2 Consumer 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 an improving economy will drive greater demand for consumer goods, the upside has already largely been factored into stock prices. Although brand-name companies are defensive against an uncertain future, this is not a strong enough reason to buy a large stake in consumer goods companies. Below, I review my outlook on a few stocks.
Procter & Gamble (NYSE: PG) Is Overvalued Despite Ackman Move
P&G may be a quality name brand, but at a respective 22.1x and 16.2x past and forward earnings, it is quite expensive. With a dividend yield of 3.3%, the stock appears relatively safe. However, when the economy enters a full recovery and concerns over a double dip have fully dissipated, investors will be interested in taking on stocks with faster growth trajectories and lower multiples.
One major catalyst that the firm has going in its favor is Bill Ackman. The activist hedge fund manager of Pershing Square Capital is known for taking large amounts of stock in undervalued companies and lobbying management for changes to drive abnormal returns. With costs running high and the restructuring plan failing to yield meaningful margin expansion, change is needed. Booting the CEO would be a step in the right direction, since he instills bad memories of past strong returns.
I am also optimistic about the company's attempts to increase scale in emerging markets. These high-growth geographies represent less than two-fifths of business, so there is room for expansion. In my view, however, growth will not be enough to justify the current price tag. Analysts forecast 8.5% annual EPS growth over the next 5 years. Assuming it meets expectations, 2016 EPS will come out to $5.41. At a multiple of 17x, the future value of the stock is $91.97. Discounting backwards by 10% yields a present value of $57.11. This implies that the stock is currently 17% overvalued.
Unfortunately, Colgate is not a good alternative for investors. It trades at a respective 21.3x and 18.3x past and forward earnings, with forecasts for 8.8% 5-year annual EPS growth. Results have been less than stellar, with only one nominal beat over the last 5 quarters. Yet, over the last 12 months, the stock has gained 14.7% - only slightly underperforming the S&P 500.
On the positive side, Colgate has seen growing penetration in emerging markets, with 13% organic sales growth. It is mostly diversified abroad (international business represents three-quarters of sales). Like P&G, Colgate has attempted to cut costs, and it has been successful in generating upwards of $700 million in pre-tax savings in the past. However, these measures are being reinvested in new products that I don't believe will translate into market success. For example, management has touted its recent exploration of the rechargeable toothbrush market. If this sounds funny to you, it's because it is.
In my view, a much more attractive alternative would be to buy shares of Clorox, which is small enough in market cap ($9.8 billion) to be a viable takeover target. With a 3.4% dividend yield and meaningful accretive opportunities, I believe activist investor Carl Icahn was on to something when he pushed the firm to sell itself. The company has a weak balance sheet, as evidenced by the quick ratio of 0.5x, and could thus fare much better when equipped with cash from a suitor. Earnings growth of under 5% during the last half decade would also need to be reversed before multiples could elevate to peer levels.
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.