P&G: Limited Upside Potential With Attractive Dividends

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 |  About: The Procter & Gamble Company (PG)
by: Efsinvestment

By Ahmed Ishtiaq

Procter & Gamble (NYSE:PG) is focused on providing consumer packaged goods. The company's products are sold in more than 180 countries primarily through mass merchandisers, grocery stores, membership club stores, drug stores and high-frequency stores. In the beauty segment, the company offers a variety of products, ranging from deodorants to cosmetics to skin care, such as its Olay brand, which is the facial skin care brand in the world. In the fabric and home care segment, the company offers a variety of fabric care products, including laundry detergents, additives and fabric enhancers. In home care products, the company offers dishwashing liquids and detergents, surface cleaners and air fresheners.

As of February 15, 2013, P&G stock was trading at around $76, with a 52-week range of $59.07 - $76.96. It has a market cap of about $209 billion. The trailing twelve-month P/E ratio of 19.6 is higher than the forward P/E ratio of 17.0. P/B, P/S, and P/CF ratios stand at 3.2, 2.7, and 15.6, respectively. The operating margin is 17.8% while the net profit margin is 15.5%.

P&G has a 2-star rating from Morningstar. Out of ten analysts covering the stock, four have a buy recommendation, two have hold recommendations and one analyst has market outperform rating. On the other hand, two analysts are neutral about the stock. Average five-year annualized growth forecast estimate is 8.40%.

We can estimate P&G's fair value using discounted earnings plus equity model as follows.

Discounted Earnings plus Equity Model

This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:

V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5+ Disposal Value

V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 +…+ E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]

The earnings after the last period act as a perpetuity that creates regular earnings:

Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r

While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.

Valuation

Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.

In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year. The average EPS for P&G is $4.24.

While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 8.40%. Book value per share is $24.20.

Fair Value Estimator

V0

E0

$4.24

V1

E0 (1+g)/(1+r)

$4.14

V2

E0((1+g)/(1+r))2

$4.04

V3

E0((1+g)/(1+r))3

$3.95

V4

E0((1+g)/(1+r))4

$3.86

V5

E0((1+g)/(1+r))5

$3.77

D

E0(1+g)5/[r(1+r)5]

$34.24

BV

Equals

$24.20

Fair Value Range

Lower Boundary

$58.23

Upper Boundary

$82.43

Potential

7.70%

Click to enlarge

(You can download FED+ Fair Value Estimator, here.)

I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for P&G is between $58.23 and $82.43 per share. At a price of about $76, P&G is trading close to the upper boundary of its fair value range. The stock still has up to 8% upside potential to reach its fair value maximum.

Summary

P&G has been reporting better than expected earnings. There were fears about foreign currency losses and slowing global markets. However, the company was able to beat these fears and report impressive earnings. In the recent earnings announcement, the company raised its future outlook, indicating better than expected future demand. I believe the recovering global economy and increasing purchasing power is bound to have a positive impact on the company.

Furthermore, P&G offers impressive dividends and a strong history of dividends. Currently, the firm has a dividend yield of 2.96%, and an annual dividend of $2.25 per share. P&G has a long history of dividends, and the company has been increasing its dividend payouts on regular intervals. I see there is still upside potential in this stock. The company also plans to repurchase some shares, which should further boost the EPS.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: Efsinvestments is a team of analysts. This article was written by Ahmed Ishtiaq, one of our equity analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.