Procter & Gamble (NYSE: PG) stock has struggled for some time now. This time five years ago you could get your hands on shares in the Cincinnati based giant for around $77 apiece. Right now they’re changing hands at around the same price. Chuck in all the cash dividends paid out in the intervening period – roughly equivalent to around $13 per share – and you’re still only looking at compound annual returns of around 3% a year: broadly inline with the average annual rate of inflation. By comparison the Dow Jones Industrial Average has returned compound annual returns of 12.10% without dividends reinvested and around 12.80% with dividends reinvested over the same period.
Though the company has had its struggles, including a well publicized spat on the composition of the board, not everything is the fault of the underlying business. Like most high quality dividend payers Procter & Gamble shares have looked quite expensive for some time now, and have spent almost all of the past five years trading above 20x earnings on a trailing-twelve-month basis.
The last time I covered the stock back in November I remarked that the valuation was arguably its greatest headwind going forward. Now that the shares are trading some 15% lower I’d like to roll back a bit on that statement. There are tentative signs that things may begin to pick up from here on out, and some of the headwinds that have held back reported earnings have started to abate.
For instance, foreign exchange effects have had a massive impact over the past few years. On a cumulative basis the company generated what it calls “core” earnings per share of $22.30 between fiscal year 2012 and fiscal year 2017. This is essentially the cumulative sum of earnings per share minus any one-off and non-recurring items. Over the same time frame the negative currency impact of a strong dollar has added up to around $1.50 per share. In other words the actual underlying business is doing a bit better than the reported numbers would imply.
This all has a knock on effect in terms of the stock’s valuation. As it stands P&G shares are currently trading at a shade under 21x reported FY 2017 earnings per share. Not particularly cheap for a slow growing consumer staples stock I hear you say. However, on a core currency neutral basis that valuation drops to a slightly more reasonable looking 19x last year’s earnings. Going forward the company expects core earnings per share growth to clock in at around 5-8% for 2018 and for “mid-to-high single digits” growth thereafter. On that basis we could reasonably be looking at 2018 core earnings per share of around $4.30, or a forward price-to-earnings ratio below 18x.
As a long-term proposition that seems to me to be a pretty sensible starting position. Some years the valuation will contract, in others it will it expand. Over the long-haul, though, I don’t think paying 17-18x earnings will have anything other than a relatively small impact on shareholder returns. Throw in a current dividend yield of around 3.65%, plus mid-single digit average annual long-term growth, and the outlook seems okay for a stodgy company that regularly and reliably posts such high quality profits.