Is Procter & Gamble A Good Dividend Stock? Yes Indeed

Summary

• Procter & Gamble Co. catches my attention because profits are up in 2021, while the stock is about flat.
• Investors fear inflation will hurt P&G stock, but I view these concerns as overblown due to P&G's high margins and economies of scale.
• P&G has a 2.4% dividend yield and is likely to significantly outperform in the next downturn.
• You won't make a fortune in Procter & Gamble stock, but investing in P&G (and other companies like it) has a risk profile that is lower than the stock market as a whole and returns that are much higher than bonds.

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Procter & Gamble Co. (NYSE:PG) stock is up substantially since 2017 when investors were pessimistic that the company would not be able to compete with nimble startups looking to grab market share. That year, billionaire activist investor Nelson Peltz began a campaign to agitate for change, citing excessive bureaucracy and lack of innovation at the company. He obtained a board seat in March 2018 (roughly the low point in PG stock's journey) and began his plan to change their corporate strategy. Wall Street took Peltz's campaign seriously and rewarded PG stock with a higher valuation-all before the pandemic took hold in early 2020.

Data by YCharts

Since the pandemic, things have been up and down for the stock-P&G has faced inflationary pressure and has begun the process of raising prices. Still, with 50% gross margins vs. 35% for the consumer staples sector, Procter & Gamble is not in bad shape by any means. Inflation is particularly worrisome for marginally profitable companies, but P&G has great margins, especially on products like razors (razors have crazy margins). As a result, gross profits for P&G have returned to the previous peak of about $40 billion per year, up from around $32 billion when Peltz started his campaign. The company will have to stay ahead of inflation to maintain this, but so far in the 2020s, management has successfully navigated the environment.

P&G appointed a new CEO last month in Jon Moeller. I don't know much about Moeller, but I do know the stock rose when it was announced he was taking over.

Procter & Gamble Stock Forecast

Volatility has been on the rise lately for the market as a whole. While it remains to be seen whether this is the start of a trend or something that will quickly pass, the truth is that the broad market faces an increasingly poor risk/reward profile as stocks continue to outrun business fundamentals. That's why I believe that solid businesses like Procter & Gamble are worth a look in today's market. P&G stock isn't immune to the rising valuations that the whole market is experiencing, but their revenue is stable, they pay a nice dividend that they're likely to raise in a couple of quarters, and if the market gets hit, P&G is likely to outperform.

Digging into the numbers, P&G is expected to earn about $5.93 for this fiscal year (ending in June 2022) and $6.36 for the next fiscal year, ending in June 2023. With the stock at around $147 as of my writing this, PG stock trades for slightly less than 25x earnings (4% earnings yield). I'd expect P&G's profits to grow over time at roughly the same rate as the economy at large, which is about 4% nominally. Put these together, and you get an expected return of roughly 8% annually. Stocks obviously will return higher or lower than using a simple yardstick model like this implies, but consumer staples stocks with fairly stable revenue are ideal for this type of analysis.

Why Is PG Stock A Good Buy?

1. P&G's earnings are more likely to be sustainable than other companies.

When stimulus hit in the US in 2020 and 2021, consumers spent like there was no tomorrow. Cars, boats, TVs, furniture-you name it, demand went up. But did consumers buy more toothpaste, razors, or diapers because of stimulus? On the whole, probably not much. The issue for consumer discretionary comes when stimulus runs out. With higher prices for essential goods like food, fuel, and toiletries, and wages up less than inflation, US consumers are not going to be able to spend like they did in 2021. The goods and services produced by the US economy are about the same as pre-pandemic, but profits are up massively, and the only place the difference could come from is fiscal stimulus. PG stock might look conventionally expensive, but if investors are valuing the market in general on unrealistic earnings estimates, PG may well be cheap compared with the market.

2. COVID variant-proof earnings.

To the above point, consumer staples stocks may fall on pandemic fears, but their businesses are not likely to suffer from public health fears. Businesses are what earn the money to pay dividends, which means that even if the world goes into panic mode, people are still going to buy diapers, and PG shareholders are going to get their $0.87 per share in cash each quarter.

3. Downside cushion.

During the three major bear markets of the 21st century (2000-2002, 2007-2009, and 2020), PG stock has acted like a sea anchor, beating the market each time over the full bear market.

• In 2000-2002, P&G went down initially but rallied back to even by December 2001.
• In 2007-2009, P&G outperformed by 16 percentage points.
• In the 2020 crisis, P&G outperformed by 8 percentage points.

P&G stock is still a stock, and it trades as such, but I'd rather have a dividend-paying stock from an AA-rated company like PG than a bond from many BBB issuers, especially given the difference in compensation that you get. In both cases, there are idiosyncratic risks to investing in any company, which is why I believe you should diversify as much as possible.

Markets are fairly good at pricing similar assets, goods, or services against one another. For example, if you go to lease an apartment or office space for your business, you'll find that the prices tend to be quite similar per square foot or by other similar metrics. But when you take independent markets and compare them, things get really interesting. When the office market was hot, startup founders used to rent mansions and base their team out of them for less cost and more flexibility than renting office space. There's an old joke (I don't know if it's a true story or not) about hedge funders getting free parking in Manhattan by offering their cars up as loan collateral. In the financial markets, investors like Bill Ackman figured out that buying credit default swaps was a cheaper crash hedge than selling stocks or even buying puts. REIT valuations and private real estate valuations are often inconsistent as well. In this particular case, there are a lot of dividend stocks out there from A and AA-rated companies that have solid returns and a better risk profile than investment-grade and high-yield credit. PG stock is an interesting example of this after going sideways for the last year. If you think the market will crash 50% next year, then PG stock isn't the place to be. But if you think earnings estimates are too high for the broad market and in the consumer discretionary space (I think this), then you can gain a nice advantage over the next year over the market if you tilt towards consumer staples and other relatively safe dividend stocks.

Conclusion

This isn't news to many Seeking Alpha readers that have been dividend investors for decades, but if you aren't getting the returns you need from bonds, I'd consider moving some money into a broad basket of dividend stocks with good balance sheets, dividend growth potential, and recession-resistant business models. In a world where everyone is chasing returns without regard for risk, I like certain asset classes that are considered riskier than bonds but less risky than the broad stock market, like dividend stocks and preferreds. PG stock and stocks like it are a nice start towards tilting your portfolio this way.

Disclosure: I/we have a beneficial long position in the shares of PG either through stock ownership, options, or other derivatives. 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.