It Is Not The Right Time to Invest in This Stock!

Mihir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

How would the idea of going on an adventure without any safety equipment whatsoever sound to you? Many would call it completely absurd. While investing in stock markets is not completely an adventure, it is definitely an activity that entails some risk and calls for some safety measures. It is always prudent to have some safe investments in your portfolio that allow you to trade with confidence and satisfaction. Clorox (NYSE: CLX) is one such safe stock that carries on a pretty simple business and generates healthy returns.

Simplicity is this business’s best feature

One of Peter Lynch’s investment principles is to invest in an idea that can be illustrated with crayons. Clorox more than fulfills this parameter with a comprehensible business model. It manufactures various consumer products for daily sanitation and hygiene, the demand for which is relatively inelastic. Such inelasticity shields the business from major revenue swings during periods of recession. Its flagship bleach product enjoys a favorable reputation across the globe, ensuring a sustainable revenue stream. Recently, the company launched a concentrated version of its famous bleach, and this new product is gaining traction in the consumer market.

The numbers are good

For the past few years, Clorox has been operating with a gross margin of over 40% and following a disciplined expense management system. In the most recent quarter, the company's gross margin declined by 20 basis points to 42.1% of sales. While logistics cost hurt the margin in a big way, a favorable impact from cost savings and incremental pricing helped in partially offsetting the negative impact. As a result, the company has generated $352 million in free cash flow year-to-date, as compared to $214 million for the same period in 2012. As this Fool article states, Clorox has successfully generated approximately half of its current valuation in free cash flow. In the 2013 fiscal year, volumes of its bleach products have remained flat because of slight upward changes in price and increased competition from private labels.

Clorox is definitely a dividend champion

Since the recession of 2008, U.S. markets have been experiencing higher level of volatility. During such times, it is prudent to invest in stocks that create reasonable value for shareholders. Clorox is a valuable company in that regard as it has created impressive value for its shareholders via its dividend policy. It declared a total dividend of $2.48 per share in 2012, an increase of 188% from the $0.86 per share that it offered in 2002. The company has consistently kept its dividend payout ratio below fifty percent in order to build up cash for capital expenses. Recently, the company has been piling cash in order to finance its bolt-on acquisitions.

Industry rivals

A leader in consumer products, Procter & Gamble (NYSE: PG) offers an array of packaged goods. At the beginning of 2013, it sold out a portion of its bleach business to its counterpart in the Italian joint venture that it has operated with the Angelini group. The company cited its concern in terms of market reach for its bleach products as a reason for the divestiture. Like Clorox, Procter & Gamble has also maintained a healthy dividend policy. The company trades at a lower price-to-earnings multiple than Clorox, however, which puts it on a higher pedestal. Apart from a reasonable valuation, it also possesses strong financials. Its current debt-to-equity ratio stands at 0.48, which is quite impressive considering the fact that it operates in multiple categories and also returns a sizable amount of cash to its shareholders.

In contrast, Colgate-Palmolive (NYSE: CL) is quite an expensive buy at approximately 23 times the earnings. From a purely technical perspective, Clorox and Procter & Gamble are better investments because of their comparatively higher yields and cheaper valuations. One of the company’s biggest strengths is research and development which enables it to launch new products on a consistent basis. In fact, it saw a modest growth in the Euro region in the first quarter despite the region going through a massive macroeconomic crisis; this was due to the release of new products and product variations. In its first quarter earnings call, the management announced a plethora of new versions for its flagship Colgate range of toothpastes. Colgate-Palmolive has always been ahead of the league in terms of innovation, and this has worked out very well.

Final words

As I mentioned in the beginning, Clorox is not an adventurous stock with wide swings or complicated developments. The company is a leader when it comes to creating shareholder value. Market analysts have recently criticized Clorox’s valuation and in certain sense, I believe that it is slightly overvalued at the current price level. The company has a price-to-book value ratio of around 74, a scary number when compared to industry peers. It has also been unable to grow its overall sales in the 2013 fiscal year because of the poor performance of its household segment. The main reason behind this was a considerable decline in charcoal sales.

While Clorox is a worthy stock for your portfolio any day, it is not advisable to take a new position in the company right now. In my opinion, a quarter’s wait is worthwhile because the company still needs to increase charcoal sales. Also, its flagship bleach products are seeing flat volumes as the market still needs time to accept the price increase. This simply is not a good time to buy the company's stock.

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Mihir Mehta has no position in any stocks mentioned. The Motley Fool recommends Procter & Gamble. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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