Procter & Gamble Stock: Valuation Limits Upside

• Procter & Gamble stock has risen 30.3% since the beginning of the year.
• We see less upside in Procter & Gamble stock due to the high valuation and difficult YoY comparisons.

Procter & Gamble (PG) stock has risen 30.3% since the beginning of this year. The stock has outperformed the benchmark index by a healthy margin. The S&P 500 has risen 19.6% on a YTD (year-to-date) basis as of Monday.

Strong organic sales, improved core margins, and a strong positive earnings surprise history contributed to Procter & Gamble’s success this year. However, the stock is trading at a multiyear high valuation, which could limit the upside in the stock.

Procter & Gamble stock trades at 24.7x its fiscal 2020 estimated core EPS of $4.85. Moreover, the stock trades at 23.2x its fiscal 2021 estimated core EPS of $5.17. Both of these multiples look expensive based on the projected growth rates of 7.3% and 6.6%, respectively, during those periods. Also, the stock trades about 16.4% higher than its historical average multiple of 21.2x.

Notably, Procter & Gamble stock is trading at a premium compared to most of its peers except Church & Dwight (CHD) stock. Church & Dwight’s forward PE ratio of 26.8x seems high and continues to restrict the upside in its stock. Procter & Gamble stock trades at 17.3x its next 12-month enterprise value-to-EBITDA multiple, which is higher than the peer group average of 16.9x.

Besides Procter & Gamble and Church & Dwight stock, we don’t like other significant household and personal care manufacturers’ current valuations. We think that the high valuation could restrict the upside in Colgate-Palmolive (CL) and Kimberly-Clark (KMB) stock. Notably, Colgate-Palmolive and Kimberly-Clark shares have fallen 7.3% and 9.7%, respectively, since we published CL and KMB: Why Their Upside May Be Capped on September 5.

While we think that Procter & Gamble’s high valuation could limit the upside, the company is still positioned the best in the household and personal care sector. Procter & Gamble’s underlying or organic sales have risen about 5% in fiscal 2019. Meanwhile, underlying sales rose 7% during the last reported quarter, which is exceptional.

We expect Procter & Gamble’s organic sales to continue to improve due to premium innovation. In the near term, the sales and earnings will likely register healthy growth. However, the company faces tough YoY (year-over-year) comparisons later in fiscal 2020, which could limit the sales growth rate. Management expects organic sales to increase 3%–4% in fiscal 2020, which indicates sequential deceleration.

Procter & Gamble has a strong positive earnings surprise history, which means it beat analysts’ EPS estimates over the past several quarters. Notably, the company has outperformed analysts’ estimates by an average of 4% in the last 17 quarters.

Part of the exceptional performance on the bottom line front has been Procter & Gamble’s share buybacks. The company repurchased $5.0 worth of shares in fiscal 2019, which cushioned its bottom line. Also, a lower effective tax rate supported growth in the company’s core earnings.

We expect Procter & Gamble’s bottom line to continue to grow at a healthy rate due to better organic sales and margin improvements. Share repurchases will likely drive the company’s earnings. However, tough comparisons, especially in the second half of fiscal 2020, could limit the EPS growth rate.

Analysts maintain a favorable outlook on Procter & Gamble stock. However, analysts’ target price indicates less upside.

Notably, 50% of the analysts covering Procter & Gamble stock recommend a “buy,” 42% recommend a “hold,” and 8% recommend a “sell.” Analysts’ target price of $123.73 implies an upside of 3.3% based on its closing price of $119.75 on Monday.

As of this writing, Market Realist analyst Amit Singh doesn’t hold a position in any of the securities mentioned above.