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Avoid This Expensive Consumer Staple Company

Published 07/22/2014, 06:07 AM
Updated 05/14/2017, 06:45 AM

Tide, Gillette, Duracell, Crest, Pantene, Old Spice, Bounty, Pampers, Tampax, Charmin…

These are some of the world’s most well-known household product brands.And they’re all produced by Procter & Gamble (NYSE:PG).

In fact, the company has 25 brands that each generate $1 billion in annual sales.

This blue-chip stock has been a component of the Dow Jones Industrial Average since 1932. Its 3.2% dividend yield is comfortably above the S&P 500 median of 2.0%. And the company is also a Dividend Aristocrat, having raised its dividend for 58 consecutive years.

So, what’s not to like about this consumer staple colossus?

Two words: Expensive valuation

The Golden Ratio

I’ve talked about the merits of the enterprise value-to-EBITDA ratio in the past. One way to use this fantastic valuation metric is to compare a company’s current multiple with its historical average.

LOFTY-VALUATION

P&G currently trades at a 13.5x EV/EBITDA multiple.

That’s expensive relative to its 10-year average of 12.1x. And in July 2012, P&G traded at a 9.5x EV/EBITDA – far lower than today’s level.

In other words, if you were disinterested in P&G in 2012, but are super bullish on the stock now, you might want to adjust your stock-picking process.

Remember, we want to buy companies that are trading at cheap valuations and sell those that are trading at rich valuations.

As you can see in the chart, P&G reached an EV/EBITDA multiple of 13.9x in July 2013. At the time, this was the highest level in six years. Since August 1, 2013, the stock has produced a total return (dividends reinvested) of just 1.9%.

By comparison, the S&P 500 has trounced P&G with an 18.9% gain over the same period. Even the Consumer Staples Select Sector SPDR ETF (ARCA:XLP), which counts P&G as its largest constituent, has risen a respectable 11.6%.

Bottom line: P&G is significantly lagging its large-cap and industry peers, and based on its total valuation it’s not hard to see why.

The Hunt for Blue-Chip Dividend Payers

P&G is very popular among dividend investors for many of the reasons I mentioned above – along with the fact that the company has raised its dividend by 7% in each of the last three years.

Plus, consumer staples stocks are often coveted for their non-cyclical businesses and steady cash flows. And consumer staples stocks tend to be much more defensive in nature than the consumer discretionary sector.

However, it’s important for investors to resist getting lulled into a false sense of security by holding 3%-yielding large caps. P&G and other expensive consumer staples companies won’t provide you with the total return performance (or safety during a correction) that you may expect.

By all means, continue to buy P&G’s popular products that keep us, our loved ones, and our houses clean and smelling fresh. Just avoid the stock.

Safe (and high-yield) investing,

BY Alan Gula, CFA

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