This Is Not The Right Time To Make A Large Colgate-Palmolive Stock Purchase

Colgate-Palmolive is probably one of my favorite businesses—if someone said I had to make a decision today to only own eight stocks for the rest of my life, and the list could never be changed, it would occupy one of the eight slots (with Nestle, Coca-Cola, PepsiCo, General Electric, Johnson & Johnson, Procter & Gamble, and ExxonMobil occupying the others).

You’re already familiar with its product line—Colgate toothpaste, Hill’s petfood, Irish Spring soap—and the fact that the company has been growing dividends for 50+ years (and, like Procter & Gamble, has been paying dividends in uninterrupted quarters dating back to the 1890s). Not only is it a blue-chip with a long history, but its recent growth has been good as well: In the past ten years, revenues have grown by 7.5% annually and dividends have grown by 12.5% annually. That means the company has meaningful top-line growth, and not only do you get the safety inherent in a durable business model with a very long track record, but you are receiving growth in your income at a substantial rate as well.

I would have a few concerns about buying the stock right now:

The company has covered up slow foreign market growth in recent years by giving shareholders dividend raises above actual growth in profits. Throughout the 1990s and until 2003, Colgate was paying out 30-40% of its profits in the form of a dividend. The payout ratio has increased in recent years, as Colgate experienced a year decline in 2013 as profits dipped to $2.38 from $2.58 in 2012 (and should come in around $2.60 this year). This drop was due to negative currency translations, which is generally irrelevant background noise over the long-term, but also lower than-expected revenue growth (Colgate only grew its revenue from $17 billion in 2012 to $17.4 billion in 2013, and it’s expected to be somewhere around $17.6 billion this year).

Because of this slow near-term growth, the $0.36 quarterly dividend amounts to $1.44/$2.60=55% of the company’s profits. The dividend constituted a higher percentage of Colgate’s profits during 2013 and 2014 than at any point in the past twenty years. The company has covered up some of the stagnating growth by taking on debt to retire 10% of the company’s outstanding stock since 2008.

Are these near-term problems that should dissipate in the coming years? Absolutely. The company has indicated that it plans to grow revenues by 7% in Asia and Latin America, and 2% in the United States and other developed markets over the coming five years. That can doably translate into 8.5% or so earnings per share growth, and if the company continues with its buyback program, it can achieve long-term growth in the 9-11% range.

My concern about buying here has to do with valuation. Just check out Colgate’s typical P/E ratio over the past ten years: 21.8x earnings in 2004, 19.7x earnings in 2005, 20.6x earnings in 2006, 20.5x earnings in 2007, 19.8x earnings in 2008, 16.1x earnings in 2009, 18.6x earnings in 2010, 17.3x earnings in 2011, and 19.6x earnings in 2012. Last year, people were willing to pay 25x earnings for Colgate. Now, with a stock price of $67 per share and $2.60 in earnings, the stock is trading at 25.7x earnings.

This is loosely analogous to what happened to the stocks trading in the 1990s, when the company traded at a little over 30x earnings. If you bought the stock in the summer of 1999, you paid 31x profits for it. You received 8.5% annual returns since then, which is nice in an absolute sense given the quality of the company, but it is also frustrating knowing that Colgate grew profits per share by 12.5% from 1999 through 2014, and shareholders had to suffer impaired returns because of their starting valuation (and considering it is my contention that the stock is overpriced right now, the long-term returns would be even worse than that 8.5% annually if company were fairly priced right now).

Is 25x profits as bad as 30x profits in 1999? No, it’s not. But it is enough overvaluation that someone buying now will probably see their total returns lag the growth of the business by 2.5 percentage points or so. If the business grows at 10%, you’ll get 7.5% returns. If it grows at 7%, you’ll get 4.5% returns. You need things to go quite well to earn above average returns, and if the company encounters any pro-longed setback, as occasionally happens to great companies (see Coca-Cola’s troubles to grow revenue right now for a reference point on that) then you will be disappointed by your long-term returns as you would simultaneously have to deal with lower earnings growth and a compressing P/E ratio at the same time.

If someone were dollar-cost-averaging a small amount into Colgate among a bunch of other companies, it probably wouldn’t be a big deal to your overall strategy—the point of dollar-cost averaging is that you buy through the highs, fair pricing, and the lows to eventually receive returns that mirror the growth of the business. But if you are making a one-time lump sum investment, and you have any kind of bent towards value investing, then now is not the season to buy the stock, as its dividend payout ratio is about fifteen percentage points higher than historically, and the valuation these past two years is the highest since 2001.

If you want to be a good growth-at-a-reasonable price investor, then you should insist on a price below 21x earnings, or the $54-$55 range. If you want to take value investing seriously, and apply it to even the best-of-breed companies, then I would look for a price below 17x earnings, or $44 per share (you would have been able to do this for good chunks of 2008 and 2009, and briefly in 2010 and 2011, but it generally requires significant patience to get a price where Colgate is actually cheap). It’s a wonderful long-term hold in the portfolio—how many places in the world can reliably give you 8-11% annual dividend increases for the next twenty years?—but this isn’t the right season to start a large position.

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2 thoughts on “This Is Not The Right Time To Make A Large Colgate-Palmolive Stock Purchase

  1. Owner5524 says:

    In case anyone is interested, I ranked your master list of stocks (plus a few others which you highly recommend but are not on the list) in Fastgraphs from most undervalued to most overvalued. The following lists the company name, followed by the 15yr normal P/E (the average of what people have been willing to pay for earnings over the last 15 years) followed by the current P/E, followed by the average P/E subtracted from the current P/E. For undervalued stocks, this is a negative number, for overvalued stocks this is a positive number. Technically, a number of zero would indicated the stock is exactly fairly valued. All this is according to Fastgraphs of course, so it’s value will likely depend on how strongly you feel about the accuracy of  Fastgraphs system of valuing equities. I tend to start my purchases at the beginning of the list and work my way down as my positions reach their max. Hopefully somebody may find some value in this method. Happy investing!
    BHP Billiton plc

    23.2
    12.6
    -10.6
    International Business Machine

    16.4
    10
    -6.4
    Wal-Mart Stores Inc.

    20.9
    15.8
    -5.1
    JPMorgan Chase & Co.

    14.7
    10.9
    -3.8
    Aqua America Inc.

    25.6
    22.1
    -3.5
    Royal Dutch Shell plc

    13.1
    9.7
    -3.4
    Walgreen Co.

    23
    20.2
    -2.8
    Wells Fargo & Company

    15.4
    13.1
    -2.3
    General Electric Company

    18
    16
    -2
    GlaxoSmithKline plc

    16.8
    14.8
    -2
    Emerson Electric Co.

    18.4
    16.9
    -1.5
    United Technologies Corporatio

    17.3
    16
    -1.3
    Kellogg Company

    17.6
    16.4
    -1.2
    Microsoft Corporation

    19.1
    18.3
    -0.8
    Pfizer Inc.

    14.3
    13.5
    -0.8
    The Walt Disney Company

    21.2
    20.6
    -0.6
    Exxon Mobil Corporation

    13.4
    13
    -0.4
    The J. M. Smucker Company

    17.5
    17.2
    -0.3
    The Coca-Cola Company

    20.6
    20.8
    0.2
    Lockheed Martin Corporation

    16.7
    17
    0.3
    Johnson & Johnson

    17.6
    18.4
    0.8
    Campbell Soup Company

    16.7
    17.5
    0.8
    General Mills, Inc.

    17.2
    18.1
    0.9
    Chevron Corporation

    10.4
    11.4
    1
    Pepsico, Inc.

    20.3
    21.3
    1
    McDonald’s Corp.

    17.5
    18.7
    1.2
    Southern Company

    15.7
    16.9
    1.2
    U.S. Bancorp

    13.2
    14.4
    1.2
    The Procter & Gamble Company

    19.6
    20.9
    1.3
    Colgate-Palmolive Co.

    21.4
    23.5
    2.1
    Diageo plc

    16.4
    18.5
    2.1
    Abbott Laboratories

    17.7
    19.9
    2.2
    Anheuser-Busch InBev SA/NV

    18.8
    21
    2.2
    The Hershey Company

    22
    24.3
    2.3
    Kraft Foods Group, Inc.

    16.5
    18.8
    2.3
    Unilever plc

    17.1
    19.5
    2.4
    Becton, Dickinson and Company

    18
    20.5
    2.5
    McCormick & Company, Incorpora

    19.3
    21.8
    2.5
    Philip Morris International, I

    14.6
    17.2
    2.6
    ConocoPhillips

    9.4
    12.2
    2.8
    Kimberly-Clark Corporation

    16.1
    19
    2.9
    The Clorox Company

    19.1
    23
    3.9
    Visa Inc.

    23.3
    27.3
    4
    Church & Dwight Co. Inc.

    20.5
    24.8
    4.3
    Nestl

    15.1
    20.2
    5.1
    Dr Pepper Snapple Group, Inc.

    14.4
    19.7
    5.3
    Dominion Resources, Inc.

    15.1
    21.2
    6.1
    Brown-Forman Corporation

    21.9
    29.2
    7.3
    Berkshire Hathaway Inc.

    13.5
    21.5
    8

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