Take a look in your bathroom cabinet. How many products are made by Colgate-Palmolive (NYSE:CL)? Now look underneath your sink -- any of the company's products there? A quick peek in my house yielded six different Colgate brands. That speaks to the ubiquity of this consumer goods giant.
When consumers are this familiar with a company's products, it helps investors rest at ease. They know we will likely keep buying these goods well into the future, making the company's dividend imminently safe.
But that doesn't necessarily mean the company's stock is a buy. In fact, Colgate has underperformed the S&P 500 by 45 percentage points since the bottom of the Great Recession.
Why is this? Let's take a closer look and find out.
The most important metric for dividend investors
If you're interested in Colgate for its dividend -- as many investors are -- no metric is more important than the company's free cash flow. This is a measure of how much money a company actually brings in during the year, minus its capital expenditures.
Dividends are paid from free cash flow, which makes that number so critical. Since 2010, here's what Colgate's free cash flow and dividend situation looks like.
There's good news and bad news in that chart. The good news is that Colgate's dividend is quite safe ... for now. The company only uses 56% of its free cash flow to pay out its dividend. That means if free cash flow shrinks, there's still a margin of safety to maintain the payout. And if free cash flow rises, there's lots of room to grow the dividend.
The bad news is that free cash flow has been largely stagnant over the last five years. In 2010, only 43% of free cash flow was used to pay the dividend, but that has steadily crept up to the current 56%.
To see why this is happening, let's dig further into the company.
What's going on with Colgate's business?
Colgate's products cover a wide array of categories: oral care, personal care, home care, and pet nutrition. When the company reports results, the first three categories are lumped together and broken down by geography, while pet nutrition stands alone.
Looking at how the company has fared since 2011, it's easy to see why free cash flow might be so stagnant.
While results are somewhat encouraging in North America and Asia, the same cannot be said for Europe and Latin America -- Colgate's two largest segments. Sales have actually gone negative over the last four years. And though some of that has to do with currency fluctuations, the overall picture of stagnation persists.
That alone wouldn't be a huge problem -- all companies eventually reach a saturation point -- but Colgate's stock is quite pricey in this context. It trades for 22 times earnings and 24 times free cash flow, which are hefty premiums for a company whose growth days are long past.
If you are simply after the company's dividend, a 2.2% payout isn't bad. However, Colgate isn't the only dividend paying stock out there and Foolish investors looking for a decent - and growing - yield are better off looking elsewhere.
Brian Stoffel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.