I have been studying this latest market move stock by stock, and I believe that as it ages it will grow more discriminating. The rising tide has lifted mostly all ships to this point, but I am calling for the sale of Procter & Gamble (PG) on valuation here.
With capital flowing in heavily, fund managers seem to have been simply increasing their holdings in stocks already researched and approved, but at valuations that are getting difficult to explain those same fund managers are going to have to reconsider some securities and replace them with better value. That is why I just downgraded P&G peer Johnson & Johnson (JNJ) and why Morgan Stanley just downgraded Colgate-Palmolive (CL) on valuation. The Consumer Staples Select Sector SPDR (XLP) was off by 0.7% at the hour of scribbling here Friday, indicating that the hot group is finding reconsideration now on valuation.
Procter & Gamble's valuation is extended in my opinion. The current P/E on PG is 17.4X trailing 12 month EPS (according to listed data at financial info providers), which is 115% higher than the stock's five-year average P/E. I note the issue with the P/E because I believe a calculation of P/E based on diluted EPS from continuing operations would be much higher. Further illustrating, Yahoo Finance and others have FY 2013 EPS at $3.85, but the company's 10K lists diluted EPS from continuing operations at $3.12, and if that same issue has continued in this fiscal year as it appears, it would mean that the trailing P/E on PG should be at a much higher point than the 17.4X figure I'm seeing.
If we compare apples to apples, or flawed data to flawed data, the stock is not trading at its five-year high P/E like JNJ, but it is nearly at its five-year average high P/E of 17.9. As far as growth is concerned, analysts see PG growing 5.2% this year ending in June, and 6.4% on an average annual basis over the two-year period ending in June 2014. The five-year growth outlook is set at 8.1%. I prefer to look at the forward 12 months EPS in my PEG ratio construction, and so I average the EPS of the fiscal years 2013 and 2014 to get an EPS number of approximately $4.21 for the next 12 months. This gives me a forward P/E of 18.2X; this further indicates that the trailing 12 month EPS and P/E figures have some noise in them. Otherwise the P/E would be higher for the trailing figures, not lower than the forward P/E as it appears on many financial websites.
This serves to make PG look less pricey than some of its peers, but the PEG ratio illustrates that it is a mirage. The PEG ratio using the forward P/E and the five-year average growth estimate offer a measure of 2.2X. Perhaps that valuation was justifiable by some money managers in a questionable economic environment, but they will be unable to do so moving forward should the economic environment improve. Furthermore, the capital driver behind the latest run up in these shares should be running out of steam at these valuation levels, so busy money managers should be finding new places for capital other than PG and other expensive consumer staples. Therefore, I would sell PG here and find value elsewhere.