Avoid This Expensive Consumer Staple Company
Wall Street Daily | Jul 22, 2014 06:07AM ET
Tide, Gillette, Duracell, Crest, Pantene, Old Spice, Bounty, Pampers, Tampax, Charmin…
These are some of the world’s most well-known household product brands.And they’re all produced by Procter & Gamble (NYSE:PG).
In fact, the company has 25 brands that each generate $1 billion in annual sales.
This blue-chip stock has been a component of the Dow Jones Industrial Average since 1932. Its 3.2% dividend yield is comfortably above the S&P 500 median of 2.0%. And the company is also a Dividend Aristocrat, having raised its dividend for 58 consecutive years.
So, what’s not to like about this consumer staple colossus?
Two words: Expensive valuation
h2 The Golden Ratio/h2I’ve talked about the merits of the enterprise value-to-EBITDA ratio in the past. One way to use this fantastic valuation metric is to compare a company’s current multiple with its historical average.
P&G currently trades at a 13.5x EV/EBITDA multiple.
That’s expensive relative to its 10-year average of 12.1x. And in July 2012, P&G traded at a 9.5x EV/EBITDA – far lower than today’s level.
In other words, if you were disinterested in P&G in 2012, but are super bullish on the stock now, you might want to adjust your stock-picking process.
Remember, we want to buy companies that are trading at cheap valuations and sell those that are trading at rich valuations.
As you can see in the chart, P&G reached an EV/EBITDA multiple of 13.9x in July 2013. At the time, this was the highest level in six years. Since August 1, 2013, the stock has produced a total return (dividends reinvested) of just 1.9%.
By comparison, the S&P 500 has trounced P&G with an 18.9% gain over the same period. Even the Consumer Staples Select Sector SPDR ETF (ARCA:XLP), which counts P&G as its largest constituent, has risen a respectable 11.6%.
Bottom line: P&G is significantly lagging its large-cap and industry peers, and based on its total valuation it’s not hard to see why.
h2 The Hunt for Blue-Chip Dividend Payers/h2P&G is very popular among dividend investors for many of the reasons I mentioned above – along with the fact that the company has raised its dividend by 7% in each of the last three years.
Plus, consumer staples stocks are often coveted for their non-cyclical businesses and steady cash flows. And consumer staples stocks tend to be much more defensive in nature than the consumer discretionary sector.
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However, it’s important for investors to resist getting lulled into a false sense of security by holding 3%-yielding large caps. P&G and other expensive consumer staples companies won’t provide you with the total return performance (or safety during a correction) that you may expect.
By all means, continue to buy P&G’s popular products that keep us, our loved ones, and our houses clean and smelling fresh. Just avoid the stock.
Safe (and high-yield) investing,
BY Alan Gula, CFA
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