There are a lot of things that one must consider
prior to buying stock in a publicly-traded company. Some of these
things include the strength of a company's business model,
geographic diversification, financial condition, valuation, and
Another important concern is the dividend that the
company in question pays out. Strength and sustainability of the
dividend are very important for dividend growth investors. In fact,
did you know that 42% of the total return of the S&P 500 over the
last 80+ years came from dividends? This is why dividends are so
important for any investment portfolio.
Today, let's dig into the consumer staples sector and
check out the dividends from Procter & Gamble and
Colgate-Palmolive. As most
everyone knows, these two companies produce everything from
toothpaste to toilet paper to household cleaning products. We will
look into the dividend history of each company, its historical
dividend growth rates, whether or not each company's dividend is
supported by cash flows, and whether the companies can sustain their
dividend growth rates in the future.
When talking about a
company's dividend, the first thing that normally comes to mind is
the dividend yield, which is the percentage of your capital that you
receive in return over the next 12 months, as long as the dividend
amount is not changed. Here are the dividend yields from both P&G
Table 1: Dividend Yields Of Procter & Gamble and
Procter & Gamble is the clear winner in this
category, with a dividend yield of 3.1%, well above the 2.2%
currently being offered by Colgate-Palmolive.
The dividend yield is just one of many factors that
need to be considered when it comes to the strength of a company's
dividend. A company's stock can have a high dividend yield due to an
unsustainable dividend payout ratio, or poor fundamentals that have
brought down the stock price. These items could then lead to a
dividend cut, which will reduce your yield on cost.
Dividend growth should also be considered. This is
because a company that increases its dividend payout every year
maintains the purchasing power of the income streams that are
received by its investors. If dividend growth rates can't keep up
with inflation, then investors are really losing money when they
consider the loss in purchasing power. Dividend increases also
signal a strong outlook by management and underscores their
commitment to shareholders. Many companies regard their dividends as
a sacred cow. Over time, dividend growth can supercharge an
investor's yield on cost. Consider Warren Buffett, who started
buying Coca-Cola back in the '80s. Now, he receives a yield on cost
of 40%, and growing every year as long as Coca-Cola keeps increasing
their payout. Sounds like a pretty good deal, no?
Let's see how the dividends of Procter & Gamble and
Colgate-Palmolive have grown over the last 5 years. The numbers in the table
represent the average dividend growth rate over the last five years.
Table 2: Five-Year Dividend Growth Rates of Procter &
Gamble and Colgate-Palmolive
Both of these companies have shown outstanding
dividend growth rates over the last five years, easily outpacing the
erosive effects of inflation. However, Colgate-Palmolive comes out
on top here with an average annual growth of 11.1%, well above P&G's
8.5%. Colgate-Palmolive has increased its dividend every year for
the last 50 years. Procter & Gamble has increased its dividend for
57 years straight.
This strong dividend history could not have happened
without each company's exceptionally strong business models and
brand strength. For right now, Colgate-Palmolive is the winner, when
looking at dividend growth over the last five years.
Dividend Payout Ratio
High dividend yields and strong growth rates are all
well and good, but we need to make sure that the company in question
is making enough money to keep the dividends going. This is where
the dividend payout ratio comes in. The payout ratio is the
percentage of the company's profits that get returned to
shareholders in the form of dividends. You usually like to see this
ratio at 60% or below, as that will insure that the dividends will
continue to get paid, even if the company experiences a downturn
over a short period. Dividend payout ratios that approach or exceed
100% may signal future dividend freezes or cuts, which are not good
at all for investors.
The table below shows the dividend payout ratios for
Procter & Gamble and Colgate-Palmolive, both on a trailing twelve month and a
four-year average basis. The earnings that I used in these
calculations are referred to as core earnings, which remove one-time
items that don't have an impact on the company's operations.
Table 3: Dividend Payout Ratios of Procter & Gamble
From the looks of Table 3, the dividend payments of
both Procter & Gamble and Colgate-Palmolive are in pretty decent shape. None of
them appear to be in any danger of getting cut. The current payout
ratios are inline with the four-year averages.
While both companies are looking very good in this
category, Colgate-Palmolive is just a little bit better here, with a
slightly lower payout ratio, both on a trailing 12-month basis and a
4-year average basis.
How About That Free Cash Flow?
A lot of folks would end their analysis after
calculating the dividend payout ratio. However, we need to keep in
mind that that figure is based on dividend payout as a percentage of
earnings, not actual cash that comes into the business over a
certain period of time. Earnings often contain items like
depreciation, asset impairments, actuarial gains on pension plans,
and other non-cash items that can distort the picture as to how
healthy a company's dividend really is. For this reason, I like to
calculate the free cash flow payout ratio, which shows us what
percentage of cash that comes in over a 12-month period gets
distributed to shareholders. This paints a more accurate picture
when it comes to the dividend safety of the company in question.
Table 4 shows how much of both Procter & Gamble's and
Colgate-Palmolive's free cash flow was paid out in dividends. Note that free
cash flow is calculated as operating cash flow, subtracted by
capital expenditures. Trailing 12-month and four-year average
figures are shown.
Table 4: Free Cash Flow Payout Ratios of Procter &
Gamble and Colgate-Palmolive
Here, we see that the dividends that are currently
coming from each company are more than well-supported. With that
said, the current free cash flow payout ratio of Procter & Gamble is a bit elevated
when compared to what has been seen over the last several years.
With the free cash flow payout ratio in the 70% area,
I would expect to see the dividend growth of Procter & Gamble slow down a bit in the years
to come unless the company can show some growth in free cash
Colgate-Palmolive on the other hand, looks really good
here, with a lower free cash flow payout ratio that shows more
potential for dividend growth going forward.
When it comes to the free cash flow payout ratio,
Colgate-Palmolive is the winner here.
Any Ways To Predict Dividends Going Forward?
A lot of folks would end their analysis here,
especially after looking at the free cash flow payout ratios.
However, these figures are all based on what happened in the past.
We need to find some clues as to whether the company can continue
paying steadily increasing dividends in the future.
Interest Coverage Ratio
The interest coverage ratio illustrates the size of
the company's pre-tax profits relative to the company's interest
payments. Generally speaking, the more debt a company has, the more
interest it has to pay, and the less that the company has left over
to pay out dividends. The interest coverage ratio is calculated by
dividing the company's earnings before interest and taxes (EBIT) by
the company's interest payments made over the same period of time.
Low interest coverage ratios (usually below 2) generally show that
the company is having a hard time just trying to make its interest
payments. That may signal dividend cuts or eliminations in the
future. For this reason, we like to see high interest coverage
Table 5 shows the interest coverage ratios of Procter
& Gamble and Colgate-Palmolive over the last 12 months.
Table 5: Interest Coverage Ratios of Procter & Gamble
Table 5 shows us that while Procter & Gamble was able
to cover its interest obligations nearly 22 times last year,
Colgate-Palmolive didn't have to make any interest payments at all.
So, while both companies are excellent in this regard,
Colgate-Palmolive steals the show.
Net Debt To Equity Ratio
The amount of debt that a company has can ultimately
influence the future direction of the company's dividend. Companies
that have more debt typically pay more in interest. It should also
be noted that at some point, the company's debt will need to be
repaid. While many companies are working around this by refinancing
the debt at low interest rates, this option might not be as
attractive when interest rates head back up. When the company
finally does extinguish its debt, it may have an adverse effect on
whether it can continue paying dividends.
The net debt to equity ratio can offer us some clues
as to how much of a problem debt will be when it comes to paying out
dividends. It is calculated by subtracting the company's cash
position from the company's short and long-term debts, and then
dividing that by the company's equity position. The lower this
ratio, the better it is for not only the company in question, but
for us as investors. Ratios under one are typically considered to be
Table 6: Net Debt To Equity Ratios of Procter &
Gamble and Colgate-Palmolive
Table 6 shows that Procter & Gamble is the clear
winner when it comes to who has the lower net debt to equity ratio.
Forecasted Earnings Per Share Growth
Dividend growth can be driven by a couple of
different factors. One of these factors is the expansion of the
company's payout ratio, where the company decides to pay out a
higher percentage of its earnings or free cash flow to shareholders
as dividends. However, you can only expand the payout ratio so much.
Eventually, you must have free cash flow growth in order to pay
steadily increasing dividends. And, we all know that free cash flow
growth comes from earnings growth. To get a good idea as to the
prospects of a company's future dividend payments, it may behoove us
to look at analyst projections for future earnings per share growth
over the next couple of years. Table 7 shows the forecasted earnings
per share growth rates for Procter & Gamble and
Colgate-Palmolive over the next
couple of years. These numbers come from the analysts at S&P Capital
Table 7: Forecasted Earnings Per Share Growth for
Procter & Gamble and Colgate-Palmolive
Both Procter & Gamble and Colgate-Palmolive are expected to post
solid earnings per share growth over the next couple
of years. Procter & Gamble, however, has slightly more favorable
Today, we have looked at a number of different
factors in order to determine the strength and sustainability of the
dividends of Procter & Gamble and Colgate-Palmolive. These factors include the
dividend yield, historical dividend growth rates, payout ratios,
interest coverage ratios, net debt to equity ratios, and analyst
projections for future earnings per share growth. After giving
careful consideration to all of these factors, we can conclude that
none of the dividends being paid by either of these companies appear
to be in any danger as of this writing.
While Procter & Gamble has shown a higher
dividend yield and a superior balance sheet, Colgate-Palmolive has
shown superior dividend growth over the last 5 years, and lower
payout ratios that indicate that there is plenty of room remaining
for more dividend increases. While P&G should be able to maintain
its current level of dividend growth if the forecasted earnings per
share growth materializes, Colgate-Palmolive should be able to
continue growing its dividends at a faster rate than P&G.
When it comes down to whose dividends are better, I
would say that a lot of it has to do with the time horizon of our
investor. While Colgate-Palmolive has shown to be superior to
Procter & Gamble with regard to most of the metrics discussed, you
need to keep in mind that Procter & Gamble's yield is currently 40%
higher than that of Colgate-Palmolive. The starting yield of
Colgate-Palmolive is so low right now that if you extended the
5-year dividend growth rates of both companies out indefinitely, you
would see that it would take almost 15 years before an investment in
Colgate-Palmolive would show a higher yield on cost than an
investment in Procter & Gamble.
So, to conclude, if you are a dividend-minded
investor who has more than 15 years ahead of him, then
Colgate-Palmolive might make more sense. However, if you are an
older investor with a shorter time horizon, then Procter & Gamble
might be more appropriate.
Of course, before making a final decision between the
two, you must consider other items like valuation, product and
geographic diversification, and business models.