Shares of Colgate-Palmolive (CL) are up 8.34% since bottoming on Oct. 29, 2018, and in my opinion, now is a good time to book any gains you may have on the shares of this consumer products company. The company's history of earnings growth has been anaemic and unimpressive, and the future growth ratios point to continued weakness over the next twelve months. I lay out my bearish argument for the company below by reviewing some pertinent fundamental and technical aspects of the stock.
Momentum Growth Quotient
My Momentum Growth Quotient (MGQ) plays a critical part when it comes to determining if I am going to go long or short a stock. Generally, I only want to go long a stock with an MGQ higher than that of the S&P 100, and I want to go short a stock with an MGQ lower than that of the index (for a more detailed explanation of how I calculate the MGQ, please see my blog post).
As of the end of November 2018, the MGQ for the S&P 100 was 9.19.
The current MGQ for CL stands at 8.73, which implies a 4.97% lower growth rate compared to the S&P 100. This tells us that CL has weak future growth potential and is a good candidate for a short position.
Let's dig a little deeper into the financial data to get a better feel for how the company has performed on certain fundamental metrics and what these numbers imply for future growth.
Caveat Lector: I am a Quant Trader - that is, I seek to understand market behaviour by using mathematical and statistical modelling, measurement, and research. So, you won't find much qualitative analysis in my work or in my trading process. The goal is to identify optimum entry points for trades based on my quantitative model and execute those trades as effectively as possible.
During the past 12 months, the average EBITDA per share growth rate of Colgate-Palmolive Co. was 3.50% per year. During the past 3 years, the average EBITDA per share growth rate was 1.40% per year. During the past 5 years, the average EBITDA per share growth rate was 0.50% per year. During the past 10 years, the average EBITDA per share growth rate was 4.00% per year. (GuruFocus). The earnings growth rate for this company has been disappointing over the last 10 years.
The operating margin % for CL stands at 22.73%. Each dollar of revenue the company generated brought in 22.73 cents of earnings. The company's operating margin has grown at an average clip of 1.60% over the last five years - this tepid operating margin expansion does not instil much confidence in the company's ability to grow earnings.
Knowing how a company has performed in the past is important in order to evaluate management's past record in running the business. But more important to us is how profitable the company will be in the future because we are investing going forward, not backward. And it's the forward-looking metrics that should really get you excited about CL.
I like to use two measuring sticks to gauge the future growth potential for companies: forward P/E and forward rate of return.
I prefer to use the forward P/E ratio (current stock's price over its "expected" earnings per share) rather than historical P/E to gauge a company's expected future earnings power. A high forward P/E ratio means that investors are anticipating higher growth in the future and are willing to pay more for future earnings - momentum investing is all about following the trend (perceived or real).
CL has a forward P/E of 19.60 compared to a 16.99 forward P/E for the S&P 100. The forward P/E for CL is greater to that of the index, suggesting that the market is expecting a higher growth rate for the company compared to the broader market - but this one positive growth metric is not enough to put me long the stock.
The forward rate of return for a stock (created by Donald Yacktman) is one of my favorite quotients for gauging the market's expectation for future growth for a company. Yacktman defines forward rate of return as the normalized free cash flow yield plus real growth plus inflation. In simple terms, the forward rate of return can be thought of as the return that investors buying the stock today can expect from it in the future.
The forward rate of return for CL stands at 6.03%. This implies that an investor buying the stock today should expect a 6.03% return over the next 12 months. The average forward rate of return for the S&P 100 as of the end of November was at 7.90%, so CL has an implied potential rate of return that is 1.31x lower than that of the index.
The risk inherent in the forward rate of return is that the calculation is reliable only if the company can grow or not grow at the same rate in the future as it did in the past. If the growth rate changes, the projected returns will not materialize. But we are willing to accept this risk as part of the difficult process of forecasting earnings and growth momentum.
As per my ChartMasterPro Daily Trade Model, there is a high probability of a price drop to the $58.00 level from here, which would equate to a decline of 8% for the shares:
- The MACD has started to decline and the convergence lines look ready to roll over (bearish momentum signal).
- The RSI14 is on the verge of crossing below 50.00 (bearish momentum signal).
- The shares hit strong resistance at the $64.00 price level and there is a high probability that they will now decline from here.
I will buy put options for CL to participate in the anticipated drop to the $58.00 level.
For investors in the shares, I recommend that you book any gains you may have and move to the sidelines for now.
When looking for companies to short, I look for management teams that have under-performed their peers in the same industry with regard to growing sales, earnings, and dividends.
|Sales - 5-Yr Growth Rate||-1.99%||5.60%|
|Dividend 5-Yr Growth Rate||5.44%||12.58%|
|EPS - 5-Yr Growth Rate||0.12%||8.95%|
Price to Sales TTM
This is a company that's posting lower growth rates for sales, earnings, and dividends than its competitors. Even if you had bought the shares for its 2.65% dividend yield, there are better options in the same industry with companies that have been growing their dividend at a much higher rate. The price pop in the shares over the last month presents an excellent opportunity to lock in any gains you may have on the shares.
Declining Revenue Growth
The chart below shows the company's revenue on a TTM basis - you can see that although revenue climbed in the first half of 2018, it has now once again begun to decline, and this does not bode well for the share price. The bearish trend in revenue growth which began in 2015 appears set to resume.
When I go short a stock, I want to invest in a company that shows weak future growth potential, but I also want to time the entry into any position to try to maximize my return.
So, I use fundamental analysis to identify shares with unimpressive future growth rates, and then, I apply technical analysis to identify ideal entry points.
In my opinion, CL is a good short opportunity at these levels from both a fundamental and technical perspective.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in CL over 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.