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Choosing the Duck

George L Smyth

Having done my homework, I've decided to open a DRiP with AFLAC. I wish that I could say that this was something that was done quickly and easily, but the truth of the matter is that it took me about four months to arrive at my selection. Having tossed and turned for so long, I thought that I would offer the thoughts behind my selection.

Do I need another DRiP?

The DRiPs in my portfolio that I have held for numerous years are Johnson & Johnson, Pfizer, Schwab, and Intel. The latter announced that they would change to a very high-fee plan, and as I average sending about $50 to a company, this would result in an 8% hit to my investment. Obviously, this is not acceptable, so although I will maintain my current holding with them, I will not be making additional purchases in the future.

I have owned MMM for my daughter's education for many years, and as I was looking to sell it to pay tuition, I decided to investigate the company for a possible DRiP. After a fair amount of research, I decided to do this, so I held onto a few shares, and used them to open a MMM DRiP in the middle of 2000.

Exxon is a more resent acquisition, though I am having problems actually classifying them as part of my DRiP portfolio. Normally, I select a company for a DRiP because I want to make regular purchases over a long period of time. I did start an XOM DRiP at the beginning of 2002, but my purpose was to be able to make purchases on dips without having to pay a discount broker. So although I have DRiP with them, I don't think of it as part of my DRiP portfolio.

One other company I owned for my daughter's education was Pepsi, and I held the shares in a DRiP because I will turn over five shares to her when she graduates. Actually, it will be more than five shares, as she has given me money to make additional purchases - smart girl. I have also used this to make purchases without going through a discount broker, so again, although I have a Pepsi DRiP, I do not consider it part of my DRiP portfolio.

So my currently DRiP portfolio contains JNJ, MMM, PFE, and SCH. I decided years ago that I could track and make regular purchases on five or six companies, so I am at least one company short in this respect. I half-heartedly began looking at companies four months ago, and when Intel announced their conversion to the dark side, I began to actively seek a replacement.

How should I select my new DRiP?

The bulk of my equity portfolio is in Vanguard's Total Market Fund, so diversification is maintained there. I have no concern for attempting to maintain some form of supposed diversification within my DRiP portfolio because this cannot be done with so few companies as I am willing to hold. If anything, I wanted to overweight this portfolio in the healthcare industry, as I believe that this area will outperform over the next fifteen years.

So to make my selection, I decided to look at the following criteria.

The company must be one that I want to own.
I want to like the companies that are in my DRiP portfolio. The primary goal is to make my money grow, but secondarily I want to feel that the companies are helping people and making their lives better.

The company must have a large capitalization.
I have found that my ability to select small companies to be less than desirable. I was able to do it during the Internet bubble, but who wasn't? Although I have made more good choices of small companies than bad choices since the bubble burst, it was not to the extent where my comfort level was such that I felt that I could commit on a long-term basis.

The company must be an industry leader.
I like to see proven success, which is what gives me the confidence to continue sending money when the company's stock price is down. Being at, or close to the top of an industry shows that the company is doing something right.

The company must have good management.
The management of a company gives it direction. If any lesson should be drawn from the collapse of Enron, it is that bad management can ruin even a large, respected company. Of course, the difficulty is in detecting good management, but we can only work with the knowledge available to us.

The company must have a no or low-fee DRiP plan.
When I make an outright purchase, I keep my fees at or below the 1% level. I wish to do the same with the recurring costs associated with my DRiP. As I average sending about $50 per company per month, this means that the fees must be 50 cents or less. I do not know of any companies with a fee that is this small, so this pretty much limits me to fee-free DRiPs.

How did I select my new DRiP?

AFLAC was a company that pretty much fell in my lap. I had looked at many companies, and many initially looked good to me, and many of them could have been good selections for me. As happens sometimes, however, when I find a company that looks better the more I look into it, I tend to continue investigating and concentrating just on that company. AFLAC was such a company.

About the company
AFLAC (American Family Life Assurance Company of Columbus) has been around since 1973. Their primary focus is in supplemental health and life insurance, with operations in Japan (where they command 85% of the offered supplemental health insurance) and the United States, the former commanding about three quarters of the revenue stream. This product helps customers pay for costs that are not reimbursed by their insurance system. In Japan the policies also cover death benefits, in the United States dental insurance has recently been offered.

The company must be one that I want to own.
I have known of AFLAC for years. A year and a half ago I bought a stuffed AFLAC duck as part of my girlfriend's Christmas bundle (the proceeds go towards their Cancer Center (http://www.aflac.com/about_us/community_cancer.asp). Anyone watching the few television shows that I watch cannot have missed the commercials, where the duck is the center of attention, offers the company name numerous times, and even I now understand what supplemental insurance is all about. The company is on Fortune's Most Admired Companies and Best To Work For lists.

The company must have a large capitalization.
Currently, AFLAC's market capitalization is about $16.5B. This is well within the parameters with which I am looking.

The company must be an industry leader.
There were a number of comparisons that I made, and each one pointed to AFLAC's leadership in their industry. Below is an example of one of them. Morningstar rates companies in comparison to their peers in the industry. I converted their alpha values to numeric and bolded the values that knocked a company off the list. Financial health was the most important element, with profitability also being important. As can be seen from the chart below, most companies had problems in at least one of these areas.

DRiP? Ticker Company Market
Cap $Mil
Sales
$Mil
Growth Profit-
ability
Financial
Health
No HUM Humana 2,587 10,195 3 0 10 4.3
No ANAT American Natl Insurance 2,620 2,134 0 5 8 4.3
Yes UTR Unitrin 2,682 2,534 8 8 9 8.3
Yes TMK Torchmark 5,015 2,732 5 9 10 8
Yes NFS Nationwide Fin Services 5,684 3,179 7 0 6 4.3
Industry Average 5,734 7,743 4 2 5 3.7
Yes UNM Unumprovident 6,177 9,395 0 3 9 4
Yes AET Aetna 6,769 25,191 9 0 10 6.3
No ATH Anthem 6,963 10,445 9 7 9 8.3
Yes JP Jefferson-Pilot 7,148 3,330 3 7 9 6.3
Yes LNC Lincoln National 8,663 6,381 0 0 6 2
No PFG Principal Financial Group 10,328 8,855 0 0 6 2
No JHF John Hancock Financial 11,439 9,109 0 0 6 2
No MFC Manulife Financial 14,118 9,539 2 8 9 6.3
Yes CI Cigna 14,600 19,115 0 4 2 2
Yes AFL AFLAC 19,436 9,598 2 7 10 6.3
No PRU Prudential Financial 19,593 27,144 0 0 5 1.7
Yes AEG Prudential PLC ADR 19,828 43,657 8 2 3 4.3
No UNH Metropolitan Life Insuran 22,852 31,928 6 0 4 3.3
No UNH UnitedHealth Group 27,408 23,787 6 9 8 7.7
No MET Aegon NV 31,494 28,571 10 3 3 5.3
Yes AXA AXA ADR 37,191 93,267 9 0 7 5.3

I anyone has an interest in what analysts think, their feeling is that the industry should be growing at about 14% over the next five years, with AFLAC showing slightly greater strength there. This flies in the face of the low growth rating given above, which is weaker than one would normally like to see. However, the company says that 90% of Americans recognize their name, and the opportunities for growth in this market I see as exceptional.

The company must have good management.
Daniel P. Amos is the Chairman of the Board for AFLAC, nephew of one of the three original founders. With a degree in Insurance, he started in the Sales Department of AFLAC, eventually running operations in Alabama. He is primarily motivated by family pride, as noted by the fact that he took an 80% pay cut when he moved up to the executive position.

Kriss Cloninger is the company's Chief Financial Officer. Having worked for the company for 14 years as a consulting actuary with KPMG, he was brought on as senior vice president and CFO in 1992.

Yoshiki Otake is the Chairman of AFLAC Japan. He has been with the company for over 25 years, primarily as Vice President of Marketing, and has studied both in Japan and The United States. He served the committee that helped AFLAC Japan obtain its original operating license in that country, a feat that took four years.

The company must have a no or low-fee DRiP plan.
AFLAC has a no-fee DRiP plan that can be directly entered without cost.

Conclusion

As previously noted, there were a number of companies that would have fit my criteria, but AFLAC clicked on each one and captured my interest. I see this as a company that will not only be around for a long time, but will thrive in the coming years. The singular caveat might be their current valuation, which is said to be high. Not only is current valuation not a concern of mine (if I am going to be interested in a company for the next decade, their current stock price has little significance to me), but I have not been able to see it. When comparing their valuations to other companies in their industry, they appear to fall right in the middle for most comparisons. Nonetheless, my expectations are that a decade form now, I will have been glad that I committed to making regular purchases.