Clorox (CLX) has one of the most popular dollar cost averaging plans among blue chips in the country, with a very shareholder friendly plan. After a one-time set-up fee of $15, those investors seeking to regularly accumulate Clorox shares only have to pay $0.03 per share in transaction fees. If you invest $250 per month into Clorox stock, your annual transaction costs are only around $0.72. It’s as close to free something can get without actually being free.
If someone had to commit to only owning 20 stocks for the rest of his life, the diversified and well-branded collection of cleaning/housing goods would be a persuasive candidate for consideration. Everyone has heard of Clorox. The brand dominated the bleach industry over the 20th century and still owns a market-leading position.
The net profit margins are crazy high at 10.7%. Although the dividend is occasionally frozen–see the $0.84 payout of 2001 and 2002–the payouts march nearly straight upward over time thanks to the long-term execution of the General Electric business model of having dominant market shares (Clorox generates $5.6 billion in revenue per year, and $4.5 billion of that comes from products that either have the first or second position in their market).
Since 1980, shareholders have earned 14% annually. Since 1990, shareholders have earned 13% annually. And since 2002, shareholders have earned 11.5% annually (I used 2002 instead of 2000 as a measuring point to avoid the misleading impression created by the 33x earnings valuation that was present in 2000). For people who do nothing but sit and hold this stock, a great fate awaits (historically speaking.)
But, as the critics of using historical stock performance point out, the past returns are not guarantees of future performance. My own perspective is this: When conditions are generally the same, there should be a presumption that the future results for a business will mirror the performance of the past. When the variables shift, so should the analysis.
When I study Clorox right now, it is clear to me the valuations have shifted. Over the past twenty-five years, Clorox has an annual sales growth rate of 7.8% that has translated into earnings growth of 9.2%. But those figures have been trending down: Clorox has only grown sales per share by 6.5% over the past ten years, and 2.0% per share over the past five years. And the earnings per share figure has declined to 5.5% annually over the past ten years, and 3.0% annually over the past five.
And those figures somewhat understate the slumping growth at Clorox because the per share figures are much more impressive than the core business changes due to a strong buyback program that began in 2003. Over the past thirteen years, Clorox has changed the characterization of its balance sheet from cash rich and low debt to low on cash and moderately high on debt. This facilitated a stock buyback program that reduced the share count from 212 million in 2003 to 128 million at the end of 2015 which has reduced the share count by 39%.
Over this time, earnings per share grew from $2.33 to $4.57. Shareholders have experienced 96% earnings per share growth, with 37.44% of the EPS growth coming from stock buybacks and 62.56% coming from old-fashioned organic growth.
From 2003 to the end of 2015, Clorox has been a business growing earnings per share at 5.77%, with buybacks giving you earnings per share growth of 2.16% per year and the business itself growing by 3.60% annually.
That is not a sign of a fast growing business. It’s possible that organic earnings per share growth could have been higher if the Clorox board and officers decided to reinvest into the business instead or repurchase shares these past thirteen years, but presumably, they repurchased stock because they considered it the best use of retained earnings,so the contemplated alternative wouldn’t have generated more than 2.16% per year. And, even being more generous to management, you can’t assume that the money used for buybacks could have given more than 3.60% annual earnings per share growth unless you believe that the 12th, 13th, 14th, and 15th best ideas for capital deployment are better than the 1st, 2nd, 3rd, and 4th ideas. Maybe it works that way sometimes, but you cannot reasonably create that presumption.
I can deal with slow-growing businesses. You have seen my case study on how The Southern Company has delivered exceptional returns despite not delivering anything impressive in terms of earnings per share. But if the business is growing slowly, then the valuation has got to be right, and there should be a good chunk of cash being returned to shareholders in the form of dividends.
Because Clorox generates somewhere between 81% and 83% of its profits in the United States, the strong dollar has not created an artificial drag on earnings. What you see is what you get. Even if you take the $4.57 per share in earnings and add a dime, generously treating the earnings power of the firm as $4.67 per share for true earnings power analysis purposes, the P/E ratio of the stock is 27x earnings.
That bothers me because it is the highest valuation the stock has seen since 1999 when the stock traded at 26-33x earnings. If you bought then, and held through 2013, your returns on the stock would only be 6.33% annually. The reason why I use the end of 1999 through 2013 as a relevant measuring period is because Clorox shifted from a valuation of 28x earnings at the end of 1999 to 18x earnings at the end of 2013. That is darn close to what I expect to happen for prospective investors now–they will see the P/E ratio of 27 drift somewhere to that 18-20x range over the long run depending on the corresponding interest rates.
And keep in mind that, from 1999 through 2005, Clorox grew earnings from $1.63 to $2.88. That was a six-year burst in which earnings per share grew 76% or 9.95% annually. For the performance of 2016 onward to even mimic the 6.33% returns, you would need an improvement in the status quo performance of the business and/or another spurt like Clorox saw from 1999 through 2004.
Clorox management has found that its core housing and cleaning brands don’t translate neatly overseas. The great thing about Coca-Cola’s international expansion is that all the company had to do was sell Coca-Cola abroad. The post-Marshall Plan economy was an accommodating environment for American multinationals that wanted to expand the sale of their existing inventories.
But the current landscape is less accommodating for American companies seeking to become multinationals by selling its existing product lines. Hershey has had to deal with it–the brand equity of a Hershey bar in China is nearly negligible. Clorox bleach doesn’t inherently mean anything to a Brazilian, and so Clorox either needs to advertise to make it mean something and build brand equity, or it needs to buy an existing Brazilian (or whatever country) bleach product. High advertising costs, or high acquisition costs, will dot the expansion trail for these American firms that are trying to create an international footprint. It will also have to build out its own international distribution network. The theory that Clorox can boost earnings growth through international expansion may prove true, but it’s easy to underestimate the costs of executing this strategy.
The short version of the story is that you shouldn’t buy non-cyclical blue chips at a valuation of 27x earnings with earnings growth presumably in the 5% range while also carrying a moderately high debt burden.
Perhaps the best way to invest is to have a wide circle of competence in which you find the most attractive company available out of the entire publicly traded markets. But let’s assume, either through desire or competence limitations, you can only consider similarly situated firms for consideration. I would much, much rather own Colgate-Palmolive than Clorox right now based on the current terms of the transaction. Even if I already owned a full position in Colgate-Palmolive and had to choose between doubling down on Colgate or adding Clorox as a diversifier to Colgate, I’d still choose Colgate. The disparities are that significant.
Colgate at $66 appears to trade at a P/E valuation of 24x earnings compared to $2.70 per share, but it actually is affected by the strength of the U.S. dollar because over 80% of its sales occur outside the U.S. It’s basically the same profile as Coca-Cola–American in domicile and reputation, but global in execution. The “real” earnings per share on a currency-neutral basis are closer to $3.10 per share, for a P/E ratio of 21. It’s got a dividend growth streak dating back to 1963, an uninterrupted dividend payment history back to 1892, 15% profit margins, and long-term earnings and dividend growth of 10.5% and 9.5% respectively over the 2003-2015 measuring period that I used for Clorox. Furthermore, these figures are understated because I didn’t adjust them to make them currency neutral. I’d much prefer a firm at 21x earnings growing earnings and dividends around 10% to a firm growing at 5% or so while trading at a valuation of 27x earnings. It would surprise me a lot if Clorox outperformed Colgate-Palmolive from 2016-2026.
Originally posted 2016-02-10 16:35:32.