This past January, Colgate-Palmolive traded at $77.90 per share. Over the course of 2017, this company, perhaps the only one in the world that can be fairly called Big Sodium Fluoride, earned $2.59 per share in profits. On a trailing basis, the stock traded at 30x earnings.
As you well know, this is the type of valuation for a large-cap, blue-chip stock that makes it difficult to sustain significant outperformance because the earnings per share growth and the dividends will be partially offset by a compressing P/E ratio that will act as a limiting factor on what the price growth of the stock could otherwise be.
Over the past year, the investing has gotten a bit mum about Colgate-Palmolive as its stock price has declined from $77 to $62.
This catches my attention, especially as someone aware of Colgate’s current business excellence and as someone aware of its distinguished history.
Regarding its business excellence, it sells Colgate toothpaste, Irish Spring and Softsoap soap, Palmolive dish soap and dishwasher detergent, Hill’s pet foods, and approximately two-dozen other high profile brands. These are products that earn high profit margins, on average of approximately 17%, are purchased regularly, and are able to capture premium pricing due to the strength of their brands. And, perhaps best of all, stand very low probabilities of being subject to technological obsolescence or intense regulatory burdens. Colgate is Coca-Cola without the looming beverage tax regulation and the saturated markets.
Another reason why I’ve long paid attention to Colgate-Palmolive is that it has a habit of slightly outperforming its blue-chip peers over super long periods of time. If you plug in Colgate-Palmolive’s stock performance into a calculator at just about any point between 1973 and 1995, and compare it to the present, you will see somewhere between 13% and 16% annual compounded returns. In comparison, firms like Coca-Cola, Pepsi, Procter & Gamble, Clorox, and Hershey, fantastic compounders in the top 0.1% of investment decisions though they are, deliver investment returns of somewhere between 11% and 13% over similar time frames. That extra 1-3% annualized over decades can amount to hundreds of thousands or millions of dollars in extra household wealth depending upon the amount of the starting investment.
This raises a fantastic question: Why does a brand like Colgate toothpaste compound at a higher rate than a brand like Coca-Cola soda, especially in light of the fact that soda drinkers will purchase the beverage far more frequently than the typical individual purchases toothpaste?
The answer is largely a result of size and market opportunity. Coca-Cola is limited to beverages, Colgate is less limited in that its core competency includes toothpaste, dishwashing liquids, soaps, detergents, pet foods, and other household cleaners. Bolt-on acquisitions are more available.
Also, a firm like Colgate is smaller in comparison to Coca-Cola. It’s only a $55 billion company. Coca-Cola is approximately a $200 billion company. Much more room remains for international growth at Colgate than at Coca-Cola. Between 1988 and 1998, Coca-Cola increased ten-fold before levelling off into a single-digit growth streak. Most of its international growth happened in this ten-year band.
My view is that Colgate-Palmolive has not yet had its 1988-1998 equivalent yet. This company still has the ability to have a six or seven year stretch where it triples earnings or does something unusually impressive for a company of its size, and that is something that distinguishes it from similarly situated high-quality companies (i.e. I don’t think Coca-Cola will ever triple earnings in a six or seven-year stretch, absent a takeover by private equity that guts costs and diminishes the brand equity in a series of one-time gasping moves).
And lastly, there is the matter of advertising. Visa, Coca-Cola, and Procter & Gamble (with Gillette) have to spend more than $3 billion each advertising credit payments, sodas, and razors in order to maintain their market position–i.e. What these companies gain in pricing power by having strong intellectual property in the form of their brands that mean something to customers, is somewhat offset by the high advertising costs that are necessary to maintain this advantageous position).
In a world where these megacaps spend 15% of their annual revenues on advertising alone, Colgate-Palmolive only has to spend a little over 5% of its annual revenues on advertising to maintain and grow its marketing position. The magnitude of the competition for maintaining one’s position in the toothpaste market is dramatically less than for e-payments or sodas, and this means that Colgate’s pricing power means a little something more because there is not as high of an advertising cost to maintain it.
With this in mind, I am acutely aware of how Colgate’s valuation proposition has changed over the course of 2018. As mentioned above, the valuation proposition at the start of 2018 was something like 30x earnings for new shareholders considering purchase of this stock. Now, as we near the end of 2018, Colgate is earning around $3 per share while the price has come down to $62 per share. This is a value of a little over 20x earnings, which is about in line with the valuation I expect Colgate will trade at over long periods of time.
Colgate-Palmolive is in the funny position of having its stock price fall by close to 20% from its high point in 2018 while earnings per share growth is somewhere around 15% for the course of 2018. That’s what happens when a P/E ratio readjusts to where it ought to be. But now Colgate is priced at a point where I believe owners stand to capture the full earnings per share growth of the company in the form of commensurate stock price advancement, and given the distinguished history, strong current economics, and long runway for growth, I find Colgate-Palmolive to be the most compelling of the “buy it and forget about it” class of high-quality investments.