Are Consumer Staples Stocks Still Undervalued?

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

Income investors already know the merits of investing in companies like The Clorox Company (NYSE: CLX), but it bears repeating: specifically, reliable profit growth and annual dividend increases. Investors who love receiving income from their stocks take those quarterly checks very seriously.

Indeed, Clorox recently did what its investors probably take for granted. The company recently raised its dividend by 11%, marking the 36th consecutive year of a dividend increase.

Clorox isn’t the only consumer staples giant that provides investors with annual pay bumps, and the recent stock price performance of the company and its industry peers has been truly impressive.

For example, Kimberly-Clark (NYSE: KMB) and Colgate-Palmolive (NYSE: CL) recently provided investors with healthy 9% dividend increases.  Kimberly-Clark still yields 3%, while Colgate-Palmolive's dividend payout amounts to roughly 2.2% at recent prices.

There's no doubt that many consumer staples giants, including Clorox, Kimberly-Clark, and Colgate-Palmolive are premier dividend stocks with long track records of raising their payouts every year.

However, given how much these stocks have rallied and the lofty valuations they now enjoy, it's worth discussing whether these stocks have soared too far, too fast, and if their total return potential is still compelling enough for new investment.

Slow-and-steady stocks that have been anything but

Investing in the consumer staples sector is usually a conversation dominated by dividend payouts, and less so by compelling share price gains. However, notable industry titans including Clorox, Kimberly-Clarke, and Colgate-Palmolive, have soared in price over the past year. Each of these three supposedly ‘slow-and-steady’ type stocks is up 25% or more over the past 52 weeks, and up more than 15% just since the beginning of this year. Note, too, that these gains don’t even include the dividend yields these stocks are known for.

Since these stocks have rallied so much in recent months, their valuations may be a cause for hesitation among investors considering buying shares. Clorox, Kimberly-Clark, and Colgate-Palmolive now trade for at least 20 times earnings. Colgate-Palmolive’s valuation now exceeds 25 times earnings.

Future growth unlikely to justify these valuations

Clorox provides investors with what it calls its Centennial Strategy, designed to underscore its long-term strategic initiatives. One of which is long-term revenue growth between 3% and 5% per year, and profit growth to be slightly above those levels. While these growth rates are sufficient to cover dividend increases in line with the company’s track record, whether they’re enough to justify paying 20 times earnings is a debate worth having.

Clorox is a high-quality blue chip that will likely reward shareholders for many years in the form of steady profit growth and consistent dividend increases in the high single digits or low double digits. My issue with Clorox certainly has nothing to do with the underlying business, but rather, with the stock’s valuation.

Even the highest-quality businesses can turn out to be mediocre investments if you pay too high a price. I’ve owned Clorox in the past, but not at the present time, and I don’t see a compelling enough case to warrant new investment at a recent price of $86 per share.

While there’s absolutely nothing wrong with owning Clorox, Kimberly-Clark, and Colgate-Palmolive, I see more attractive opportunities elsewhere for new investment. Frankly, my personal opinion is that each of these consumer staples heavy-weights is fairly valued. Income investors are likely tempted by 2% to 3% dividend yields on these names, which is understandable in today’s investing climate of historically low interest rates.

That being said, total return potential must be considered, not just dividend yield. I would love to own Clorox, Kimberly-Clark, or Colgate Palmolive; at this point, however, I’m going to wait for a pullback before buying shares. I would advise investors to do the same.

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Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Kimberly-Clark. 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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