Let’s compare snapshots of Procter & Gamble between 2006 and 2016.
In 2006, each share of Procter & Gamble represented $2.64 in net profits. In 2016, each share of Procter & Gamble earned $3.67 in net profits. That seems like a disappointing, though tolerable, ten years of 3.35% annual growth.
The reality is worse, though. Over this time Procter & Gamble added $7 billion in debt and leaned on that financing along with $20 billion in retained profits over the decade to retire 500 million shares of stock.
The other big strategic decision at Procter & Gamble has involved the sale of low-margin businesses as the company focuses its core on its most lucrative brands. As a result, net profits have increased from 12.5% to 16.0% over the past ten years.
The problem is that Procter & Gamble has been using buybacks and its shift towards high-margin products to cover up the fact that it struggles to sell more stuff. P&G sold $65 billion worth of merchandise in 2006; it is going to sell somewhere around $68 billion this year.
Despite all of this problem on the growth side, the stock is not trading at a discount. At $87 per share, it is trading at 20x next year’s earnings.
It seems that most of its stockholders are willing to tolerate low growth because the earnings quality of the stock is so extreme. If I were in wealth preservation mode, I could not name twenty-five businesses I’d rather own than Procter & Gamble. It has never cut the dividend that it initiated in 1892, and it has raised its dividend every year since 1963.
But when you analyze the stock from the perspective of someone trying to build significant stock market wealth, the stock leaves a lot to be desired. I’m looking at Amazon right now, and most 92 oz. liquid detergents from Tide cost around $12-$16. That is a very strong brand that is immensely profitable on a per unit basis, but I’m not sure there is a lot of pricing power left.
When I see Colgate toothpaste, it would surprise me if the $1.25 tube cost $2.50 in 2020. It wouldn’t surprise me if the $5 Listerine bottles from Johnson & Johnson shot up to $7 or $8. I could see Nike shoes that sell for $125 going for $200 in five years. You as a customer may not want those price increases, but I could see those price hikes happening concurrently with sales growth.
But when I look at the signature Procter & Gamble brands, I’m not sure that there is a lot of pricing power left. People are already starting to generics and competitors such as Kimberly-Clark, and I suspect this is due to excessive product costs. If that 92 oz. Tide laundry detergent cost $7-$10, I suspect the brand would be in a stronger position and with more room to raise the prices ahead.
Also, I am troubled by last year’s news that Procter & Gamble was experimenting with lowering the volume size in its detergent offerings as a way to boost profits. That is a less than forthright way of doing business to begin with—you’re going for a backdoor price increase—but you shouldn’t try those gimmicks on your premium products with generationally strong brand names. If people are going to pay $15 for Tide detergent, satisfy them.
The touchstone inquiry for determining the strength of a brand is this: What happens to sales volumes when you raise prices? Michael Eisner discovered what a goldmine he had at Disney when he raised the prices at the park by 10% every year and the foot traffic still increased. When Procter & Gamble raises its prices, there seems to be some Newtonian law at work demanding an opposite and equal decline in volume figures—the total revenues stagnate.
Long-term employees, and investors generally, that have spent their life building up a position in Procter & Gamble stock are in a pretty sweet spot. A $5,000 per year investment every year since 1980 would give you 13,700 shares of PG today that are sending you $9,000 checks every ninety days. That amount will grow by 4-7% each year, and will continue to provide one of the best passive income bases that you could possibly hold.
But if you are trying to turn X into 10x within twenty years, Procter & Gamble is not going to be your vehicle of choice. I’m not even sure it is going to deliver returns that match the historical 10% returns of the stock market that investors experienced from 1926 through 2012. Given that the S&P 500 now trades at 24x earnings, I am agnostic as to whether Procter & Gamble is a superior investment to a broad-market index fund. With a lot of financial engineering, you could squeeze out 4-5% long-term growth from PG. Combine that with a 3% dividend, and you are looking at 7-8% returns.
Originally posted 2016-10-31 13:30:07.