Take a look in your cabinets and closets. You would be hard-pressed not to find a product made by Procter & Gamble (PG 0.54%), the company behind everything from Old Spice to Pampers. The consumer goods titan is everywhere.
But does that make Procter & Gamble stock, as well as its dividend, safe? Read below to find out.
A sampling of Procter & Gamble's product lines. Photo: P&G. .
The most important metric for dividend investors to watch
Procter & Gamble has a dividend-paying history that is the envy of many companies. It has increased its dividend for six straight decades. Over the last five years, the payout has increased by 8% annually. And it currently offers up a very nice 3.2% yield.
The most important metric to watch is free cash flow. This represents all the money the company took in as a result of doing business, and subtracts anything used for capital expenditures.
Here's how P&G's free cash flow has looked since 2009, and how much of it has been used to pay the company's dividend.
If you're a P&G dividend investor, there are some good and not-so-good things to note here.
On the good front, along with the annual dividend increase, the company is using about 68% of free cash flow for the payout. While that's a tad bit higher than some of the company's peers, it's still well within the safety zone. Should free cash flow shrink, there's more than enough of a buffer to keep the payout steady. And if free cash flow grows, there's still a fair amount of room for dividend growth.
But I was a little surprised to see free cash flow go up and down so much over the years. On the whole, it has actually shrunk over the last half-decade: what was once a 43% payout ratio is now up to 68%. If this trend continues indefinitely for P&G, it would not be a good sign for investors.
What's behind this decline?
To see whether this is a harbinger of things to come for P&G, let's dive into the company and its stock. As a whole, Procter & Gamble has five reporting divisions. Health & Grooming is the largest, bringing in about one-fourth of the company's revenue. The other divisions all average between 12% and 14% of P&G's revenue.
For comparison's sake, I've also included the inflation rate for each year on the right.
As you can see, the company recovered nicely from the Great Recession from 2010 to 2012. Over the last two years, however, sales increases have not kept pace with the rate of inflation.
Even more concerning is the consistent underperformance of P&G's most important division: grooming. Gillette, Fusion, and Prestobarba are three billion-dollar shaving brands within this business unit. Sales have been struggling for the past three years. Sales for the division as a whole are down 3% since 2011 while inflation itself is up 6.3%--a fairly serious divergence.
The company says the popularity of beards -- and even the "Movember" social media movement -- has contributed to falling grooming sales. Several start-ups, most notably the Dollar Shave Club, are also taking away market share.
So is it a buy?
Investors interested in Procter & Gamble need to weigh what's going on with the company. For the time being, the dividend is very safe. However, trends within the company's grooming business are not going well.
If you believe that the new propensity for beards will soon die off, or that P&G's other divisions will pick up the slack, then the company's woes in this area shouldn't bother you much.
But if you believe there's a long-term trend away from using P&G's razors -- whether because of start-up competition or social fashion trends -- then you might want to reconsider buying the stock, which is trading for a pricey 21 times earning.
