When first starting out as a dividend growth investor, it can sometimes seem frustrating seeing just a few dollars at a time trickle into your brokerage account via dividends. But the maxim of slow and steady wins the race can be applied to many areas of life, and especially to investing.
The beauty of dividend growth investing is that it can yield impressive results. The consumer staple company Procter & Gamble (PG 0.54%) has delivered 8% average annual dividend growth to shareholders over the last 20 years. As a powerful example of compounding in action, this has turned every $1 of initial dividend income into $4.67 of dividend income, without even considering dividend reinvestment.
I believe that the company will be able to generate nearly as much dividend growth on behalf of shareholders for the next 10 to 20 years. Let's dig into P&G's fundamentals and valuation to better understand why the stock is a buy for dividend growth investors.
P&G is an innovative company
Don't let P&G's status as a top consumer staple stock put you to sleep: With 37,000 active patents, the company is about as innovative in its space as any of the most highly regarded tech businesses. The secret to P&G's creativity lies within its culture as a company. Recognizing the importance of not just keeping up with the preferences of consumers, but staying ahead of them, the company dedicates more than $2 billion each year to research and development.
P&G's net sales edged 1.4% higher year-over-year to $20.6 billion during its first quarter ended Sept. 30. And since the company has extensive operations throughout the world, this includes a 6% foreign currency translation headwind due to the strong U.S. dollar. Excluding unfavorable foreign currency exchange rates, P&G's organic sales surged 7% higher in the first quarter.
In response to rising commodity and labor costs, the company passed on 9% price hikes to consumers. And because the company's portfolio of products maintains first or second positions in categories that are critical to consumers, such as paper products, diapers, and laundry detergents, volume declined just 3% for the quarter. Finally, growth in the healthcare segment had a favorable impact of 1% on sales. This was the result of higher-than-average prices in that segment compared to P&G's overall business.
The company recorded non-GAAP (core) diluted earnings per share (EPS) of $1.57 during the quarter, which was down 2.5% over the year-ago period. A 4.6% rise in P&G's cost of goods in the quarter led to a nearly-110-basis-point drop in the company's non-GAAP net margin to 19.2%. P&G's 2.2% reduction in its outstanding share count to 2.5 billion wasn't quite enough to compensate for the reduced profitability and foreign currency factors. That's why core diluted EPS lagged behind net sales growth for the quarter.
As inflation cools off and foreign currencies eventually strengthen against the U.S. dollar, analysts believe that P&G's core diluted EPS will compound at 4.8% annually through the next five years. And given that the company's brand portfolio is arguably the strongest it has ever been, this could prove to be a somewhat conservative estimate from analysts.
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The viable payout ratio can support future dividend growth
P&G's 2.8% dividend yield is considerably more than the S&P 500 index's 1.7% yield. And the company's 66-year dividend growth streak as a Dividend King looks like it will be built upon in the years ahead.
This is because the company's dividend payout ratio came in at 60.6% in its previous fiscal year. P&G is retaining more than enough funds to grow its business, pay down debt, and repurchase shares. As a result, I believe that the company will hand out at least mid-single-digit annual dividend growth in the long run.
A world-class business at a reasonable valuation
P&G is a business that manages to steadily grow year in and year out. And the stock's valuation isn't prohibitively expensive.
P&G's forward price-to-earnings (P/E) ratio of 22.7 is above the S&P 500 consumer staples sector average forward P/E ratio of 19.3. But this 18% premium is well-deserved in my opinion, considering that P&G's dividend growth track record is the lengthiest in the entire consumer staples sector.
