The Snowball Effect: How To Multiply Your Wealth by Ben Reynolds, Sure Dividend
What happens when you push a small snowball down a hill… And what does this have to do with growing wealthy?
Baupost's investment process involves "never-ending" gleaning of facts to help support investment ideas Seth Klarman writes in his end-of-year letter to investors. In the letter, a copy of which ValueWalk has been able to review, the value investor describes the Baupost Group's process to identify ideas and answer the most critical questions about its potential Read More
When you push a small snowball down a hill, it continuously picks up snow. When it reaches the bottom of the hill it is a giant snow boulder.
Source: Calvin & Hobbes
The snowball compounds during its travel down the hill.
The bigger it gets, the more snow it packs on with each revolution.
The snowball effect is a metaphor for compounding. It explains how small actions carried out over time can lead to big results.
This article shows how to harness the power of the snowball effect to multiply your wealth and income many times over.
It also includes 7 real world examples of the ‘snowball effect’ stocks that have compounded investor wealth.
The Power of The Snowball Effect
Before we discuss how to harness the power of the snowball effect we must understand the power of compounding.
The snowball metaphor visually shows the power of compounding.
“The most powerful force in the world is compound interest” – Attributed to Albert Einstein
Here’s the power of compound interest:
Imagine you invested $1 that compounded at 1% a day. In 5 years your $1 would grow to over $77 million. You would be the richest person in the world by year 7.
Keep in mind that compounding is not a get rich quick scheme. It takes time – and lots of it. There are no investments that compound at 1% a day in the real world.
The stock market has compounded wealth (adjusting for inflation) at 6.9% a year over the long run. At this rate an investment in the stock market has historically doubled every 10.5 years.
It takes more time to compound wealth in the real world – but that doesn’t make the principles of compounding any less powerful.
Take Warren Buffett as an example. Warren Buffett is worth over $60 billion. Warren Buffett’s wealth comes from the tremendous benefits of the snowball effect through time.
Warren Buffett compounded his wealth through a specific type of investment.
Specifically, Buffett invests in:
- Shareholder friendly businesses
- With strong competitive advantages
- Trading at fair or better prices
“All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies.” – Warren Buffett
The next section of this article discusses how to harness the power of the snowball effect by investing in the same type of businesses Warren Buffett does.
How You Can Harness The Power of The Snowball Effect
You can harness the power of the snowball effect by investing in the same type of businesses that have made Warren Buffett so wealthy over time.
Take a look at Warren Buffett’s portfolio. His top 5 stocks make up 67% of his portfolio:
- 19.8% is invested in Wells Fargo (WFC)
- 18.0% is invested in Kraft Heinz (KHC)
- 13.0% is invested in Coca-Cola (KO)
- 8.5% is invested in IBM (IBM)
- 8.0% is invested in American Express (AXP)
These 5 businesses are the core of Warren Buffett’s current compounding machine. Do you know what’s interesting about these 5 business?
All 5 are well established businesses that pay dividends.
- Wells Fargo was founded in 1852 and has a 3.2% dividend yield
- Kraft Heinz traces its history back to 1865 and has a 3.0% dividend yield
- Coca-Cola was founded in 1892 and has a 3.0% dividend yield
- IBM was founded in 1911 and has a 3.5% dividend yield
- American Express was founded in 1850 and has a 2.0% dividend yield
The weighted average dividend yield and founding date of Warren Buffett’s top 5 stocks is 3.0% and 1870, respectively. Warren Buffett holds a concentrated portfolio of businesses with above-average dividend yields and long histories of success.
Investing in this type of business is the surest way to benefit from the snowball effect.
The good news is you don’t even have to search for these businesses.
There is a list of 17 businesses with 50+ years of consecutive dividend increases called the Dividend Kings list.
Nothing says long-term success like 50 or more years of paying rising dividends in a row.
Coca-Cola (one of Buffett’s biggest investments) is a Dividend King. There are many other well-known stocks in the Dividend Kings list, including:
- P&G (PG)
- 3M (MMM)
- Johnson & Johnson (JNJ)
You may read this and think: “these businesses may have a history of success, but isn’t their run over”.
Investors have wasted tremendous sums of money chasing ‘the new hot stock’. You cannot benefit from the snowball effect by investing in businesses that are unproven. Steady dependable results lead to wealth multiplication.
What would happen if you had invested in some of the most well-known Dividend Kings in 1990?
The 7 examples businesses below all had 25+ years of consecutive dividend increases by the end of 1990. They were well-known, well established blue chip stocks in 1990.
It didn’t take a genius to buy and hold them…
But the results speak for themselves. 7 examples of the snowball effect in action are below. All examples assume dividends were reinvested.
Example #1: Coca-Cola
Every $1 invested in Coca-Cola at the beginning of 1990 was worth $15.25 by the end of 2015. Coca-Cola compounded investor wealth at 11.5% a year (including dividends) over the last 25 years.
Coca-Cola was the largest soda brand in the United States in 1990… And had a 98 year operating history at the time. It was not a start-up.
Example #2: Lowe’s
Lowe’s (LOW) is the 2nd largest home improvement store in the United States. In 1990 Lowe’s was one of the largest home improvement stores in the United States. It had a dividend history of over 25 consecutive years of increases.
Investors in Lowe’s 25 years ago have done very well…
$1 invested in Lowe’s in 1990 was worth $108.49 by the end of 2015 (including dividends). An investment of $9,217 in Lowe’s in 1990 would be worth $1 million today.
This comes to a compound annual total returns of 20.6% a year.
Example #3: Procter & Gamble
Procter & Gamble (PG) was just as well-known in 1990 as it is today. The company has an iconic brand portfolio with names like Tide, Bounty, Gillette, and Charmin (among many others).
The company was founded in 1837. In 1990, Procter & Gamble had been around for 153 years… Not exactly a young company.
Still, long-term investors in Procter & Gamble have done well. Every $1 invested in Procter & Gamble has become $16.54 by the end of 2015. This comes to a compound annual growth rate of 11.9% a year.
Example #4: Colgate-Palmolive
Colgate-Palmolive (CL) traces its history back to 1806. Both the Colgate and Palmolive brands are easily recognized.
In addition to these brands, Colgate-Palmolive owns the Speed Stick, Soft Soap, and Science Diet brands (among many others).
Colgate-Palmolive has paid dividends since 1893. The company has paid increasing dividends for 53 consecutive years. In 1990 the company had a streak of 27 consecutive dividend increases.
How did 1990 investors do?
Every $1 invested in Colgate-Palmolive stock in 1990 grew to $28.85 by the end of 2015. Colgate-Palmolive generated a compound annual growth rate of 14.4% during this period.
Example #5: Hormel
Hormel Foods (HRL) recently declared its 50th consecutive annual dividend increase. The company was founded in 1891.
Hormel is a dominant player in the consumer meat industry. The company has generated compound returns of 14.5% a year for investors from 1990 through 2015.
$1 invested in Hormel in 1990 grew to $29.63 by the end of 2015. Not bad for a well-established packaged foods business.
Example #6: Johnson & Johnson
Johnson & Johnson (JNJ) is currently the largest health care corporation in the world. The company is one of the most stable businesses in the world as well.
This stability is reflected in Johnson & Johnson’s ultra-low stock price standard deviation. The company has the lowest 10 year stock price standard deviation of any business with 25+ years of dividend payments without a reduction.
This ‘slow and steady’ business has been a boon for shareholders over the long-run.
Every $1 invested in Johnson & Johnson stock in 1990 grew to $24.46 by the end of 2015. The company generated compound returns of 13.6% a year for shareholders during this time period.
The company’s low stock price volatility only adds to its appeal. Investors have historically generated excellent returns with Johnson & Johnson stock without as many gut-wrenching ups and downs as compared to other stocks.
Example #7: 3M
3M (MMM) is a large, diversified manufacturing and consumer products firm. The company makes Filtrete air filters, Post it notes, Command adhesives, and much, much more.
3M was founded in 1902 and has increased its dividend payments for 56 consecutive years. Back in 1990, the company had been in business for 88 years and had paid increasing dividends for 31 years.
How did an investment in 3M in 1990 do?
Every $1 invested in 3M grew to $15.43 by the end of 2015, for a compound annual growth rate of 11.6% a year.
Snowball Effect Stocks for the Next 25 Years
A summary of results for the 7 real-life examples is below:
- Lowe’s grew $1.00 to $108.49
- Hormel grew $1.00 to $29.63
- Colgate-Palmolive grew $1.00 to $28.85
- Johnson & Johnson grew $1.00 to $24.46
- P&G $1.00 to grew $16.54
- MMM $1.00 to grew $15.43
- Coca-Cola grew $1.00 to $15.25
For comparison, an investment in the S&P 500 as measured by the Vanguard 500 Index Fund (VFINX) – which has historical data back to 1990 – would have turned $1 into $9.61 for a compound return of 9.1% a year.
All 7 examples above trounced the market despite being well established businesses with long dividend histories.
What stocks will be the next snowball effect compounders?
There’s no need to reinvent the wheel. Anyone holding the serial compounders above should continue to do so.
For those looking to enter into new positions in snowball effect stocks should look for the following:
- Above average dividend yield
- Below average price-to-earnings ratio
- Long dividend history
The biggest constraint of the 3 is the long dividend history. We will start by selecting only from the Dividend Aristocrats List.
To be a Dividend Aristocrat a stock must have 25+ years of consecutive dividend payments and be in the S&P 500. There are currently just 50 stocks that match this criteria.
Out of the 50 Dividend Aristocrats, we will screen for:
- A dividend yield oabove the S&P 500’s 2.1% yield
- A price-to-earnings below the S&P 500’s ratio of 22.6
24 Dividend Aristocrats match these criteria. We will then sort these by expected total return. Total return is the expected earnings-per-share growth rate plus the current dividend yield.
The 10 highest expected total return Dividend Aristocrats with above market dividend yields and below market price-to-earnings ratios are listed below:
- Air products & Chemicals (APD) expected total return of 10.8%
- Rowe Price Group (TROW) expected total return of 10.9%
- Procter & Gamble expected total return of 11.2%
- Pentair (PNR) expected total return of 11.4%
- 3M expected total return of 11.7%
- Emerson Electric (EMR) expected total return of 12.5%
- Abbott Laboratories (ABT) expected total return of 12.5%
- HCP (HCP) expected total return of 12.6%
- VF Corporation expected total return of 12.8%
- Archer-Daniels-Midland (ADM) expected total return of 13.3%
The 10 stocks listed above best match the criteria to best take advantage of the snowball effect.
‘Snowball stocks’ have strong and durable competitive advantages. Evidence of their competitive advantages is seen by their long operating history and consistent dividend increases.
Long-term investing in great businesses with shareholder friendly managements at fair or better prices will very likely produce compound wealth gains over time.
Remember the snowball effect when choosing your investments.