I wouldn’t even have to look up the ticker symbol of Procter & Gamble Co (NYSE:PG) to tell it would be near its all-time high. Any company which pays a consistent dividend is worth its weight in gold in this market. Did investors suddenly change their portfolio management perspective? Nope, the Federal Reserve and other central bankers have suppressed yields causing investors to go up the risk curve and buy dividend stocks. A stock which pays a dividend is like a bond except, of course, the dividend can be cut at any moment. Stocks are an uncomfortable place for these pension fund managers, but they have to purchase them to chase returns.
It’s always a bad thing when an investor is forced into a position. I will give an analogy to explain this point. If a young investor is given the advice to buy technology story stocks because he/she can take more risk, this is likely going to end badly. The young investor is ignoring the place in the business cycle and the valuation of the securities. If you pigeon hole yourself into a particular investment, you will do badly. With interest rates at record lows and the S&P 500 having 5 quarters of negative earnings, this is the only explanation for stock valuations being at these excessive levels. The fact that pension funds need a certain amount of returns to pay off obligations is a problem for another article. The point is chasing returns a bad idea.
The chart below has become the most important one in predicting movements in the market, unfortunately. As you can see, the two liquidity pauses correspond to the corrections we had in the market in August 2015 and in January 2016. This crystallizes the point I was making earlier as investors are moving up the risk curve into stocks like P&G. I say this scenario is unfortunate because central bankers should be adding liquidity to prevent a crisis, not to endlessly boost stocks to improve the ‘wealth effect.’ This policy hasn’t boosted wages, unsurprisingly.
Fed policy creating excess liquidity creates an environment where bubbles form. I’ve highlighted this in my other consumer staples articles in the past. The scenario is no different for P&G as it approaches an all-time high and a current PE of near 24 even as its 2016 currency neutral core earnings fell 8% for the year. As an investor, paying an above market multiple for a company with declining earnings is not palatable. However for investors looking to get out of low yielding bonds, a 3% yield is too much to pass up.
P&G fits in like a glove with its counterparts. As you can see from the chart below, it has been able to reach $7 billion in cost savings. The company is targeting up to $10 billion in cost savings from 2017 to 2021.
While cost savings have been a success, sales growth hasn’t been great. Total P&G organic sales growth was 2% last quarter with standouts being grooming growing 7% and healthcare growing at 8%. This is the problem giant companies with mature brands have. They need to innovate and come up with new products like the Tide pods just to maintain sales stability. The chances of accelerating profit and sales growth are nil.
Normally this wouldn’t be a problem for P&G because no investor is expecting it to be a growth company, but when it is being valued at the current price and the stock is up over 26% in the past 12 months, you have to be concerned with the lack of growth.
Investors are faced with a tough scenario because growth is slowing yet stocks are rising. Typically, in this environment it would be a good idea to buy consumer staples stocks, however we are past that point as earnings have declined for 5 consecutive quarters. It would have made sense to buy these stocks 18 months ago and sell them 6 months ago as the cycle began to end. As you can see from the chart below, stocks are rising in the face of declining 2016 GDP growth expectations.
The question for P&G investors is when we will end this pre-recessionary part of the cycle and enter the actual recession. Bond yields will not stay near record lows forever and stocks will not trade at record highs forever. This low growth environment will also not last. These are surprising facts to some investors because these factors have been in place for years.
Psychologically investors have been able to ignore the 1% GDP growth in the first half because of mental accounting. They say to themselves that the economic recovery has always been weak, therefore the 1% growth doesn’t matter. However, when the collective market realizes that the recession risks are real, there could be a collective stampede out of stocks. P&G will not be able to sidestep the pain because of the rally it has had in the recent past and the expensive valuation.
P&G fits into the category of consumer staples stocks that have had bigger than normal ramps at the end of the business cycle because the market has been able to accelerate higher into bad results. The question of when this situation will end may be psychological in nature because the economic facts have not mattered up until this point as you can see from the chart above.
P&G should be able to grow profits in the low single digits next year and reach its cost cutting projections. These reasonable expectations and this consistent business does nothing to explain the risk the stock faces if stocks fall or bond yields rise. I’d recommend pairing back your holdings even if you have to pay capital gains taxes. Maybe you can offset your gains with losses. Even if you cannot, sometimes it’s a good idea to take a profit and pay the taxman in order avoid losses.