Is P&G Stock a Buy or Hold Ahead of Earnings?

Procter & Gamble (NYSE:PG) has been rewarding investors with a stellar record of more than 100 years of dividend payments coupled with a run of 55 years of dividend increases.  But what have they done for us lately? Although the company still shows a respectable dividend yield of 3.30%, the share price has underperformed both the DJA and the S&P 500 with a year to date rise of 2.38% compared to an 13.68% rise in the S&P and a 8.91% increase in the Dow.

Is P&G still a long term BUY, or has this American icon slipped to WAIT and SEE or STAY AWAY status? (See my conclusion at the end of this post.)

Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s Movement

Despite P&G’s place on multiple advisory lists of attractive dividend yielding stocks, the company has a growth problem that has now earned it a spot on many cautionary watch lists.  Lowered guidance in June of 2012 sent the stock price skidding downward, making future earnings releases and pre-announcements even more likely to act as catalysts for the share price in either direction.

H = High Quality Product Pipeline

P&G has a history of product innovation with families of products.  The company’s flagship Tide detergent is available in more variations than similar competitive products.  P&G created a new market with the introduction of Pampers diapers and their more recent introduction of the Swiffer line of cleaning products.  Swiffer tools and replaceable cleaning elements rewarded P&G with a 5% increase in profits and investors with a 143% increase in share price in the product family’s maiden year of 1999.

E = Equity to Debt Ratio is Close to Zero

P&G’s debt to equity ratio of .47 is less than half that of rivals Colgate-Palmolive (NYSE:CL) at 2.33 and Kimberly Clark (NYSE:KMB) at 1.25.  The company has $29.8 billion in debt with $4.44 billion total cash on hand and a Current Ratio at a substandard 0.88.  In contrast, CL has a current ratio of 1.36 and KMB stands at 1.28.

A = A-Level Management Runs the Company

In early Q1 of 2012 P&G announced an ambitious plan to cut operating costs by $10 billion by the end of 2016 to improve eroding margins.  Cutting employees, marketing expenses and operational costs is often viewed as a positive development as it is evidence management sees a problem and is taking corrective steps.  However, one can also view these efforts as evidence of poor management in the past.

There is no question management at P&G is under the microscope, especially CEO Bob McDonald.  CNBC stock guru Jim Cramer placed McDonald on his CEO “Wall of Shame” earlier in the summer but later removed him, stating that McDonald inherited the problematic situation at P&G.

Of far greater concern than the opinion of Cramer is that of hedge fund manager Bill Ackman, whose Pershing Square Capital Management recently moved up its stake in P&G stock. According to Reuters, Ackman  spoke to a recent Value Investing Congress and layed much of the blame for P&G’s problems of late squarely at the feet of senior management. 

T = Technicals on the Stock Chart are Strong

As of October 16, the stock price was 0.55% below its 20 Day Simple Moving Average, or SMA; 1.03% above the 50 Day SMA; and 5.93% above the 200 Day SMA. The stock price has been volatile but trending upward since the reduced earnings forecast in early July.

S = Support is Provided by Institutional Investors & Company Insiders

With P&G 57.18% institutionally owned, the company has one of the lowest percentages of institutional holders of any Dow component.  The top five holders are Vanguard, BlackRock Institutional Trust, Fidelity Investments, and Northern Trust Bank.  Insider transactions at P&G are robust at 5.75% with several large direct sales over the last six months from company officers.  CEO Bob McDonald drew some attention with his April 2012 purchase of 1,205 shares at $63.55.  This garnered positive comments in some circles but McDonald’s August direct sales of about 130,000 shares went largely unnoticed.

E = Earnings Are Increasing Quarter over Quarter

This is the trouble spot for many investors.  Quarter over quarter earnings were down 9.11% but perhaps of greater concern is the dismal 5 Year Earnings per Share growth of a meager 1.86%.  In contrast, smaller rival Colgate-Palmolive (NYSE:CL) had 3.3% quarter over quarter growth and 14.98% 5 year EPS growth; and Kimberly Clark (NYSE:KMB) showed  21.91% quarter over quarter earnings improvement and an 8.2% growth over 5 years.

E = Excellent Relative Performance to Peers

Colgate and Kimberly are outperforming P&G on some other measures as well.  Return on Equity at Colgate is a staggering 93% and 32.73% at Kimberly-Clark; in sharp contrast to an ROE of 13.83% at P&G.  Colgate has the highest operating margins of the three at 22.78% with P&G at 15.88% and Kimberly-Clark at 12.94%.

T = Trends Support the Industry in which the Company Operates

The rise in middle class consumers in emerging markets should be a favorable trend for P&G with their existing 37% revenue from these markets.  But the company has moved too far too fast in the eyes of some analysts and trails rivals Unilever (NYSE:UL) and The Clorox Company (NYSE:CLX).  P&G will slow expansion plans to concentrate on core country product categories but there is another trend in developed countries that does not bode well for P&G.

While the prognostication of the demise of the middle class may be overstated, there is no denying the stagnation of middle class incomes in the US, Canada, and elsewhere in industrialized countries.  As the middle class consumer gets squeezed harder and harder, cheaper product alternatives to P&G’s premium brands become more attractive.  The Wall Street Journal reports that P&G and other consumer companies are moving towards an “hourglass” marketing strategy, focusing products and pricing on the top and the bottom of the economic spectrum and increasingly ignoring the middle.  An upward focus maintains higher margins but in a smaller market while the downward focus will put severe pressure on margins going forward.

Conclusion

P&G seems to be a company looking to find its footing in a changing market environment.  The cost cutting efforts will improve margins in the near term but over the long haul the company’s ability to restore growth in the face of shifting consumer spending preferences remains to be seen.  Loss of market share and lower margins may lead to decreasing dividend payouts which make the best case for investing in P&G.  Despite their fabled history, P&G right now looks like a WAIT and SEE at best.

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