Procter & Gamble (PG 0.68%) knows how to reward shareholders. Not only has the consumer goods conglomerate paid a dividend for the past 124 years straight, but it has also increased that dividend for the last 58 consecutive years at a compounded rate of more than 9% a year. While this is undoubtedly impressive, there are plenty of reasons to worry when companies begin buying back shares at a breakneck pace. With Procter & Gamble set to spend as much as $6 billion this year in share repurchases, let's take a deeper look to uncover if this is actually in the best interest of shareholders.
A balancing act
American companies have purchased more than $500 billion of their own shares in the past year, according to The Economist. On the surface, this seems like a good thing for investors because share buybacks create value by reducing the number of shares outstanding. However, stock buybacks can also artificially inflate a company's earnings per share, thereby making the underlying business appear healthier than it actually is. Investors should also keep a close watch of how the company is paying for their buybacks. If said company is over borrowing to pay for these repurchases it will likely come back to bite them down the road.
Source: Procter & Gamble
Procter & Gamble boasts a dividend yield of 3%, which is significantly better than the S&P 500 that yields 1.9%. The conglomerate increased its dividend 7% to $2.45 per share in fiscal 2014, and returned a whopping $6.9 billion in dividend payments to shareholders during that period. Importantly, the consumer staples giant spend an additional $6 billion in share repurchases in fiscal 2014 -- for a total return of $12.9 billion in cash to shareholders.
P&G funded these buybacks with both operating cash flows and through long-term and short-term debt. The company had $35 billion in debt on its books as of June 30. Nevertheless, Procter & Gamble's ability to generate loads of cash makes its buybacks reasonable at this level. P&G generated $10.1 billion in free cash flow during fiscal 2014, compared to the $6 billion it spent in stock repurchases over that time. Additionally, P&G's operating profits are roughly 20 times greater than interest payments therefore the company shouldn't have any problem paying back debt.
Despite heavily spending on dividends and buybacks, Procter & Gamble also continues to invest in its business. The company spent $2 billion on research and development this year. This is important for long-term investors because you want to know that management has enough cash on hand to invest in future product development and innovation.
Moreover, as one of the largest consumer goods companies in the world today, Procter & Gamble has a strong global distribution network and portfolio of brands that should continue to fuel revenue growth in the years ahead. Gillette razors, Tide laundry detergent, and Crest toothpaste are among the high profile brands under Procter & Gamble's umbrella today.
Ultimately, the company has been rewarding shareholders with dividends for over 100 years, and thanks to its solid portfolio of products it should have no problem continuing to do so for many years to come. Therefore, I believe Procter & Gamble's decision to invest in buybacks is not only sustainable but also smart at this time.
