The Discussions Concerning Procter & Gamble Miss The Forest For The Trees

If you’ve read the headlines about Procter & Gamble’s plans for its future lately, you have probably encountered headlines like “Procter & Gamble Set To Shed 100+ Brands” or other similar expressions aimed at noting a shake-up at P&G. At first glance, it sounds like a lot—Procter & Gamble has 170-180 brands, and plans to get rid of about 100 of them, conjuring up the image that it’s shedding half its portfolio or something that sounds similarly drastic.

The thing to keep in mind is this: the brands being sold only amount to $8 billion in sales per year. As a point of reference, Procter & Gamble sells $88 billion worth of household cleaning merchandise per year. We are talking somewhere between 9% and 10% of the company being sold off here, not enough to really change the quality of the company or expectations for future growth.

I think the frustration at Procter & Gamble headquarters largely stems from the fact that the past two decades could be summed up like this: we cut costs, we increased productivity, we bought back some stock, we grew sales 2-3%, oh, and we bought Gillette sometime in the past decade. Since 2004, P&G has delivered 6-7% annual returns, so while the results might be lower than what you’d anticipate upon buying the stock, it hasn’t been the end of the world, either.

I don’t really have much of an opinion on these minor divestments—P&G is largely driven by Gillette, Olay, Tide, Crest, and Pampers, and from the investor perspective, I’d be more concerned about the growth plans for those plans rather than company modifications around the peripheries. Without any big acquisitions or changes in the status quo, P&G could march along with 7% annual earnings per share growth if the management of the company were left to the wild without any deliberate changes in strategy.

To get back to a situation where you’re seeing 10% annual earnings per share growth, you’d need another Gillette-level acquisition. That’s just life when you’re a $222 billion company.

The other thing is: You don’t necessarily need high sales growth to make something a satisfactory long-term investment. For instance, sales have only grown at 3% or so over the past decade, but total returns have been in the 6-7% range over that time frame, depending on your purchase point. Why is that? Because the company has bought back some stock, cut some costs, and focused on premium-brands with higher profit margins so that across the company, it is now earning 14% profits on each item sold instead of 12%, which is a nice side benefit that hasn’t gotten much attention.

For me, the bottom-line is this: The shedding of 10% of the company’s portfolio is a non-event; you won’t hear people talking about this years later like you did with the Gillette acquisition. If the status quo remains in place, you’re looking to collect a 3% dividend and achieve 6-7% growth in the dividend thereafter. Plus, you have a 25-30% chance P&G pulls off something big in the next couple of years to tilt the earnings growth in the direction of 10% annually. The appeal of P&G isn’t necessarily going to be growth that outpaces the S&P 500 like you’d see with Visa, but rather, that you own a company of such high caliber that you can feel confident reinvesting the dividends each and every quarter without it someday disappearing in Wachovia fashion. It’s a place to inventory wealth, rather than rapidly build wealth.