Dividend stocks have underperformed in bull market areas this year, as is customary during raging bull markets. I’ve said on many occasions here at Searching Alpha that I favor growth over value (and dividends) and I continue to see so going into 2024.
One name that is an absolute legend in the dividend stock space is The Procter & Gamble Company (NYSE:PG), and while her epic generation ready seven decades dividend growth is good, the stock is just not attractive today. I’ll cover the reasons why I think this below and why I’m placing a sell on the stock heading into 2024.
More weakness ahead is likely
Let’s start with a quick look at the chart, which shows that during a massive bull run in 2023, PG has gone nowhere.
IN In fact, it’s lower today than it was at the start of the year, lagging the S&P 500 by a staggering 23% over the past twelve months. This kind of underperformance for value/dividend stocks – in my view – is much more likely to continue into 2024 than not, and the chart supports this view.
Momentum, as measured by the PPO and 14-day RSI, remains quite weak. If there was sustained buying pressure from the bulls, you would see it here. I do not.
I have drawn in a symmetrical triangle pattern that looks close to completion. I suspect given the stock’s poor performance and the fact that momentum shows zero conviction from the bulls, that this pattern is likely to break on the downside. The first clue would be a close or two below the blue trend line I’ve drawn, followed by a close or two below the previous relative low at ~$140. I fully expect these breakdowns to happen, it may just take a while. But the bottom line on the chart is that I see absolutely no reason to allocate capital here.
PG has a margin problem
We all know that the pandemic upended the margin construct for almost every company that makes physical products. This was especially true for the major consumer companies, as supplies became limited – and therefore more expensive – and they were forced to pass these increases on to customers. This is all well and good and out of the control of these companies, but the problem is that PG has never recovered.
Below we have trailing twelve month revenue, gross margins (in black), SG&A costs (in orange) and operating profit (in green).
Revenues have grown quite nicely since the pandemic, seeing fairly steady growth over several years. That’s good, and PG should be commended for continuing to grow during an extremely difficult period.
The problem is that gross margins are still miles away from their pre-pandemic levels, and while SG&A costs have been well under control, the lack of gross margin production is still hampering operating profits to this day.
You would expect, all else being equal, that increased revenue would produce higher profits. The reason is because operating leverage allows fixed costs to account for a lower percentage of revenue as revenue increases. PG has growing revenue, and SG&A costs have really come down recently as a percentage of revenue. The problem is that gross margins remain very weak, and while they are growing, there is a long way to go to get back to what they were years ago, let alone reach new levels.
You can decide for yourself whether PG will see previous levels of gross margins or not, but the issue I have is that the analyst community seems to be treating that margin expansion as a certainty, rather than a possibility.
Revenue growth is expected to be roughly 4% per year for the foreseeable future, which is entirely reasonable given PG’s track record. I have no problem with that, and I think we’ll likely see something like this going forward.
The problem is that EPS estimates are building at least that much growth into margins as well, and as far as I can tell, PG’s poor gross margin performance means I’m not willing to assume there are years of growth ahead on that front. Can it happen? Of course. Am I willing to assume that he will? No, because PG has not earned the right to that past performance. Any company that sees weaker margins on higher revenues over a period of years is one that deserves increased skepticism and scrutiny from investors, and it’s my opinion that the analyst community is likely to be very positive right now.
Evaluation and conclusion
Let’s take a look at the assessment we have planned for the last five years. PG’s rating has recovered, but has remained quite low over the period, which you’d probably expect for a major production company.
The stock trades for 22X forward earnings today, which compares slightly favorably to the range of 19X to 27X and the average of 24X. Is a company growing at mid-single digit rates at 22x earnings cheap? I wouldn’t say that, however, based on PG’s historical multiples, an argument could be made that it’s a bit underpriced today. This leaves the upside bias from a valuation perspective, so it helps mitigate some of my downside from margins and the stock price chart.
However, given PG is a dividend stock through and through, we can also use dividend yield as a proxy for valuation. With dividend stocks, you can look at the dividend yield as a valuation tool in that when the yield is high, the stock is relatively cheap and vice versa.
The yield today is off the lows, but also far from the highs. At 2.6%, I would argue that PG’s usefulness as an income stock is reduced given that it is well below normal PG yields and still well below that of Treasuries, which are risk and have tax advantages. Each person must decide for themselves how to achieve their income goals, but in this context, the case for PG as an income alternative to Treasuries is difficult for me.
PG is a legend in dividend investing, and deservedly so. However, I just think the company’s ability to capture the difference from ever-increasing earnings is very weak, and I think the estimates for EPS growth are quite aggressive. That doesn’t mean PG can’t achieve ~8% growth, but it does mean the bias for surprises is lower in my opinion. Valuation is good and may offer some upside. The yield, however, does not look attractive.
With all that in mind and the views I expressed in the price chart, I am currently shorting The Procter & Gamble Company stock, as I think there are countless places that are better suited for your investment dollars.