As a company, Procter & Gamble (NYSE:PG) has traditionally been touted as an essential holding in any long-term investor's portfolio, almost by default. And why not? The company manufactures many of the well-known household brand names we take for granted, such as Ariel, Febreze, Gilette, Oral-B, the list goes on. Given the fact that we use many of these items on a daily basis without even thinking about them, PG has always commanded brand loyalty among consumers. Moreover, it is commonly assumed that the company's performance can only grow from here thanks to such brand loyalty which is assumed to last. Procter & Gamble has always been promoted as a traditional "buy and forget" stock, if you will. However, I see various problems with this line of thinking. It is erroneous to assume that a company will continue to do well simply because it has done well in the past. Specifically, there are three areas where Procter & Gamble's financial performance has not been up to the mark as of late:
1. The stock is fairly priced with financial performance that does not justify such a valuation.
With PG currently trading at $82.37, the stock is trading above fair value which I calculate as $84.24 given a current P/E ratio of 20.8 and an EPS of $4.05 for this year. i.e. (20.8*4.05 = 84.24). If one adopts a buy and hold mentality, one is doing so because they believe that the security is mispriced. In other words, it is currently trading at a lower price than what it should be trading in the marketplace. This is not the case with Procter & Gamble.
2. Its ability to continue to pay generous dividends is in question.
Granted, Procter & Gamble has succeeded in providing an ever-increasing stream of dividend payments to their shareholders. Since 2009, DPS is up 37% from $1.72 per share in 2009 to $2.36 per share in 2013. These results are impressive and have rewarded loyal shareholders for their patience. However, let me throw another metric into the equation; free cash flow. The reason I like to place more emphasis on this metric is simply because it gives an indication of a company's capacity to continue increasing such dividend payments in the future. In this regard, the trend is not nearly as promising:
From the graph above, we can see that free cash flow growth overall has been negative from 2010 to 2013. While this in itself is not disastrous, we can also see that there has been little sign of consistent increases in Invested Capital over that period. I would gladly hold a stock with a lower dividend payout if I knew that the company was investing that money in worthwhile assets that would result in future growth. Procter & Gamble does not seem to be doing this. This suggests that the company's dividend payouts are not sustainable, and this has serious implications for investors who are dependent on such payments as a source of regular income.
3. There have been little signs of sales growth over the past five year period.
As can be seen in the graph below, domestic sales have declined by -0.65% overall, with foreign sales and operating revenue seeing a modest gain of 1.62% and 0.47% respectively over a five-year period. In my view, if Procter & Gamble was performing at its optimum, the rebound in US consumer confidence would show a much higher degree of sales domestically. In addition, given the myriad of opportunities presented by emerging markets in the consumer staples industry, Procter & Gamble does not seem to have capitalised on this.
To conclude, Procter & Gamble has been performing well below optimum as of late. I highly question whether the company can grow on a sustainable basis going forward, and if lackluster performance continues, then the company's credence as an income-generating stock is also put into question. Ultimately, I am of the view that far better opportunities exist in today's market and one should not simply put their money into an under-performing brand name.