This Dividend Play Is Overrated

Bad times are good times for some stocks. In periods of uncertainty, investors flock to industries like consumer staples, asserting that people will always need toothpaste and detergent, even in a recession. These defensive stocks also tend to pay high dividends, which investors love. In fact, of the six household-products stocks we'll look at today, our CAPS community -- the Fool's group of 180,000-plus investors -- has given them either four stars or the maximum five.

But I think you'll also see why I think Kimberly-Clark (NYSE: KMB) may be lagging behind the industry.

Sources: Yahoo! Finance, YCharts, marketwatch.com, company press releases.
*Adjusted to reflect restructuring charges.
**Operating profits and margins used.

Kimberly-Clark is the worst performer in three categories: gross margin, gross margin change, and PEG ratio -- and the second worst in gross profit change. Gross profit, which measures the difference between sales and the costs paid to make those goods, is important because it's the best indicator of brand strength and market power, and of how profitable an industry is overall. Gross margin is simply gross profit divided by sales. Ideally, you'd like to see improvements to the bottom line coming from widening gross margins.

In part, Kimberly-Clark's smaller gross margins come from selling mostly paper products, so they make sense, but thinner margins still mean the company is bringing in less from each sale. This product makeup also leaves less room for future innovation, and it basically condemns Kimberly-Clark to a battleground of decreasing margins in the future. Although its brand strength and dominant product portfolio will probably elevate it to the higher end of this spectrum, the margins of more profitable competitors in the consumer-goods space -- which also have dominant product portfolios -- are simply more attractive to me.

I'm also concerned with the slow growth in gross profits and the declining gross margins. Prices of pulp, one of Kimberly-Clark's key inputs, soared earlier this year and could continue to squeeze profits down the road if they turn back upward again.

Finally, the PEG ratio of 2.30 downright scares me. Standard investing theory dictates that growth-rate percentages should match P/E ratios. If a company has a P/E of 10, then it should be growing at 10% a year, giving it a PEG of 1. A lower PEG ratio indicates that the stock is undervalued based on expected growth. I can stomach a PEG ratio of more than 2 for a growth stock, for which future earnings are often difficult to estimate, but for a stalwart like Kimberly-Clark I'd expect it to be much lower.

Some other red flags I see are just a 1% volume growth projection for the year and a 1% decrease this past quarter in North American sales. Despite Kimberly-Clark's international expansion, North America still contributes more than 70% of operating income, and 76% of all sales come from just two product segments. Finally, baby-care products such as Huggies make up a significant portion of personal-care sales, its largest segment, at a time when the domestic birth rate is at an 11-year low. Industrywide, diaper sales have fallen 5% in the last year, according to one market research group.

Despite these potential negatives, you'll continue to the talking heads loving this stock because of its healthy dividend yield, the highest of the group we looked at. Kimberly-Clark has even joined the hallowed ranks of the S&P 500 dividend aristocrats, companies that have increased their dividends every year for more than 25 years. Certainly, that's an achievement, but even a solid dividend is no assurance for stock performance. In fact, after years of consistent growth, Kimberly-Clark's stock price has struggled since 2001 and has underperformed its peers. At just 19.1%, its return is far below Colgate-Palmolive's 57.44%, the second worst of our group.

Given Kimberly-Clark's overvalued PEG ratio and narrowing margins, not to mention the macroeconomic factors such as higher input costs and a declining birth rate, you might want to think twice next the time you hear Kimberly-Clark is a great buy. Until I get those questions answered, you won't see me jumping on the bandwagon anytime soon.

If you're after high-yielding dividend stocks without Kimberly-Clark's drawbacks, check out the Fool's special free report, "13 High-Yielding Stocks to Buy Today," with some great dividend buys recommended by our newsletter teams.