Image Source: Alan Levine
“The forward 12-month P/E ratio is 17.0. This P/E ratio is based on Thursday’s closing price (2170.06) and forward 12-month EPS ($127.93). The P/E ratio of 17.0 is above the prior 5-year average forward 12-month P/E ratio of 14.6, and above the prior 10-year average forward 12-month P/E ratio of 14.3. It is also above the forward 12-month P/E ratio of 16.6 recorded at the start of the third quarter (June 30).” – FactSet Earnings Insight, July 29, 2016
Kleenex anyone? Because we’re at nosebleed valuations in the consumer staples (XLP) sector!
At arguably no time in the history of the stock market have investors been willing to pay so much for each unit of earnings to capture a dividend yield of just a few percentage points. Negative interest rates across much of the world have created this scenario. In many ways, the strongest business models have become some of the most risky stocks, to no fault of their own. What do the bulls say though — as long as everybody keeps buying these steady-eddy companies to capture yield, share prices will continue to go up. Why not?
The makings of a dividend-growth bubble are well underway on some of the strongest business models in the market and have been for some time. It sounds so backward, but it’s true–you know as well as I do that a good company a good stock does not always make. But at what earnings multiple do market participants finally say that it has become too expensive to stretch for that 2-3% dividend yield? Today, the consumer staples sector stands at a forward price-to-earnings ratio of 21 times, well above its 5-year and 10-year averages and significantly above the market multiple. Is 25 times the “right” forward number for consumer staples stocks? 30 times? How about 50 times? How big can this bubble get if nobody sells these fantastic business models?
Only time will tell.
Partaking in this bubble is Dividend Aristocrat Kimberly Clark (KMB), which reported that second-quarter 2016 net sales fell 1.2%, while revenue dropped nearly 3% during the first half of the year. No matter to the bulls–it seems. The company’s full-year adjusted earnings per share guidance of $5.95-$6.15 implies a current-year earnings multiple of 21 times. Yes, you read that correctly. Reported revenue is dropping, but the company is fetching a forward-earnings multiple more representative of a growth company. That’s what the impact of a near-3% dividend yield is having in today’s market, something Kimberly-Clark sports. Sure, organic growth expanded 3% at Kimberly-Clark in the second quarter, but is this worth 21 times forward earnings? Investors need to really think about its valuation. Is it time to bring the Kleenex out?
Read: Kimberly-Clark second-quarter report: “Second quarter 2016 net sales of $4.6 billion decreased 1 percent…”
Next up – Coca-Cola (KO). Reported net revenue declined 5% in its second quarter as a result of “challenging macroeconomic conditions, structural changes and foreign exchange headwinds,” and 2016 comparable earnings per share is expected to be down 4%-7% versus last year’s level of $2.00. Assuming Coca-Cola hits $1.91, the mid-point of its targeted earnings decline for the year, shares of the beverage giant are trading at a full 23 times current-year earnings. Yep–23 times for a company that is experiencing a shrinking top and bottom line. Pay no mind the bulls say–Coca-Cola is a Dividend Aristocrat and offers a dividend yield of ~3.2%, and global volume has grown 1% year-to-date. 1%! Caffeine high, anyone?
Read: Coca-Cola’s second-quarter report: “Reported net revenues declined 5%…”
How about Colgate-Palmolive (CL)? Well, its reported worldwide net sales fell 5.5% in its second quarter, as global unit volume fell 3%, but the bulls say pay no mind to reported results or that the company expects a low-to-mid-single digit net sales decline for 2016. It’s all about the yield! Annualizing its first-half reported bottom-line performance, one arrives at a reasonable $2.52 per share earnings per share estimate for 2016, which means Colgate-Palmolive is trading at a cool 29 times current-year earnings. That’s nearly 30 times! Consensus, which adjusts for a variety of items, puts its bottom-line forecast at $2.82 for the year, which means the company is only trading at 26 times. Did we mention that reported worldwide net sales are falling? But Colgate-Palmolive yields ~2.1%, the bulls say!
Read: Colgate-Palmolive’s second-quarter report: “…worldwide Net sales of $3,845 million in second quarter 2016, a decrease of 5.5% versus second quarter 2015.”
On to Procter & Gamble (PG). To be fair, we include shares of P&G in the Dividend Growth Newsletter portfolio, so we’re poking fun at ourselves with this piece, too. Still, we’re not in denial, and we’re watching shares of P&G like a hawk to take profits. The company is but a fraction of its former self as a result of brand divestitures in recent years, but that doesn’t matter to the bulls. To them, shares yield 3.1%, and that fiscal year 2016 revenue fell 8% on a reported basis really doesn’t matter. How much growth will investors get to pay 23 times fiscal 2017 earnings for P&G? How about 1%? That’s right – P&G estimates all-in sales growth for fiscal 2017 will be 1%. What a great company though…
Read: Procter & Gamble’s fiscal fourth-quarter report: “FY’16 Net Sales -8%…”
So how are we playing this bubble? First, we’re not denying it, and that’s the most important step. Though organic growth numbers and currency fluctuations have muddied comparisons for the group, we’re reaching unprecedented valuations on consumer-staples equities regardless, as interest rates drive asset flows into these yield instruments. Every company in this representative list of consumer staples giants, for example, will have or has experienced a reported revenue decline in 2016. In today’s frothy market, such performance is good for north of a 20 times multiple? Unbelievable.
Obviously, we don’t think these bubbly prices will last forever–but it could be years before income investors are forced to make the real tough choices. We believe the tipping point will be when inflation becomes a real issue in necessary goods (not equity prices) in the US and the Fed has to tighten in a hurry, perhaps causing a dislocation. Until then, it’s the roaring 1920s in the US, and investors can’t get enough of dividend-paying companies! Champagne pop! Everybody’s all-in, it seems. In all seriousness, however, please be careful out there. It’s important to understand the risks of this frothy market if one is participating in it.
Related tickers: SDY, NOBL, VIG, DVY, TDIV, DGRW, SCHD, QDEF, DIA, SPY