PG Dividend Growth (Annual) data by YCharts.
Rising yields pressure valuations
The U.S economy remains strong, but that’s not necessarily great for future stock returns. As the above chart shows, inflation has been sticky. Additionally, tech stocks — the best performers over the last few years — saw a broader sell-off in July, led by semiconductor stocks. The bigger problem may be that stocks that have generated above-average returns in the recent past may be running too hot and could be overvalued. Investors may not get higher returns without a valuation pullback, and rising bond yields are evidence of that.
The mathematics behind this is simple: As bond yields go up, investors usually demand higher earnings yields from stocks as well. Breaking it down further, the earnings yield of a stock is just the inverse of its price-to-earnings (P/E) ratio. So as the earnings yield goes up, the P/E ratio falls, pushing down the price.
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NYSE: PG
Procter & Gamble
Today’s Change
(-0.98%) $-1.41
Current Price
$142.97
Key Data Points
Market Cap
$332BMarket cap calculated using publicly traded s outstanding only. Does not include unlisted, private, or dual-class non-traded s. Implied market cap may vary.
Day’s Range
$142.56 – $144.92
52wk Range
$137.62 – $167.25
Volume
5.1K
Avg Vol
9.2M
Gross Margin
50.87%
Dividend Yield
3.00%
The uncertain environment does not make P&G’s business less attractive
P&G may not have been the stock market’s darling over the past few years, but its globally recognized brands give it scale and pricing power — the most important qualities of a business with growing recurring cash flows. It sells necessities and household products, things that people need irrespective of an economic downturn or a stock market drawdown. Brands such as Tide, Dawn, Pampers, Gillette, Crest, and Oral-B, among others, don’t simply lose pricing power or see demand fall.
Management still expects fiscal 2027 organic sales growth to clock between 1% to 3%, and net earnings per (EPS) growth in the range of 1% to 5%. This growth is despite expectations of an additional $1 billion in cost pressures due to higher raw material, transportation, and energy prices.
Additionally, the company expects adjusted free cash flow (FCF) productivity (calculated as the ratio of adjusted FCF to core net earnings) to remain above 85%. In layperson’s terms, this means management expects at least 85% of its core net income to be converted to free cash flow. In short, P&G’s revenue and cash flow growth are persistent, leading to a persistent increase in capital returned to holders.
Shouldn’t buying Treasury bonds suffice then?
Investors looking for safety could, in theory, buy Treasury bonds as their yields rise. But holding bonds has a disadvantage: there’s no income growth. That’s where I’d argue that P&G stock is better suited to tackle an inflationary environment and ensure income growth through rising dividends.
What about owning higher-yielding stocks? Again, a great idea, but future income growth is usually unreliable when dividend yields are high.
Image source: Getty Images.
A 3% dividend yield may not seem much. However, it is the starting point for a dividend that has historically outpaced inflation, thus preserving purchasing power over a five- or 10-year period. If P&G’s dividend grows annually by 5% on average over a 10-year period, the dividend would have grown by nearly 63%. If you bought the stock today, your yield on the original investment would be substantially higher a decade later, at nearly 4.9%.
The stock isn’t overvalued
Defensive stocks, such as Procter & Gamble, don’t get much credit in a bull market. But slow growers shine in volatile markets, or simply when investors don’t want to take on too much risk. At 21.6 times trailing earnings and four times trailing sales, the stock isn’t overvalued. At the same time, these numbers don’t suggest the market has been ignoring the stock. I think that’s the sweet spot — a stock that is poised to perform well in the future without any fears of overvaluation.
If you are worried about uncertainty in the U.S. stock market as valuations stretch to historic highs and long-term interest rates remain elevated, P&G’s dividend appeal lies in stable income generation and the ability to grow your purchasing power over longer time horizons.
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About the Author
Isac Simon is a contributing Motley Fool stock market analyst and financial editor with experience spanning institutional research and equity analysis. Previously, he worked in the Investment Research division at Goldman Sachs, focusing on the editorial and digital strategy behind institutional research publications. Prior to Goldman, Isac specialized in oil and gas equities as a contributor at The Motley Fool, identifying undervalued companies and explaining the business and market forces that drive long-term stock performance. He holds a bachelor’s degree in physics, bringing a rigorous analytical approach to financial research and investing.
Stocks Mentioned
Procter & Gamble
NYSE: PG
$142.97
(-0.98%)-$1.41
Motley Fool Stock Advisor’s Latest Pick
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