The broader economy has been a bit scary over the last seven or eight years.
We had the financial crisis.
The Great Recession.
The fiscal cliff.
Sequestration.
And it seems like a crisis in the eurozone pops up every year or so – the threat of “Grexit” seems to have abated for now.
[ad#Google Adsense 336×280-IA]But you know what’s not scary?
The thought of investing in companies that manufacture and provide products that are so ubiquitous and necessary to everyday life that their demand isn’t sensitive to the broader economy.
Think products like toothpaste, soap, shampoo, deodorant, and household cleaners.
After all, you’re not going to stop grooming yourself or brushing your teeth because Greece isn’t sure whether or not it wants to say in the eurozone.
Well, I hope not!
No matter what happens to the economy, these products will continue to sell.
That’s why I like the idea of investing in a company like Colgate-Palmolive Company (CL).
Colgate-Palmolive Company is a consumer products company that markets a variety of oral care, household care, and pet nutrition products in more than 200 countries and territories across the world.
The company has a history dating back to the early 1800s, but their products are extremely relevant to today’s consumer.
Think brands like Colgate, Palmolive, Irish Spring, Speed Stick, and Softsoap.
And they even offer pet nutrition through their Hill’s Pet Nutrition business.
But it’s really in that Colgate brand that the company has built strong competitive advantages. The company sports an approximate 45% worldwide market share in toothpaste, which is substantially greater than everyone else.
And it’s because of that leading position that I think Colgate will continue to prosper. Consumers tend to remain loyal to a toothpaste brand if it’s getting the job done right. Who wants to risk the health of their mouth to save a few pennies?
We see that in their financial results. Colgate’s operations remained robust right through the financial crisis and basically haven’t skipped a beat since.
Let’s take a look…
Revenue was $11.397 billion in fiscal year 2005. The company grew that to $17.277 billion in FY 2014. That’s a compound annual growth rate of 4.73%.
Meanwhile, earnings per share is up from $1.22 to $2.36 over this period, which is a CAGR of 7.61%.
Not the most outstanding growth around. But what they perhaps lack in absolute growth, they make up for with stability: EPS grew significantly between 2008 and 2009, only to dip ever so slightly in 2010. But then right back up again strongly in 2011.
While some companies were struggling (or even went bankrupt altogether) during the financial crisis, it was almost as if Colgate didn’t even know such an event was occurring. Certainly didn’t pop up on their financial statements.
In addition, the strong dollar has had a negative effect on Colgate’s operational results over the last few years. And that’s because approximately 80% of their sales come from international operations. That’s a wonderful metric for the long haul, but it is a headwind right now with the strong dollar.
S&P Capital IQ is predicting that EPS will grow at a 12% compound annual rate over the next three years, citing strong share buybacks and volume and pricing growth.
Speaking of buybacks, that’s one reason the EPS growth outpaced sales growth over the last decade. Over that time frame, CL reduced their outstanding share count by approximately 15% – more net income is being split between fewer shareholders, which makes for a great outcome.
Now, I’m a dividend growth investor. You can see that just by looking at my personal portfolio.
I only invest in companies that pay a dividend. And I almost never invest in a business unless it has a lengthy track record of increasing its dividend annually, year in and year out.
That’s because dividends act as the “proof in the pudding”. Financial statements can tell me a great story. But cash doesn’t lie. A company that can send out growing dividends for decades on end can only do so because its business is growing and operational results are strong.
You simply cannot run a poor/shrinking business and simultaneously increase cash payouts for decades and decades.
Well, it’s here that Colgate is especially impressive.
They’ve increased their dividend for the past 52 consecutive years.
Just think about what you have to get right to send checks to shareholders for more than 50 straight years. Now imagine those checks are increasing every single year. Incredible, right?
That easily qualifies CL as a “Champion” on David Fish’s Dividend Champions, Contenders, and Challengers list – a document that tracks more than 700 US-listed stocks that have increased their dividends for at least the last five consecutive years.
But they haven’t just been sending out ever-growing cash payouts to shareholders for decades, they’ve also increased their dividend at a pretty attractive rate.
Over the last decade alone, the company has increased its dividend at an annual rate of 11.5%.
Pretty outstanding and well over the rate of inflation, meaning shareholders’ purchasing power is increasing exponentially.
However, that growth rate is also greater than the rate at which profit per share has grown, leading to a slightly elevated payout ratio of 60.1%.
Not worrisome, but it’s unlikely that future dividend growth will much outpace EPS growth.
But what you get in addition to that great dividend growth track record and outstanding dividend growth is a pretty attractive yield of 2.24%. That beats the broader market by more than 20 basis points.
Really incredible dividend metrics here.
More than five decades of dividend raises, a market-beating yield, and double-digit growth.
I don’t know how you complain about any of that.
Now, one area of the business that seems to draw some criticism and confusion is the balance sheet.
With a long-term debt/equity ratio of 4.93, the company at first appears heavily indebted. But that’s because of low common equity rather than high absolute debt.
The interest coverage ratio offers quite the juxtaposition. At over 28, that means Colgate is in no danger of covering interest expenses. The balance sheet is very, very solid.
Profitability is also solid. Over the last five years, the company has averaged net margin of 13.87% and return on equity of 101.41%. These numbers compare favorably to any competitor out there, though ROE is inflated due to the aforementioned low common equity.
I really love the idea of investing in this company. I actually regret not buying stock years ago. Unfortunately, the number of high-quality stocks out there in the world far outstrips my available capital to buy them.
But you’ve got products that are purchased and used regardless of the global economy. Their dominance in oral care is incredible and unlikely to abate anytime soon, meaning their results should continue to improve year after year.
However, the company doesn’t just keep all that profit to themselves. They share it with shareholders in the form of an attractive and growing dividend. With more than 50 years of dividend growth behind them, I find it extremely hard to believe that the dividend will stop growing anytime soon. That means you can count on a check. And you can count on that check being bigger every year.
The stock trades hands for a P/E ratio of 26.79 right now. A premium valuation for a premium stock, but I think it’s important to be mindful of the fact that the five-year average P/E ratio for this stock is only 21.8.
I valued shares using a dividend discount model analysis with a 10% discount rate and a 7% long-term dividend growth rate. Modeling in an elevated payout ratio and EPS growth near 7% over the last decade means it’s unlikely the company will be able to grow the dividend significantly more than that over the foreseeable future. But a margin of safety may be present if the company is able to come anywhere close to the growth S&P Capital IQ is forecasting. The DDM analysis gives me a fair value of $54.21.
Bottom line: Colgate-Palmolive Company (CL) is a high-quality company across the board. Products that are ubiquitous and will remain in demand regardless of the broader economy, along with absolute dominance in oral care. But that quality is being rewarded with a premium valuation that’s rich even for CL’s historically lofty standards. I think a price in the mid-$50s makes a lot more sense, which would bring its P/E ratio down closer to its five-year average. Great company, but not so great valuation.
— Jason Fieber, Dividend Mantra
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