Old economy stocks appear to be out of fashion. I wrote about this recently in an article outlining my PepsiCo share purchase. Investors seem to have ditched consumer staple stocks in the first half of 2018 for racier growth stocks. This seems to have left many stellar companies on valuation levels not seen for a number of years.
Whilst stocks in the consumer staple segment have gone down as whole due to treasury yields hitting 3% and yield hungry investors rotating out of bond proxies, some names have been hit harder than others. Take Procter & Gamble for instance, it has dropped to $73 from its recent peak of $93 – a drop of 21%. So much for a safe, stable company which has historically been a champion for low volatility.
One reason P&G has fallen harder than its competitors is that investors don’t believe the company has as a wide moat as it’s once did. This is because certain brands owned by the company have lost heir allure and aren’t as strong as there once were. Whilst brands have historically signalled superior quality in the consumer staple space, it seems that this may no more be the case. There is this lingering question about whether or not brands in this space offer superior value and thus could command pricing power.
In the consumer packaged goods industry, the main purpose of a brand is to reduce search costs. Search costs are the costs sustained by a potential buyer in trying to determine what to buy. In this instance, the search cost for consumers is the cost of trying to determine the quality of the product and weighing this against price differentials prior to purchase. By eliminating search costs for the consumer, companies with a successful brand were able to charge more for their products, even while providing an improved cost/benefit offering to the consumer. The consumer could pay more for their products, because doing so reduced the search costs they were otherwise incurring. Search costs are the reason why you reach out for Colgate over any other toothpaste or coca cola over any other cola drink.
But the times they are changing. Search costs have gradually been eroding over time. And consumers can thank the internet for that. Consumers now have a plethora of information at their fingertips and can easily check information on any product online. They no longer need to buy new products themselves to determine quality, instead they could plainly see their friends vouching for them on social media or via reviews on sites such as Amazon. If these products were of low quality or value, this would have been quickly known to any consumer who spent a few minutes reading online reviews or searching their social media streams. The chances of buying a low quality product has diminished. The chances of buying quality non branded products has increase.
Have a look at one of Procter and Gamble’s biggest brands to see this disruption in action. Just a few years ago, when you would go to the supermarket to get your razor blades, you would pick out Gillette without even thinking. You simply couldn’t trust other razor blade companies to have the quality and precision that Gillette had. And you wouldn’t dare experiment with something as sensitive of your skin. This gave Gillette strong pricing power and could charge you an arm and a leg for their products. The returns on capital were high. The operating margins even higher. This gave Gillette a large advertising budget to cement the product, its quality and its trustworthiness in your mind. This entrenchment led to even higher returns.
But this looks to have change. Internet focussed companies like Dollar Shave Club and Harrys have been stealing Gillette’s market share. These companies have made it more convenient to buy blades. And at cheaper price too. Consumers are more willing to change habits and try new products that have received positive reviews on social media and the internet at large.
Gillette has lost market share in the US for six years in a row now, falling from falling from over 70% in 2010 to 54% in 2016. As a result, Gillette has been forced to cut prices and reduce margins. The barriers to entry in the consumer packaged goods industry has shrunk. The brands, which were stimulated by large advertising budgets, are not as relevant as they once were.
So there is defiantly change a foot in the consumer packed food industry and for consumer staples at large. Have a read of my articles on ‘Are Brands Really A Competitive Advantage?’ and ‘The Death Of Brands – What Investors Need To Know’ to find out more.
So even though P&G is facing difficulties at present, it should not be written off as investment proposition. The company still continues to earn outsized returns and has a double digit return on capital employed. Your job as investor is to identify if these great returns can be sustained. You need to identify whether or not disruption will affect returns going forward. You need to identify whether the days of brands in the fast moving consumer goods sector possessing pricing power are over. You need to identify whether management are competent enough to pivot the company to benefit from changing consumer preferences.
Procter and Gamble – A Historic Investor Perspective
Procter and Gamble has been a fantastic investment for many an investor. Just look at the historic returns investors have got owning shares in this wonderful company. Imagine it is the first trading day of 1990 and you have a single tax free account with $10,000 in it. You decide to invest in shares of Procter & Gamble. You buy your block of common stock, forgetting about the transaction for twenty years. A share of Procter & Gamble traded for $8.28 split-adjusted at that time so you would have been able to get the equivalent of 1,207 shares of stock.
In the twenty seven years that followed, despite multiple recessions, including the worst meltdown since the Great Depression, the dot-com bubble and the housing bubble, the Asian financial crises, multiple international wars, ballooning government deficits, exploding national debt, countless natural disasters, political earthquakes and a maelstrom of regulatory changes in the financial industry, you would have prospered.
It turns out that no matter how bad things get, consumers like purchasing Head & Shoulders, Herbal Essence, and Pantene shampoos, Gillette razors, Crest and Oral-B toothpaste, Fairy dishwashing liquid, Dawn dish soap, Downy and Bounty paper towels, Ariel, Bold and Lenor laundry detergent, Old Spice, Pert, Tampax, Safeguard, Bounce dryer sheets, NyQuil, Cascade, Mr. Clean, Fabreze, Swiffer, Charmin toilet paper, and Pampers diapers.
Procter and Gamble produces the run of mill boring products that consumers buy no matter the economic scenario. This knack for selling everyday repeat purchase items has showered the company with huge swathes of cash and investors have duly benefitted.
Your $10,000 in Procter & Gamble Stock Would Have Grown to $204,754. An increase of 1,950% or 11.34% compound per annum! This is truly beautiful. It just shows you how much money you can make holding a boring company for the long term.
Shares of Procter & Gamble have generated tremendous wealth for owners over the past two and half decades from manufacturing dozens of world-famous household brands.
That is a great outcome for someone who didn’t have to do anything except read the annual report each year to make sure that profits continued to rise, debt remained manageable, executives weren’t overpaying themselves, and the products the firm sold were still relevant to consumers.
So why don’t most people experience these types of returns? The answer is simple – they trade. Most people don’t have the ability to do nothing. That seems strange but it is true. They try to “rent stocks instead of owning businesses”.
They do not focus on finding a business with high returns on capital and an economic moat and paying a fair (or cheaper) price than it is worth on a conservatively estimated basis, and holding on for a long time. Instead they buy and sell stocks, generating commissions for their broker, spreads for market makers, taxes for the government, and needless volatility for other shareholders.
The older, wiser, and more experienced I grow, I become more convinced that the average 21 year old would do well taking a chunk of their wages and putting it in a few different asset classes including shares of a solid, boring, reasonably priced enterprise, reinvest the dividends, holding the position through a tax-advantaged account. If repeated year after year until retirement at age 65 with two or three dozen firms making it into the portfolio, it is not difficult to imagine a seven or eight figure portfolio throwing off hundreds of thousands of dollars a year in cash. You could be a C- student, a middle school drop-out, or a complete failure at nearly everything and it would still work for you if you focus on risk management by not overpaying for your shares. For those who can’t value individual companies, index funds provide much of the same benefit without the bottom-up approach.
Find great businesses. Don’t overpay. Hold for the long-term.
Oh, and one more thing: Just like almost every stock in the world, you would have experienced at least one or two 40% to 50% drops in the market value of your Procter & Gamble stock during your holding period. That is the price of generating wealth through stock ownership. If you can’t handle that, park your money in the bank and be content with the meagre returns that are available as inflation erodes away your purchasing power.
As Benjamin Graham said:
“The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored. He should never buy a stock because it has gone up or sell one because it has gone down.” – The 1949 Edition of The Intelligent Investor
P&G appears to be undergoing one of those drops right now with a 20% drop. Now the question you need to ask yourself is ‘Is it worth investing in P&G at this price?’