Procter & Gamble: Expensive Right Now

by The Compound Investor

Like a lot of folks, I enjoy owning Procter & Gamble (PG) stock because it epitomizes Peter Lynch’s ‘buy what you know’. A bunch of its brands make up a sizable chunk of our monthly shopping spend, and I doubt there has been more than a two-week stretch in which we didn’t buy the likes of Head & ShouldersFairy LiquidOlay and/or Gillette razor blades. If you force me to choose a dividend stock that will definitely be around in forty years time, I will probably plump for Procter.

Now, those recurring sales I just mentioned attract a net profit margin approaching 20%. That would be impressive enough in one year, but Procter does this year in, year out. It does this when the economy is booming, and it does it when it is in the doldrums. As a result, the company is in position to constantly shower its shareholders with cash. Procter has now racked up 129 years of consecutive dividends and 63 years of consecutive annual dividend growth. It has also spent around $100,000m on stock buybacks in its history. Some criticize the company for this, but I mention it to illustrate how much discretionary cash it generates.

By my count, the company has generated around $18,500m in post-dividend free cash flow over the past five years. Bear in mind that this was a period which many folks would characterize as a poor one for Procter. Assuming a similar performance over the next five years, the company would generate enough surplus cash to eliminate its current net debt. It could also retire circa 1% of the float each year if it spent the sum on share repurchases. As far I am concerned, any defensive stock that throws off that kind of firepower in a bad spell is worth a look.

Dollar Headwind

The company has copped a fair bit of criticism in recent years because growth has been anaemic. Indeed, if you look at the last six decades’ worth of dividend data you will find that the most recent one saw the lowest average annual growth. I see that as a rough indication that sales and profit growth has also come in relatively low recently.

The explanation for that is a probably a bit of a mixed bag. First, the firm does face some secular headwinds in terms of competition from store-owned brands and the changing advertising landscape. In terms of the latter, online advertising is a different ball game to the old linear-TV domination previously enjoyed by the likes Procter & Gamble. That is probably a legitimate concern given the company spends circa $7,000m on advertising each year.

In terms of the hard figures, these are what concern me as a stockholder. First, and this corresponds to the past five years, average annual organic volume growth (i.e. excluding divestments/acquisitions) clocked in at just 0.8%. The annual contribution from price increases over that period averaged just 0.6%. In other words, the company has both struggled to shift more goods and raise prices to offset this.

Foreign currency fluctuations have also wreaked havoc on the dollar denominated top and bottom lines. For instance, the strong dollar knocked a whole 8% off underlying core earnings per share (“EPS”) in Procter’s fiscal 2019. The situation was even worse back in the 2014-2016 period. Any analysis that highlights the lack of growth recently has to take this into account.

The good news is that recent results have been better. The three months ended September 30 saw the company report organic volume growth of 4%. Organic sales were up 7%, though this excludes a two percentage point hit from foreign currency movements and the impact of divestments/acquisitions.

The Long-Term Outlook

The million dollar question – what will Procter & Gamble stock do for me going forward? In its last fiscal year, the company posted core EPS of $4.52. The current share price is around the $120 mark, or roughly 26.5x that number. The current annualized dividend – around $2.90 per share – represents a yield of 2.5% as things stand.

Where does that leave us? Well, management’s long-term target is for mid-to-high single-digit core EPS growth. On top of a 2.5% dividend yield, that implies average annual returns of somewhere in the 8-10% range absent changes to the valuation multiple. That last part is obviously the kicker. A 26.5x earnings multiple is a problem unless management’s long-term goal proves too conservative. Averaged over a suitably long timeframe, I would expect that to amount to a headwind of around 2% per annum. If your goal is to compound wealth at a double-digit clip, this is not the time to be making a big lump-sum commitment to Procter & Gamble stock.


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