There aren’t really any good times to buy Colgate-Palmolive at fire-sale prices. The reason? Everyone knows what a great company it is. I don’t care what kind of investor you are–value, growth, old, young, medium-term, long-term–Colgate-Palmolive has been a wonderful firm to own. About the only people who might not like it are short-term traders, and even then, there are short-term periods when Colgate performs especially well.
The way I see it, there are probably six magic firms I write about. Two of them are Coca-Cola and Johnson & Johnson, which have such extraordinary earnings quality and hedges in place that it is almost certain that someone buying the stock today will be collecting cash dividends in 2050. Another two are Berkshire Hathaway and ExxonMobil, which are wonderful for reasons beyond the intrinsic characteristics of them assets themselves. Berkshire has Warren Buffett guiding a $55 billion cash hoard, and ExxonMobil frequently enjoys years of undervaluation coupled with earnings and dividend growth that make it a godsend for people that want to generate meaningful (and growing) dividend streams over the decades.
And then there are the final two: Hershey and Colgate-Palmolive. They’re in that sweet spot size where they haven’t saturated the global markets quite like Johnson & Johnson and Coca-Cola, but they have enough heft in their own right to give strength in the form of earnings quality. Hershey is about 1/10 the size of Coca-Cola, and Colgate-Palmolive’s operations are almost ⅕ the size of Coca-Cola. They give you quality with room to run.
However, I haven’t been able to write about Colgate-Palmolive as much as I’d like over the past few years because of valuation concerns. When you grow earnings by 12.5% annually for over a century, and raise the dividend every year for over half a century, everyone is going to want to own the asset. Conservative accounts, growth accounts…whether you are focused on the capital gains or an income stream that grows fast, all eyes turn towards Colgate.
Since 1980, the stock has compounded at over 16%. It has a thirty-five year earnings growth rate of 13.8% and a dividend that hovered around the 2% mark during this time. A mere $10,000 Colgate investment back in 1980 would be worth $2 million today. It has delivered earnings growth on an annual basis for 22 of the past 25 years, and it has almost quadrupled profits since 1999.
The amount of money that flows to Colgate’s corporate coffers on each item sold is extraordinary. You know those $6 Colgate mouthwashes that you see at the store? $1.68 flows to Colgate shareholders. That is money that flows to New York after paying for the ingredients, the machinery, the employee salaries, the shipping, and the taxes. Everything. Once that mouthwash is sold, $1.68 is available for Colgate’s management to allocate as it wishes. The firm is an immense torrent of profitability per item, and the company sells item that need to be purchased over and over and over again.
You know how Coca-Cola brags that 3.5% of all beverages in the world are consumed by something produced under The Coca-Cola Company’s umbrella? Well, Colgate has 44.7% of the toothpaste market. In fact, that is one of the few difficulties facing the company: it already owns such a large percentage of its given markets, that it cannot meaningfully deliver earnings growth by getting other people to switch to Colgate. It already dominates the market, and usually relies on new product offerings and price hikes to fund the day.
When a company is high quality and is always growing, it doesn’t really go on sale. You’ll suffocate if you hold your breath waiting for Brown Forman, Colgate-Palmolive, or Lindt Chocolate to trade at 10x earnings. Even during the absolute worst of the financial crisis, Colgate Palmolive only came down to 16.8x earnings.
The shareholders are sensible enough to know a good thing when they see it, and that is why there is not a lot of irrationality in the stock price (after all, Colgate grew earnings from $1.69 to $2.19 between 2007 and 2009). When you hear about “flights to quality” during difficult economic times, Colgate is exactly the kind of stock that investors cherish. And because it is growing–even during recessions–it is always dragging the fair value of the stock forward.
I mention all of this to say that there are about two or three dozen companies in the world where the goal is not to buy the stock at an undervalued price. Sure, it would be nice if that happened, but it is an event that occurs with such rarity that it would be almost useless as a strategy.
And most importantly, a whole lot of wealth gets made holding Colgate during times of fair value. I’d count the 2007-2013 period as a short-term measurement in which Colgate began and ended the measuring period at fair value, and shareholders managed to generate 13.8% annual returns during this time frame. If the company is exceptional, and there is a nice growth component inherent in the nature of the enterprise itself, why not open the wallet above what you’re usually comfortable paying and add some shares to your family’s portfolio?
But now, we are nearing that point where I can start to discuss Colgate as a prospective investment to make now. In 2012, the stock traded at $43 per share. It was fairly valued. Then, people got a little carried carried away by 2014–they big the price up to $71 per share. The company is good, but it was already trading at 20x earnings in 2012, and didn’t really have the earnings growth to support a 65% capital appreciation in only two years.
When a stock gets pricey, three plausible course of action can follow: (1) the stock dramatically falls in a short period of time down to fair value; (2) the stock delivers capital appreciation that lags the actual earnings growth of the firm for a while; (3) the stock stagnates for a bit until the earnings catch up to support fair value. The past year or so look like Colgate is experiencing Option #3.
Last year, it traded at $71 per share and made $2.36 in profits. It hit 30x earnings, which is something you might pay if you are certain of 15% to 20% medium-term growth, but is not something you want to pay for 9% to 12% earnings growth. Now, the price has come down to $65 while earnings have leapt up to $2.70. Now, we are talking 24x earnings. It’s also worth mentioning that the strong dollar has taken $0.18 off earnings–and the devaluation of Venezuela’s currency also hit Colgate particularly hard among nationals. If you use $2.88 as the base, the valuation is 22.5x earnings. We’re getting there.
If you wanted to pay 20x normalized earnings for Colgate, you probably want to see the stock come down to $58. That’s a 10% or so haircut. If you have a five year or so time horizon, that kind of patience would be warranted. But if you are building a generational portfolio–something where are putting the bricks together for a diversified portfolio that will be a powerhouse and the envy of every Wall Street retiree in 2040–then the current price of $65-$66 is close enough to fair value that any impairment resulting from P/E compression will be a rounding error.
The current valuation of $66 puts Colgate in that sphere I like to call “intelligent behavior.” It may not be the most optimal allocation of funds out of the 15,000 stocks in the universe, but it’s also true that searching for the perfect can be the enemy of doing something good, and I doubt anyone would regret paying $66 today once you get out six or seven years from now. And if you try to apply strict value investing metrics even to the most wonderful enterprises on earth, the company is getting close enough to fair value that it should re-establish itself on your watch list. It’s a fun world we live in–so many subpar enterprises are trading at unjustifiable valuations–and truly extraordinary companies like Hershey and Colgate-Palmolive are now giving prospective shareholders a fair entry price to establish a long-term position.
Originally posted 2015-11-30 12:24:41.