In a previous article we saw the 13F´s holdings of Absolute Return Investors. Here, let´s analyze if one of them, Procter & Gamble Co (NYSE:PG) is coherent to be in that long portfolio. The company does not need too much introduction. It has five segments: Beauty, Grooming, Health Care, Fabric Care and Home Care, and Baby Care and Family Care. The firm's largest competitors include Johnson & Johnson (JNJ) and Kimberly-Clark Corporation (KMB).
Turning our attention to the future direction of the stock, let's take a look at the intrinsic value of this company and try to explain to investors the reasons why it is a good buy or not.
In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends according to John Burr Williams.
- Warning! GuruFocus has detected 8 Warning Signs with PG. Click here to check it out.
- PG 15-Year Financial Data
- The intrinsic value of PG
- Peter Lynch Chart of PG
Although this is theoretically correct, it requires forecasting dividends for many periods, so we can use some growth models like: Gordon (constant) growth model, the Two or Three stage growth model or the H-Model (which is a special case of a two-stage model).
To start with, the Gordon Growth Model (GGM) assumes that dividends increase at a constant rate indefinitely.
Let's estimate the inputs for modeling:
a. Required Rate of Return (r)
The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stock j = risk-free rate + beta of j x equity risk premium
1. Risk-Free Rate: Rate of return on LT Government Debt: RF = 2.67%
2. Beta: β =0.4
3. GGM equity risk premium = (1-year forecasted dividend yield on market index) +(consensus long-term earnings growth rate) – (long-term government bond yield) = 2.13% + 11.97% - 2.67% = 11.43%
rPG = RF + βPG [GGM ERP]
= 2.67% + 0.4 [11.43%]
b. Dividend growth rate (g)
The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm's debt-to-equity ratio is unchanged and it doesn't issue new equity.
g = b x ROE
b = retention rate
ROE can be estimated using Dupont formula:
Because for most companies, the GGM is unrealistic, let´s consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage until it reverts to the long-run rate, a smoother transition to the mature phase growth rate that is more realistic.
c. Dividend growth rate (g) implied by Gordon growth model (long-run rate)
With the GGM formula and simple maths:
When the stock price is lower than the intrinsic value, the stock is said to be undervalued and it makes sense to buy the stock. I would advise fundamental investors to consider adding this stock according to our estimations.
Hedge fund gurus have also been active in the company. Paul Tudor Jones (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), Ray Dalio (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), Richard Pzena (Trades, Portfolio), Tom Gayner (Trades, Portfolio), Murray Stahl (Trades, Portfolio), Donald Yacktman (Trades, Portfolio), Charles Brandes (Trades, Portfolio) and Ken Fisher (Trades, Portfolio) have also invested in it.
Disclosure: Damian Illia holds no position in any stocks mentioned.
 This values where obtain from Blommberg's CRP function.
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