Who doesn't like a safe investment that can still garner you an attractive return? I don't know about you, but I always like to have one in my portfolio because it helps me sleep soundly at night, free from the vagaries of Mr. Market. One such investment is Procter & Gamble (NYSE:PG).
With a market capitalization of around $211 billion, Procter & Gamble is a large company. It's also a diversified enterprise that houses some of the top consumer brands in the country: Head & Shoulders, Gillette, Crest, and Pampers, to name a few. However, just because the company is large and creates products that people need doesn't mean that it is an attractive investment. Rather, these two qualities act as insurance against the company going bankrupt in the near future (absent financial mismanagement/fraud), while fundamentals play a key role in determining an investment's viability.
Looking at the company's five-year average return on equity (which is a measure of the return for investors for each dollar invested in the company), net profit margin, long-term debt/equity, and free cash flow margin, we see that Procter & Gamble is a strong, sound, and profitable enterprise. Perhaps the only metric that is worrisome is its current ratio.
At 0.79, the company's current ratio suggests that for every dollar in liabilities due in the near future, the company only has $0.79 to meet these liabilities. This is troublesome, but the company's high operating and cash flow margins suggest that this would only likely be a problem in the event that its profitability falters rather significantly. This is an unlikely event because the company has made a profit every year for at least the past 10 years.
In essence, it can be reasonably concluded that Procter & Gamble is an attractive prospective investment. However, while examining the company's fundamentals, I found something that makes me think it might just be the safest play in the market: its large hoard of treasury shares.
A Primer on Treasury Shares
When companies are profitable, they tend to return value to their shareholders. Oftentimes, this can be in the form of dividend increases, but for others it can take the form of buying back shares. Procter & Gamble has been particularly focused on the latter option. When opting for door number two, a company has the option to either retire the shares or to keep them on its books as treasury shares. This effectively gives the company the ability to easily sell the shares in the future, at management's discretion, to raise cash.
The upside to this approach is that the company in question has the option to issue the shares at will (almost the same as borrowing, but without having to worry about interest). However, there is a downside to this scenario. If the company's shares decline precipitously over time, then the company may have to sell the shares back to the public at a discount from its purchase price. On the other hand, if the company performs strongly in the future and its shares rise, then the company profitably invested in itself.
To illustrate the enormity of the impact that treasury shares have on Procter & Gamble, let's discuss the company's balance sheet. Whereas the company has a current book value of equity of $68.06 billion (or $24.82 per share), its treasury shares stand at $71.97 billion (or $26.24 per share). This means that if the company could sell these shares to the public for their price as of its most recent fiscal quarter, it could raise $71.97 billion in cash, which is 34.1% of its market capitalization. This marks a significant increase from its $55.96 billion (or $19.18 per share) in 2009.
As such a large percentage of the company's market capitalization, it is likely that the company may utilize this treasury chest (pun intended) to make strategic investments or acquisitions if future interest rates are high, or if the company falls on hard times. However, Procter & Gamble isn't alone in this quest to increase the strength of its balance sheet.
Looking at the table above, we can see how three other companies measure up with Procter & Gamble in terms of their commitment to loading up on treasury shares.
Philip Morris International (NYSE:PM), the largest tobacco provider in the world and a major consumer goods company itself, has treasury shares as a percentage of its market capitalization equal to 19.2%. Though this measure is lower than what Procter & Gamble posts, it is worth mentioning that Philip Morris has purchased so many treasury shares that its book value of equity is negative. Though typically a bad sign, this phenomenon suggests that the company's return on equity is significantly misstated.
PepsiCo (NASDAQ:PEP), is another advocate of investing in itself by acquiring treasury shares. With $19.48 billion (or 15.9% of its market capitalization) tied up in shares, the company has also increased the strength of its balance sheet such that it could raise significant capital if its shares do not fall precipitously.
Finally, we have International Business Machines (NYSE:IBM). Though the company does not fall in the consumer goods category, IBM is perhaps the prime example of treasury shares gone wild. With treasury shares amounting to $129.24 billion (or 65.1% of its market capitalization), the company might be the most extreme example of a company investing in itself.
Currently, some companies are buying treasury shares, possibly for fear of inflation and high interest rates in the future, but also possibly out of confidence that their shares will outperform the market. While it's not a guarantee that these companies will outperform, it is certainly nice to know that each one has the ability to tap into a large store of cash whenever it sees fit.
Daniel Jones has no position in any stocks mentioned. The Motley Fool recommends PepsiCo and Procter & Gamble. The Motley Fool owns shares of International Business Machines, PepsiCo, and Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.