Is Procter & Gamble Due for a 50% Run-Up?

Defensive shares have had a terrific run in this bull market -- to the point where some commentators are beginning to say that the run must surely be coming to an end. However, if you believe high-profile activist investor Bill Ackman, there is at least one prominent defensive stock which has plenty of outperformance ahead of it: Dow Jones Industrial Average component Procter & Gamble (NYSE: PG  ) .

Speaking at the Ira Sohn Investment Conference, Ackman called P&G one of the "great businesses of the world," and said it could be worth $125 in two years' time. How did he arrive at that figure? Ackman believes the company should be able to grow at 5% a year, and could trade at a forward price-to-earnings multiple of 20 by June 2015, enough to produce a $120 share price. Add an estimated $5 in dividends, and you have your $125 intrinsic value.

Ackman has already put his money where his mouth is with a roughly $2 billion stake in the firm. To verify whether he's onto something or just talking his book, the following chart displays the price performance of Procter & Gamble shares versus that of the S&P 500, as well as the progression in P&G's price-to-earnings ratio, all starting from the bear market bottom on March 9, 2009:

PG Chart

PG data by YCharts.

Two remarks are in order:

First, Procter & Gamble has badly underperformed the index in the current bull market, which suggests that outperformance over the next several years isn't a far-fetched notion (assuming you believe the business isn't in terminal decline.) Mean reversion is a genuine phenomenon.

Second, while the majority of the S&P 500's gains are attributable to an increase in earnings rather than an increase in the valuation multiple, the reverse is true of P&G. Indeed, the S&P 500's trailing 12-months' operating earnings per share are up 99%, better than two-thirds of the 141% rise in the index.

Meanwhile, the graph shows the difference in the change in P&G's share price, and the change in its price-to-earnings ratio is roughly five percentage points. Sure enough, the change in the company's normalized earnings per share over the same period is less than 6%. (Total, not annualized!) Assuming the company can jump-start its earnings, the shares could benefit from a two-fold boost if the market is willing to attribute a higher multiple to those earnings. That, in turn, suggests strong returns are possible -- even plausible.

If you're an investor who prefers returns to rhetoric, you'll want to read The Motley Fool's new free report, "5 Dividend Myths ... Busted!" In it, you'll learn which stocks provide premium growth, and whether bigger dividends are better. Click here to keep reading. 


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