Alongside the rest of the market, Proctor & Gamble (NYSE:PG) stock has been on a tear in 2019, rising 13% as the consumer staples giant has reported favorable numbers against the backdrop of improving economic and financial-market conditions.
Ostensibly, the company’s current outlook is good enough to support further gains by PG stock. PG is turning things around, leveraging non-cyclical tailwinds in cosmetics to drive its best sales and profit growth in several years. As long as those tailwinds persist, and the company’s numbers remain good, then PG stock could arguably continue on its uptrend.
But that bull thesis on PG stock is challenged by valuation.
PG stock is trading at an unusually rich and historically unsustainable valuation. Across essentially every important valuation metric, Procter & Gamble stock is trading 10% or more above its average historical valuation, and it carries a notable premium to its peers in the consumer staples and household products sectors.
PG’s growth outlook is improving, but it isn’t good enough to warrant the super-charged valuation of PG stock. As a result, worries about the valuation of Procter & Gamble stock could ultimately keep the shares stuck around $100.
PG’s Performance Has Improved
P&G’s performance has steadily improved over the past few quarters.
For the past several years, P&G has largely been a stagnant company, defined by 1%-3% organic sales growth, margin turbulence, and slightly negative to slightly positive core profit growth. But over the past few quarters, this company has broken out of its multi-year stagnancy by reporting some of the best numbers investors have seen in a long while.
Over the past three quarters, its sales growth, excluding acquisitions, has been in the 4%-5% range, led by big gains in cosmetics. Meanwhile, its core profits, excluding currency fluctuations, have been rising at a steady double-digit-percentage rate, including a 15% pop last quarter.
In other words, P&G is firing on all cylinders right now. This new, higher growth trajectory should continue, with cosmetics as the big driver.
Largely owing to the widespread proliferation of camera apps, consumers today are increasingly concerned with how they look. This has led to record results across the whole cosmetics/beauty sector. As long as the strength of this sector persists, then so, too, will P&G’s higher-than-normal growth rates.
All in all, the outlook of P&G has substantially improved over the past several quarters, and that’s why PG stock has rallied 40%-plus over the past year.
The Valuation of PG Stock Reflects Improvement… and Then Some
Although PG’s performance is improving, the valuation of PG stock already more than reflects these improvements. Consider the following:
- The dividend yield is at decade-low levels. It’s been this low three times before over the past decade (early 2010, late 2013, and late 2014). Each time, PG stock proceeded to either drop or stay flat over the next several months.
- The price-sales multiple on PG is nearly four. That’s almost a 20% premium to the stock’s average sales multiple over the last five years.
- The price-cash flow multiple on PG is at 18, roughly 10% above its average cash-flow multiple of the last five years.
- The forward price-earnings multiple is above 22, nearly 10% above its average forward earnings multiple of the last five years.
- PG stock’s EV/EBITDA multiple is at 16, which is nearly 20% above its average EBITDA multiple of the last five tears.
- The stock’s forward P/E multiple of 23 is notably above the average P/E multiple of consumer staples stocks (19) and the average P/E multiple of household products stocks (19).
Clearly, fundamental improvements are already priced into PG stock.
Overall, I see P&G as a company that can leverage non-cyclical beauty tailwinds to drive low-single-digit-percentage revenue growth over the next several years. Coupled with tepid margin expansion and some buybacks of Procter & Gamble stock, that should reasonably drive 5%-7% profit growth. That would put PG’s 2025 profits at somewhere around $6.30 per share.
Based on a forward multiple of 22, which is average for household products stocks, that equates to a fiscal 2024 price target for PG stock just south of $140. Discounted back by 7% per year (I reduced my normal 10% discount rate to account for the yield), that implies a fiscal 2019 price target of roughly $100.
The Bottom Line on PG Stock
P&G is improving But the 40%-plus rally of PG stock already reflects those improvements, and further gains in the near- to medium-term look unlikely due to what has become the overly stretched valuation of PG. As a result, the big rally of Procter & Gamble stock may ultimately end soon.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.