Clorox stock has a distinguished history. Since 1920, it has compounded at a rate of 14.5% annualized (including the period when it was acquired and spun-off from Procter & Gamble). It is one of the all-time great investments in the history of Western Civilization. And yet, I don’t own any Clorox stock.
The reason? The ten-year rate of volume gains, pre-coronavirus, is only 1% annualized. The 5.5% earnings per share growth over the past ten years has been the result of Clorox buying back 10 million shares and raising prices across all categories at a rate of 4% annualized.
Of course, Clorox is up from $152 at the start of the year to $184 at the time of this writing (April 10, 2020). The mistake that investors make is that they assume the current rise in product demand will cause long-term incremental effect.
Since Clorox was founded in 1913, we can trace its performance during the Spanish Flu in 1917-1918. I contacted Clorox’s investor relations determined that the demand increased by 250% in the Los Angeles area in in 1918. By 1921? The growth in the Los Angeles area had declined to 7%. And then, Clorox had the benefit of being a small, fast-growing firm rather than the industry stalwart.
The point is, maybe Clorox will report strong earnings in 2021 and 2022, but those gains will evaporate by 2023-2025 (i.e. the additional Clorox sales rise and fall with the degree of the threat).
Despite this, shares of Clorox stock have risen in price to $184. That is not supported by Clorox’s $6 in net profits, which may temporarily rise to $7 per share due to increased buying right now. That is a valuation of somewhere between 26-30x earnings right now, depending upon the permanency of the current uptick. This is the highest valuation for Clorox at any point in the past 35 years.
You cannot pay roughly 30x earnings for a company that has a middle single-digit growth rate and expect to get a good result. Clorox will be earning something like $7.50 to $8 per share five years from now. I expect that the P/E ratio will be 19-21x earnings. In a realistic best-case scenario, the stock will trade at $168 five years from now. The only way it will trade higher is if it manages to make some acquisitions now of some small household cleaner companies all while using the overvalued Clorox stock to pay for it.
As an added point, I think the overvaluation is understated because Clorox does not have a strong balance sheet. It has $168 million in cash and $2.7 billion in debt. If it weren’t the beneficiaries of the pandemic, and was instead facing some type of scenario where it was affected like the airlines or hotel companies, it would be in similar trouble.
Also, this is why I think reading Peter Lynch’s “One Up on Wall Street” is a must-read for most do-it-yourself investors. Lynch included an extended passage about how investors would make the mistake of investing in Ford stock because it was a common household name without realizing that it is not a long-term compounder anymore because most of its vehicles aren’t profitable over the long run (nowadays, it is the Ford F-150 and other pick-up trucks that have kept the company solvent).
In today’s age, there are certain businesses like Campbell Soup and Clorox that are not super-compounders in terms of earnings growth anymore. Yes, they are “safe stocks” in the sense that you won’t lose 80% over ten years with them, but the growth is going to be slow in the middle single-digit rate. If you pay fair value, you won’t get market-beating returns. The only time to add them is if something happens that brings the valuation down to below 14x earnings or so.
With Clorox right now, investors are buying at an all-time high in terms of valuation this generation. All-time high valuations and middling long-term growth is not a winning formula. When you see a customer buy the Clorox off the shelves right now, it is not going to translate into market-beating wealth a decade from now.
