony. You would own about 7299 shares of Coca Cola currently with no dividend reinvestment. The total return was $663,685 for an annualized return of 11.4% without dividends reinvested in anything at all. This is near the return of the S&P 500 with dividends reinvested of 11.7%. Had you reinvested your dividends in more shares of Coca Cola, you would have thoroughly trounced the S&P500, having a return $1.63 million or a 14.0% annualized rate of return. Even if you had simply reinvested your dividends in safe treasury bonds, you would have soundly crushed the S&P500.
So how did our best performing stock fare? $10k invested in Phillip Morris would have returned $706.9k in dividends, and you would now own 2941 shares of Altria, 2941 shares of Phillip Morris International, 687 shares of Kraft Heinz Company, and 2059 shares of Mondelez. The total value of all this is $1,312,965 without dividends reinvested at all, for an annualized return of 13.3%. The return would have been far better had you reinvested dividends (17.3% annualized, or $5.1 million total), and absolutely crushed the S&P500 return any which way you chose to measure it.
So how does the total portfolio fare? $40k invested in the S&P500 without dividends reinvested turns into $1.5 million. $40k invested in this portfolio returns $2.3 million without reinvestment of dividends. With dividend reinvestment, the disparity is even greater – the S&P500 returns $3.0 million with reinvested dividends, while the high quality 4 stock portfolio returns $7.5 million, more than double that of the S&P500.
| Scenario: | Quality stocks total return | Quality stocks annualized rate of return | S&P500 total return | S&P500 annualized rate of return |
| Spend the dividends | 2,322,436 | 11.0% | 1,546,602 | 9.8% |
| Invest the dividends in 30 year treasury bonds at 4.74% | 4,468,296 | 12.9% | 2,215,936 | 10.8% |
| Reinvest the dividends back into the stock/index | 7,469,693 | 14.4% | 3,005,538 | 11.7% |
| Throw out the highest returning investment (Phillip Morris) | 2,390,471 | 11.9% | 2,254,153 | 11.7% |
I chose this deliberately handicapped portfolio to help avoid any possibility of hindsight bias or cherry-picking of results when looking at quality stocks for investment. Had you been paying any attention while investing, the very serious troubles that led to the bankruptcy of Kodak and financial issues at GE were apparent many years before their share prices declined to the lowest levels, so your returns would likely have been even better than what is shown here. Even a handicapped quality portfolio without dividends reinvested does almost as good as the S&P500 with dividends reinvested. Reinvesting of the dividends in the 4 stock high quality portfolio thoroughly crushes the S&P500 by every measure.
Now, you might say that Phillip Morris was an outlier, so we should toss that one out. After all, how common would it be to turn $10k into $5 million in 39 years? So let’s take a look instead at a 3 stock portfolio composed of Kodak, GE, and Coca Cola. Investing 10k in each with dividends re-invested back into the companies gives a total return of $2.4 million for an annualized return of 11.9%. Investing $30k in the S&P 500 gives a return of $2.3 million for an annualized return of 11.7%. This scenario is shown in the last row of Table 2 above.
With the 3 stock portfolio, you still beat the S&P500 despite being quite possibly the most unlucky investor in the world, having chosen a portfolio where 66% of the companies ran into awful trouble – 33% having gone bankrupt, and 33% still having serious financial issues. Only 1 out of the 3 companies, Coke, is currently doing well. If you tried, you would have trouble managing worse luck. If you randomly picked any one of the ~4100 publicly traded companies in the US, roughly 600 go bankrupt in any one year, giving a bankruptcy rate of 15%. But the companies that do go bankrupt tend to be very small, have low access to capital, trade on the over-the-counter market, or are just very shady companies. The worst fail far more often than the best. Amongst blue chip companies the bankruptcy rate should be well below 1% per year. With good analysis, such that the investor only chooses companies with strong balance sheets, adequate liquidity, and high earnings quality, the bankruptcy rate should be well below 3% over a 40 year holding period. Coupled with monitoring of the financial condition of your stocks, there should be very few surprise bankruptcies, so you would have more than adequate time to get out of such troubled companies before they hit zero. Yet, even with these odds stacked against the 3 stock portfolio above, it still manages to beat the S&P 500 if you select what you believe to be sustainable high return on capital businesses at the outset. With study and a highly selective process for picking quality stocks for our list, I believe we can have a much better hit rate for companies that actually manage to sustain their return on capital over time than this hypothetical 3 or 4 stock portfolio.
I hope I have provided some evidence here for just how beneficial the Star List Investing method can be for your portfolio. Investing in quality stocks with a high return on capital with good pricing power and earnings quality can really boost your returns. There are mathematical reasons for this to occur regardless of the initial overpricing or underpricing of your purchase. I plan to go into this in the next post.
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