Procter & Gamble stock (NYSE:PG) provides a shelter for investors in this highly-volatile market. The consumer staples powerhouse behind multi-billion-dollar household brands has been able to post robust results in the face of uncertainty. Thus, its shares have offered a reliable sanctuary of reduced volatility when compared to the overall market indices. That said, this safety comes at a great cost; in this case, it’s a hefty valuation that may temper the stock’s potential for future returns. Thus, I’m neutral on PG stock.
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Fiscal 2024 Started Strong
P&G’s Fiscal 2024 started strong even in the face of persistent market challenges. Whether navigating a demanding economic landscape (rising interest rates and fluctuating consumer confidence) or contending with a deteriorating geopolitical climate, these market headwinds have left many businesses grappling with adversity.
However, P&G stands out as an exception, undeterred by these formidable obstacles. Such resilience is not unique to P&G; it is a characteristic shared by several companies. In the case of P&G, this theme is exemplified by its brands comprising everyday household essentials. Consequently, the company has managed to generate stable and even growing sales with minimal uncertainty despite the underlying market conditions.
Kicking off Fiscal 2024, P&G posted rock-solid results, as its Q1 net sales climbed to $21.9 billion, marking a 6% year-over-year increase. This growth was mainly fueled by a 7% upswing in organic sales, which more than compensated for the 1% negative blow of unfavorable foreign exchange rates. For a broader perspective, this 7% growth can be dissected further. It was due to 7% higher prices and a 1% boost attributable to a favorable product mix, partially offset by a 1% drop in shipment volumes.
Surprisingly, even in the face of rather lofty prices, consumers showcased minimal shifts in their purchasing behaviors. This observation strongly underscores the notion that P&G’s products exhibit a high degree of inelasticity, which is expected for everyday household essentials.
Meanwhile, during the quarter, P&G witnessed an impressive expansion in its gross margin, which increased by 460 basis points compared to the previous year. This margin expansion was driven by a fundamental increase in prices that outpaced the growth in the cost of goods sold.
As a result, EPS experienced a substantial 17% increase, reaching $1.83. With such a robust start to the year, management displayed confidence and provided optimistic full-year guidance. Specifically, the company anticipates organic sales growth in the range of 4% to 5%. Furthermore, management projects diluted EPS growth in the range of 6% to 9% compared to Fiscal 2023’s EPS of $5.90, implying a range of $6.25 to $6.43 per share.
Robust Results and the Dividend Sustain Investor Interest…
P&G’s stock has sustained investor interest in the current market climate not only thanks to its robust results but also to the added assurance provided by its storied dividend history. With an impressive track record of 67 consecutive years of dividend increases, P&G’s unwavering dedication to rewarding its shareholders is undeniable.
While the current dividend yield of 2.5% may seem modest in the context of rising interest rates, it’s the relentless and well-supported practice of dividend hikes that investors truly appreciate. Many retirees and income funds have P&G stock consistently hold a prominent place in their portfolios due to its reliable dividend payouts. This enduring allure is expected to continue bolstering the stock price, even during the prevalent volatility that characterizes today’s equity market landscape.
…But the Valuation Can Hardly be Justified
P&G’s operating excellence and legendary dividend growth track record are certainly impressive. Yet, they can hardly justify the stock’s current valuation. I believe this can end up being a problem for investors who overlook this aspect. No matter how great a business is, paying more than what it’s worth can have a detrimental effect on one’s total returns, and I believe this is exactly what P&G’s investment case is suffering from. To illustrate why P&G is likely overvalued, let’s examine its EPS growth.
Although the company delivered an impressive 17% surge in Q1 EPS, it’s important to recognize that this exceptional growth should not be regarded as the standard expectation. This substantial increase was primarily driven by a noteworthy expansion in profit margins. Margins can experience fluctuations from one quarter to the next, either bolstering or impacting the company’s overall financial performance.
However, when observed over a longer timeframe, these fluctuations tend to balance out, resulting in a net income growth pattern that parallels P&G’s sales growth trajectory. This trend is clearly reflected in P&G’s forward guidance, which anticipates EPS growth from 6% to 9% despite the company experiencing higher growth in Q1. For context, P&G’s EPS has grown at a compound annual growth rate of 4.76% over the past 10 years.
So, while P&G’s qualities do demand a boost in its valuation, it’s also worth remembering that this is a business growing EPS in the mid-single-digits. In the meantime, the midpoint of management’s guidance implies a forward P/E of 23.8, which can hardly be justified in the current high-interest-rate environment. The valuation could be easily squashed if investor confidence normalizes, negatively impacting shareholders’ return prospects.
Is PG Stock a Buy, According to Analysts?
Looking at Wall Street’s view on the stock, Procter & Gamble features a Moderate Buy consensus rating based on 11 Buys and seven Holds assigned in the past three months. At $163.44, the average Procter & Gamble stock forecast implies 8.7% upside potential.
Conclusion
In conclusion, Procter & Gamble has proven to be a reliable shelter for investors in a volatile market. The company’s ability to navigate challenging macroeconomic conditions and deliver consistent sales growth was once again exemplified in its Q1 results.
Moreover, its long-standing dividend history adds to its appeal to income-focused investors. However, the stock’s current valuation raises concerns. While P&G’s operating excellence is undeniable, the substantial increase in earnings per share in the first quarter may not be sustainable.
With a P/E ratio that might be hard to justify in the current interest rate environment, investors should carefully consider the potential impact this will have on their future returns.
