The current low interest rate environment has complicated investing, particularly for dividend-focused investors. In a search for yield, investors have moved out of the risk spectrum and into dividend stocks, creating a bubble that is unlikely to last. As venerable dividend payers pull back, as this, dare I use the term, dividend fad unwinds, when is the right time to step in? The answer will be a mixture of yield and valuation, which is why looking at Procter & Gamble (NYSE:PG) today is so interesting.
Up and down
The big story at P&G today is transition. Under previous management, the company went on something of an expansion binge, pushing strongly into emerging markets while the product portfolio got a little too broad. When that proved to be the wrong direction, there was a CEO change and a complete corporate overhaul.
Since that point, P&G has sold assets and refocused on its core strengths and largest brands. Essentially, the company has chosen to trim the fat so it can put more of its money and focus behind the products that have the biggest impact on the bottom line. That seems like a pretty good call, though only time will tell if it works out.
However, that move doesn't come without costs. For example, selling brands (and P&G jettisoned a lot of them) makes it harder to grow the top line. To put a number on that, the consumer products company's top line was over $80 billion in fiscal 2012 and 2013 and about $65 billion in fiscal 2016.
That doesn't mean the company is floundering. Quite the opposite actually. For example, operating margin was higher in fiscal 2016 than it was in any of the previous nine years. In fact, it was a full five percentage points higher than the operating margin in fiscal 2012 and around three percentage points higher than in 2013. In other words, in some ways, P&G is getting better.
But the costs of the transition are real. To use a more bottom-line number, earnings in fiscal 2016 were just three cents above where they were in fiscal 2012. And were only higher than four other years over the last decade. Meanwhile, the dividend has been increased year in and year out, and the payout ratio is now higher than at any point over the past decade.
The yield view
I believe strongly that P&G will work through this transition and exit a better company. That said, I don't understand why the company is trading just 10% or so off of its all-time highs. This is a point in time where I would expect P&G to be considered a fallen angel, with a beaten-down stock price and lofty yield.
On that score, the roughly 3.2% yield happens to be at the higher end of the company's long-term history. Over the last 10 years or so, however, it's only a little above an eyeballing of the mean. And over the past five years, the company's average yield is around 3.1%, putting the current figure at less than 5% above that shorter-term average.
So, in some ways, P&G looks cheap based on its dividend, and in others, it looks, at best, fairly valued. For a company in the midst of a major transition, however, I'd prefer something a little more enticing - something that recognizes the business risks that investors are taking on. Which is where I would bring in some other metrics.
For example, over the past decade, the company's average dividend growth was around 8.5%. More recently it's fallen into the low single digits. That's not surprising given that the payout ratio is higher than it's been in any of the last 10 years, but this just emphasizes the risks in my eyes. This also hints at a continued slowdown in dividend growth going forward.
And then there's the price to earnings ratio, which at 23.5 is higher than the roughly 20 or so average over the past five years. Even the forward PE of 21.5 is on the high side. Price to book and price to sales are elevated, as well. So even though the yield is higher than it has been over the really long term, it's hard to suggest that P&G is a great value today.
Low yields = high prices
You might argue that low interest rates justify higher valuations. That's true, but those valuations are being brought forward from the future. Yields are unlikely to remain this low forever - at least if history is used as a guide. And since P&G is, at best, fairly valued, it's hard to get too excited by its price today. Add in the transition risk, slowing dividend growth, and the elevated payout ratio and new investors should probably wait for a better price - even if that means missing out on owning P&G for the time being. When investors start looking for a new investment theme, other than dividend stocks, you'll likely find a more compelling entry point.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.