Procter & Gamble: Featured Stock In November’s Dividend Growth Model Portfolio
Long/Short Equity, Value, Deep Value, Long-Term Horizon
Seeking Alpha Analyst Since 2010
Featured Stock From November: Procter & Gamble Co.
Procter & Gamble Co. (PG) is the featured stock from November’s Dividend Growth Stocks Model Portfolio.
Procter & Gamble has grown revenue by 3% compounded annually and net operating profit after-tax (NOPAT) by 7% compounded annually over the past five years. The firm’s NOPAT margin improved from 17% in fiscal 2016 (fiscal year runs through end of June) to 19% over the trailing-twelve-month (TTM) period, while invested capital turns rose from 0.6 to 0.7 over the same time. Rising NOPAT margins and invested capital turns drive the firm’s return on invested capital (ROIC) from 10% in fiscal 2016 to 13% in fiscal 2021.
Figure 1: Procter & Gamble’s NOPAT & Revenue Since Fiscal 2016
Sources: New Constructs, LLC and company filings
FCF Exceeds Dividends By Wide Margin
Procter & Gamble has increased its dividend for 65 consecutive years. The firm increased its regular dividend from $2.70/share in 2016 to $3.24/share in fiscal 2021, or 5% compounded annually. The current quarterly dividend, when annualized, equals $3.48/share and provides a 2.4% dividend yield.
More importantly, Procter & Gamble’s strong free cash flow (FCF) exceeds the firm’s growing dividend payments. Procter & Gamble’s cumulative $62.9 billion (18% of current market cap) in FCF nearly doubles the $38.1 billion in dividends paid out from fiscal 2017 to fiscal 2021, per Figure 2. Over the TTM, Procter & Gamble generated $15.9 billion in FCF and paid $8.4 billion in dividends. Figure 2 also shows that Procter & Gamble’s FCF has significantly exceeded its dividend payments every year since 2017.
Figure 2: Free Cash Flow vs. Regular Dividend Payments
Sources: New Constructs, LLC and company filings
Companies with FCF well in excess of dividend payments provide higher quality dividend growth opportunities because we know the firm generates the cash to support a higher dividend. On the other hand, the dividend of a company where FCF falls short of the dividend payment over time cannot be trusted to grow or even maintain its dividend because of inadequate free cash flow.
PG Has Upside Potential
At its current price of $147/share, PG has a price-to-economic book value (PEBV) ratio of 1.0. This ratio means the market expects Procter & Gamble’s NOPAT to never meaningfully grow beyond current levels. This expectation seems overly pessimistic for a firm that has grown NOPAT by 7% compounded annually over the past two decades.
Even if Procter & Gamble’s NOPAT margin falls to 17% (equal to five-year low, compared to 19% TTM) and the firm’s NOPAT grows by just 2% compounded annually for the next decade, the stock is worth $176/share today – a 20% upside. See the math behind the reverse DCF scenario.
Should the firm grow NOPAT more in line with historical growth rates, the stock has even more upside. Add in Procter & Gamble’s 2.4% dividend yield and history of dividend growth, and it’s clear why this stock is in November’s Dividend Growth Stocks Model Portfolio.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
Below are specifics on the adjustments we make based on Robo-Analyst findings in Procter & Gamble’s 10-Qs and 10-K:
Income Statement: we made $1.4 billion in adjustments with a net effect of removing $1.0 billion in non-operating expenses (1% of revenue). See all adjustments made to Procter & Gamble’s income statement here.
Balance Sheet: we made $47.1 billion of adjustments to calculate invested capital with a net increase of $29.5 billion. The most notable adjustment was $14.7 billion (17% of reported net assets) in asset write-downs. See all adjustments to Procter & Gamble’s balance sheet here.
Valuation: we made $53.7 billion in adjustments with a net effect of decreasing shareholder value by $36 billion. Other than total debt, the most notable adjustment to shareholder value was $8.8 billion in excess cash. This adjustment represents 2% of Procter & Gamble’s market value. See all adjustments to Procter & Gamble’s valuation here.
Recap From October’s Picks
On a price return basis, our Dividend Growth Stocks Model Portfolio (+4.0%) outperformed the S&P 500 (+2.3%) by 1.7% from October 28, 2021 through November 19, 2021. On a total return basis, the Model Portfolio (+4.5%) outperformed the S&P 500 (+2.3%) by 2.2% over the same time. The best performing stock was up 35%. Overall, 17 out of the 30 Dividend Growth Stocks outperformed the S&P 500 from October 28, 2021 through November 19, 2021.
The methodology for this model portfolio mimics an All Cap Blend style with a focus on dividend growth. Selected stocks earn an Attractive or Very Attractive rating, generate positive free cash flow (FCF) and economic earnings, offer a current dividend yield >1%, and have a 5+ year track record of consecutive dividend growth. This model portfolio is designed for investors who are more focused on long-term capital appreciation than current income, but still appreciate the power of dividends, especially growing dividends.
This article originally published on December 3, 2021.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
Analyst's Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours.
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