3 Consumer Goods Stocks to Avoid

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

While you may be tempted to back consumer goods firms just for the sake of capitalizing on a macro recovery, I recommend caution. Some producers are already trading at a premium to the S&P 500 and historical multiples due to their presumed safety.

Procter & Gamble (NYSE: PG): Great Company Overvalued

While P&G is a solid company with a sustainable product portfolio, it is very expensive at a respective 22.3x and 16.4x past and forward earnings. With a dividend yield of 3.2% and a beta of 0.43x, I believe that many investors moved over to the company as macro uncertainty increased. However, now that the domestic economy has picked up, this will become less of an appeal. And should the Obama administration be successful in hiking dividend taxes by 164%, P&G will become even less attractive.

The stock is around its 52-week high but only 18.6% above its 52-week low. While the low beta may limit downside, it also limits upside. Analysts only project 8.5% annual EPS growth over the next 5 years, which is obviously not enough to make the business undervalued at a 10% dividend yield and a fair multiple of 17x. I thus encourage investors to hunt for turnaround plays that can gain from a macro recovery.

Weak top-line momentum makes the business unappealing for the years ahead. I am, however, optimistic about activist investor Bill Ackman's billion dollar investment in the consumer goods producer. It has been speculated that he has constructively called for the booting of the CEO and the reigning in of costs. While management is aiming to cut $10 billion in costs by 2016, the sales base is not looking like it will expand any time soon in light of wage stagnancy.

Colgate (NYSE: CL) & Clorox (NYSE: CLX): Great Companies… Overvalued & Overvalued

Colgate and Clorox are also expensive. The former trades at a respective 21.9x and 18.8x past and forward earnings, versus corresponding figures of 18.4x and 16.3x for the latter. Colgate is, however, forecasted for around 70 bps greater annual EPS growth over the next 5 years, at 8.8%.

Over the last 5 quarters, Colgate has been nearly consistently in-line with analyst EPS forecasts. By contrast, Clorox has been consistently above estimates by an average of 9%. Clorox still carries a significant amount of leverage with a quick ratio of 0.5x, which will draw investor hesitation over the 3.4% dividend yield.  Ditto for Colgate.

Despite only decent performance, however, management has stated that it is "very pleased" with results. While organic sales growth of 8% was driven both by pricing and volume gains, share gains in developed markets have been only modest. Margins have been on the increase from cost cutting, but competition and FX headwinds are rising.

Assuming Clorox meets analyst expectations, 2016 EPS will come out to $5.85. At a 16x multiple, this translates to a future stock value of $93.60. Discounting backwards by 10%, the present value of the stock is $58.12. Needless to say, this is at a substantial discount to the current market assessment of $75.44. If you factor in the impact of a 164% dividend tax hike from the Obama administration, the negative returns will be even worse. If Colgate has struggled even more than Clorox and is trading at a premium, it stands to reason that an even gloomier picture confronts Colgate.

Indeed, Colgate will have to spend more on advertising to keep demand up as new entrants try to capitalize on the recovery. And while emerging markets represent half of the business, slow returns in developed markets indicate that competition is likely to follow abroad. Management is aiming to cut costs and use the savings to fuel growth, but a significant amount of growth is already being factored into the stock price. Accordingly, I recommend holding out.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of The Clorox Company. Motley Fool newsletter services recommend The Procter & Gamble Company. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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