Consumer staples giant Procter & Gamble (PG 1.43%) is a proven blue-chip stock, selling millions of household and personal care products since the early 1800s. The share price is up more than 20% over the past twelve months as investors spent much of 2021 flocking from high-growth to defensive investments.
But the stock market often works in cycles, and what did well in 2021 might not work in 2022. Investors will want to consider these three reasons why Procter & Gamble could struggle over the rest of this year.
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1. The stock's valuation has gotten hot
Procter & Gamble had a great year, and the stock is up more than 20%, likely making investors very happy. The company is a massive business; it's a Dividend King, and a conglomerate with a sprawling $382 billion market cap. It sells tons of low-cost products and generated $78 billion in revenue over the past twelve months.
In other words, Procter & Gamble's 20% rise isn't solely a result of the business' growth. Much of that gain has come from "multiple expansion," when a stock's share price outgrows the underlying company.
You can see in the chart above how Procter & Gamble's revenue has grown just under 5% over the past year, and net income, which is a company's bottom-line profits, grew just over 2%. Meanwhile, the stock now trades at a price-to-earnings ratio of just over 28, a roughly 20% premium to the stock's long-term average P/E ratio of 23.
2. Not enough growth in the business
When a stock's valuation goes higher or lower than its long-term average, it can help to ask yourself: "Does the stock deserve this higher or lower valuation? Or is the stock more likely to revert to its average?"
Procter & Gamble's top line has been stagnant. Its revenue has slightly shrunk at an average of negative 0.8% per year over the past decade. Net income has grown at an annual average of 2%, while earnings-per-share (EPS) have increased just over 3% per year due to the company buying back its stock to help grow EPS. Growth over the past year is a notch above its long-term averages, both on the top and bottom line. But is low single-digit growth something to celebrate?
It could be that Procter & Gamble's average P/E ratio being 23 over the past decade is more a result of the long dividend history, a stable business model, and general safety that investors can feel good about when owning shares. I'm a little skeptical that the stock could sustain a higher-than-average valuation without a notable increase in growth.
3. Cooling tailwinds could slow sales momentum
Procter & Gamble delivered better growth over the past couple of years, when people generally stayed home more and stocked up on household goods during the pandemic lockdowns. Procter & Gamble's revenue has grown more than 4% per year over the past three years, and net income has averaged nearly 14% annual growth!
But Procter & Gamble might struggle to keep it up in 2022. Management issued a warning in its guidance during its fiscal year 2022 Q2 earnings report, ending December 31, 2021. The company is expecting several headwinds to pick up over the next six months, including:
- Significant deceleration of market growth
- Significant currency weakness
- Significant further commodity and freight cost increases
- Major supply chain disruption or store closures
- Additional geopolitical disruptions and economic volatility
The company is projecting EPS growth for the year between 6% and 9%, which isn't bad, but it's a slowdown from what it's been over the past couple of years. Investors will have to see how things play out in the quarters ahead; the company's guidance has a pretty wide range because of the potential uncertainty.
What to do?
Panicking at the thought of a more challenging business climate probably isn't helpful. Instead, investors should be aware of these potential headwinds and consider the current valuation when considering the stock. Procter & Gamble is still a blue-chip stock, one you could tuck into your portfolio, fall asleep on for a couple of decades, and feel pretty good about it still doing its thing when you revisit it later on.
What's important is that investors realize that even though fundamentals and valuations sometimes run apart from each other, they tend to come back together eventually. With the stock doing so well in 2021, investors should consider that before deciding whether to buy more shares.
