If you're tired of reading about Dogecoin daredevils and GameStop gurus, you're not alone. Meme-stock mania can be entertaining, but for the vast majority of investors, it simply isn't worth paying attention to. Valuations matter. And when an asset's price is propelled far above the levels that could be justified by even the most optimistic forecasts for the business's fundamentals, it's best to stay away.
Far removed from the world of celebrity endorsements and speculative subreddits lies the land of Dividend Kings -- S&P 500 companies that have increased their annual payouts for at least 50 consecutive years. These companies rarely attract headlines. And they don't have to. They aren't praised based on popularity. Instead, they are judged for their business performance, ability to keep a strong balance sheet, and track record for increasing their payouts to shareholders over time. Consumer staples stalwart Procter & Gamble (PG 0.60%) is one of the safest Dividend Kings around. Here's why it's worth buying now.
Image source: Getty Images.
A lean business model
P&G is a textbook example of why bigger isn't always better. Coming out of the Great Recession, it was expanding heavily into new markets and adding more brands. Its revenue grew, exceeding $80 billion in 2013 and 2014. But this wasn't necessarily a good thing.
Net income peaked at $13.4 billion in 2009 and free cash flow (FCF) topped out at $13.1 billion in 2010. Revenue and operating expenses were rising as P&G produced more products and paid more employees. But the company's size was making it difficult to manage. David Taylor was hired as CEO in late 2015 and given the task of making it leaner and more efficient.
Between its fiscal 2015 and its fiscal 2017 (which ended June 30, 2017), P&G reduced its brand count from 170 to 65 and its product categories from 16 to 10. Fast-forward to today, and P&G is generating record-high FCF, sporting its highest operating margin in history, and delivering net income near peak levels.
Data by YCharts.
Focusing on what it does best
P&G's transformation involved more than just trimming poorly performing brands from its portfolio. Compared to five years ago, P&G now generates more of its sales from the North American, Asia Pacific, and Chinese markets. It's also generating a higher percentage of revenue from its fabric and home care lines than in the past. In sum, P&G has been refocusing on the regions and business segments it knows best.
The company is doing a better job of playing to its strengths. A good example is in North America and China, where it has been easier for P&G to benefit from the rise of e-commerce than in other developing markets. Asia continues to be one of P&G's top growth regions. Its products, particularly its beauty and skincare brands, are being well-received by a rising middle class.
Returning value to shareholders
For income investors, a company's net income and FCF matter more than its revenues. P&G uses its free cash flow to pay its dividends and cover share buybacks, as well as to reinvest in the business. In its fiscal 2020, it generated just over $14.3 billion in FCF, but distributed $15.2 billion to shareholders through dividends and stock buybacks. And given that the company has raised its annual dividend for 64 consecutive years, it's safe to say that P&G knows what it is doing.
Demand for P&G's products tends to be relatively stable regardless of where the market is in its cycle, which gives the stock recession-proof characteristics. That's good news for investors who don't like volatility. One good measure of a stock's volatility is its "drawdown" -- the maximum price decline it has experienced from its peak to its trough.
Data by YCharts.
Over the last 15 years, P&G's maximum drawdown was less than 40%. This means that if you bought shares of P&G at its peak and then sold at its trough, you would have come out with 60 cents on the dollar. That may sound bad, but this metric does consider the absolute worst outcome an investor could have experienced with the stock. By contrast, consider that the worst annual declines for P&G over the last 15 years were 16% in 2008 and 13% in 2015 (when it was reorganizing its business).
A reasonable valuation
Shares of P&G are down slightly year to date, while the S&P 500 has gained over 12%. Relative to both the market and its historic performance, P&G's valuation is starting to look more and more attractive. Its price-to-FCF ratio is 21.7 -- which is near the low end of its five- and 10-year ranges.
Don't expect P&G stock to be a market outperformer or a fast grower. It isn't that kind of company. But what it lacks in momentum, it makes up for with a steadily rising dividend that, at current share prices, yields 2.6%, and consistent business performance that could help keep your portfolio healthy even during a stock market sell-off.
