Caution: This Dividend Champion Appears 36% Overvalued: Clorox (CLX)

Clorox (CLX) is one of the most reliable dividend growth companies on the planet. The well-known consumer staples company is a Dividend Champion and a stalwart in many dividend growth portfolios. Its streak of increasing dividends stands at 38 years, and in July it will undoubtedly move the streak to 39.

Clorox’s dividend is A-rated, with practically no risk of being cut, according to the cash-flow-based analysis from Safety Net Pro. Clorox has plenty of money to pay its dividend.

CaptureBut for all its great attributes as a company, now may not be a good time to buy its stock.

[ad#Google Adsense 336×280-IA]Why?

Because the market has bid Clorox up to a highly inflated price.

That means that over the long term, Clorox’s price growth prospects are not very good.

And over the short term, you get a lower yield right out of the starting gate.

“Inflated price” means that a stock is overvalued.

Let’s use my 4-step process to assess Clorox’s valuation.

Step 1: FASTGraphs Default Valuation

In the first step, we compare the stock’s current price to FASTGraphs’ default estimate of its fair value.

FASTGraph’s basic estimate of valuation is based on a price-to-earnings (P/E) ratio of 15. That is the long-term historical P/E ratio for the stock market. This fair value of P/E = 15 is shown by the orange line on the following graph.

CaptureAs you can see, Clorox’s actual price is far above the orange line.

In fact the ratio of Clorox’s P/E of 26.5 to the fair-value estimate of 15 is a whopping 1.77, meaning that CLX is 77% overvalued. If that is true, it suggests a fair value price of $73 compared to Clorox’s actual price of about $128.

Step 2: FASTGraphs Normalized Valuation

In this step, we adjust the fair-value line by using Clorox’s historical average P/E ratio rather than the default value of 15 that we used in the first step. Maybe Clorox is simply highly valued all of the time, as would befit a company of its high quality.

It turns out that this is the case.

CaptureClorox’s “normal” P/E over the past 10 years has been 18.2, shown by the blue line. That is 21% above the P/E of 15 used in the first step. Clorox is indeed highly valued by the stock market most of the time.

That said, Clorox is currently trading far above even that valuation.

How much? We use the same simple ratio here as above: (Clorox’s current P/E) / (Clorox’s normal P/E). In other words, 26.5 / 18.2 = 1.46. So Clorox is 46% overvalued by this valuation method.

This suggests a fair value of $88 for Clorox.

Step 3: Morningstar Star Rating

I use Morningstar valuations for two reasons. First, they are an independent source. They do not have a brokerage, and they are not trying to sell me anything other than information. So their incentive is to be as accurate as possible.

Second, Morningstar uses a comprehensive net present value (NPV) technique for valuation. It involves discounting all of the stock’s future cash flows back to the present. A stock’s fair price is considered to be the sum of all of its future cash flows. Many investors consider this to be the finest way to value a stock.

CaptureOn Morningstar’s 5-star grading scale, 2 stars means that Clorox is overvalued. They put a fair price on the stock of $114. So by this method, Clorox is 12% overvalued.

Step 4: Current Yield vs. Historical Yield

Finally, we compare the stock’s current yield to its historical yield. The higher the stock’s current yield is compared to its historical average, the better value it represents. Conversely, the lower the stock’s current yield compared to it historical average, the less attractive the valuation.

All else equal, yield is inversely related to price: When price goes up yield goes down, and vice-versa.

CaptureAs you can see, even though Clorox has been increasing its dividend every year, its climbing price has been bringing its yield down for the past 4 years. At the end of 2011, Clorox had a yield of better than 3.5%. Its yield today is 2.4%.

So again by this measure, Clorox is overvalued.

CaptureAccording to the data above from Morningstar (look at the last line in the table), Clorox’s average yield over the past 5 years has been 3.0%. It is 2.4% now.

Using that ratio, Clorox comes across as being 25% overvalued. A fair price would be $102, which would make its current yield match the 5-year average at 3.0%.

Valuation Summary

Using the 4 approaches just described, our valuation for Clorox looks like this:

CaptureMy conclusion is that Clorox is 36% overvalued at the present time. Its current price of about $128 is 36% above its fair value price of $94.

There is a school of thought that it is OK to overpay for a high quality company like Clorox, because its price will continue to go up anyway – it’s “always overvalued.”

I agree with this to some extent. I will pay up to 10% above fair value for a top-tier blue-chip company. But Clorox is 36% above fair value as computed above. If we just confine our attention to Clorox’s own historical high valuation – shown in step 2 – it is 46% overvalued.

Will Clorox’s price continue to go up anyway? Let’s look at this 10-year price chart for perspective.

CaptureWe see that Clorox’s price hardly dipped during the Great Recession, and it has been either flat or rising since then. Maybe its really high valuation is indeed a new normal.

But, to me, that’s not the way to bet. I would not buy it here. I would wait for a price that gives Clorox a yield of 3% or more. That price may never come, but there are other tasty fish in the sea. One does not have to own Clorox in order to have a high-performing dividend growth portfolio. I don’t.

— Dave Van Knapp