My view for a long time has been that ultra-high quality defensive stocks should be afforded extra leeway during periods of business-level stagnation. Procter & Gamble (PG) provides a good case study for this. Among the many thousands of publicly listed firms there are relatively few that match the business of selling brands like Tide, Head & Shoulders, Gillette and Ariel. Distilled down, it is a $1.2 billion per month profit machine operating off around $30 billion in tangible assets.
What turns that from being impressive to downright incredible is that Procter & Gamble posts this every year. There are a few key reasons for this. For one, the company operates across ten segments that give it a role in many mundane and repetitive tasks across the bathroom, kitchen and laundry room. When sales of toothpaste come in a little soft, sales of washing detergent can help smooth things out. Since a bottle of a Tide laundry detergent or Head & Shoulders shampoo only lasts so long, generating relatively consistent sales is somewhat straightforward. Furthermore, acting as a kind of one-stop shop is a more attractive proposition to retailers than finding ten different companies to meet the same product line up. Given that, Walmart’s share of Procter & Gamble’s sales in 2021, 2011 and 2001 reads as follows: 15%, 15% and 15%. Finally, the $1.2 billion that reach the corporate coffers in Cincinnati each month do so net of around $650 million in monthly advertising spending to support demand for its various products and $150 million in monthly R&D to increase their efficacy.
The above is why Procter & Gamble has paid a dividend in each year since the 1890s and has grown its dividend for 66 years in a row. It is also why I will accept periods of stagnation at the business level, because Procter & Gamble’s scope for dealing with any issues that do arise is just very wide. For instance, between FY 2008 and FY 2016 the company grew earnings by less than 1%. More specifically, the $3.64 per share in net income it made at the start of the period had grown to just $3.67 by 2016. This actually flatters its performance as the company also retired around 300 million shares through buybacks in that time.
Sometimes, there is some kind of accounting issue that makes these comparisons a tad dishonest. For instance, the base year may represent artificially inflated earnings, say from the accounting gain on an asset disposal, or the terminal year may represent similarly depressed earnings. That wasn’t really the case here. Procter & Gamble’s annual cash from operations started the period at around $5 per share and ended it at around $5 per share. Granted, there were some external factors such as a strong US dollar, but mostly business was just very slow due to the usual issues like increased competition from generic brands.
To cut a long story short, Procter & Gamble’s fortunes have changed dramatically for the better since then. For one, the company has been gaining share to supplement the typically low growth of the overall market. Earnings have also grown year-on-year in each year. As of 2022, net income per share of $5.81 represents 60% growth on 2016 compared to the zero growth that marked the 2008-2016 period. Furthermore, there are still a couple of years to go before a proper apples-to-apples comparison can be made. Procter & Gamble is expected to grow earnings a shade more by the end of that period which would improve the relative performance even further. Finally, the dividend payout ratio has improved from the low-70s area in 2016 to the low-60s area currently. That means more retained earnings for buybacks, acquisitions, debt reduction or to allow dividend growth to outpace earnings growth during another soft patch.
This success has mapped onto the returns enjoyed by shareholders. Depending on when exactly you measure (between calendar years or fiscal years: Procter & Gamble’s fiscal calendar runs from June), Procter & Gamble stock posted an annualized total return of 4.7% or 6.75%. Since then, the stock has returned around 105%, or over 12% annualized. The flip side to this is that prospective investors now find themselves paying 25 dollars for every underlying dollar of net earnings to own Procter & Gamble stock. Historically, that is a relatively high figure. In fact, outside of 2022 there hasn’t been a single year over the past 15 where the stock averaged a higher P/E multiple than that.
I think this is an issue for two reasons. Firstly, fixed income offerings now look much more competitive versus Procter & Gamble’s common stock. Depending on when exactly you start, the current P/E ratio may have been good for as much as 3% to 4% in terms of annual total returns over the past decade. The justification for this nice tailwind was that the spread between what you could earn from Procter & Gamble shares and a comparative fixed income yield was not any less attractive than in the past. That is not the case any more because you can currently collect a 4% yield just from US government debt.
Secondly, at 25x earnings Procter & Gamble’s valuation puts it in Coca-Cola and PepsiCo territory. The difference is that the latter are targeting high single digit EPS growth whereas Procter & Gamble has a slightly lower target of mid-to-high single-digit EPS growth. One reason I find that credible is that Coke and PepsiCo will be able to pull the pricing lever harder than Procter & Gamble without sacrificing volume. There is a much higher proclivity for Tide customers to trade down to a generic brand versus the Coca-Cola drinker when unit prices go up.
If your relationship with Procter & Gamble stock is nothing more than a monthly direct purchase plan with its transfer agent then I want you to ignore this article. That said, Procter & Gamble would not be in the top few names I would consider for a one-off lump sum investment for my own account right now.
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