The Procter & Gamble Company (NYSE:PG) has been undergoing a restructuring, cutting costs and improving operations, which has led to thousands of layoffs. Earlier this month, CEO Bob MacDonald suddenly retired, and the company brought previous CEO A.G. Lafley back as his successor. Changing CEO’s in the middle of a restructuring effort doesn’t seem like a great idea, but there was pressure from some investors to speed up the restructuring process.
The high payout ratio is a big red flag. At least in the short-term, dividend growth will likely be slower than earnings growth in order to get the payout ratio back to reasonable levels. I don’t expect dividend growth much faster than 7% annually over the next decade for P&G, and that might be overly optimistic. This assumption puts the fair value at about $68 per share, about 11.6% below the current market price.
P&G has already fallen from around $82, but it needs to fall a lot more before it offers any value to a dividend investor. The stock would need to be in the low 60’s before I’d consider it for The Ultimate Dividend Growth Portfolio, and even then I’d be reluctant.
A wide moat full of Coke
Almost any list of dividend stocks inevitably contains The Coca-Cola Company (NYSE:KO). With 50 years of consecutive dividend increases and a brand which is well known in the entirety of the civilized world, The Coca-Cola Company (NYSE:KO) is a fantastic company.
Unfortunately, the dividend isn’t quite big enough. A yield of 2.80% is above average, but not as high as many of the best dividend stocks. Dividend growth over the last decade was 9.8% annualized, about the same as the most recent dividend hike last year. The payout ratio with respect to free cash flow has grown from 46% to 59% in that time, which should be a cause for concern. This is partially due to an increase in capital expenditures over the last few years, and the payout ratio with respect to net income in 2012 was lower at 52%.
Realistically, 9% annual dividend growth over the next decade seems reasonable. At that rate, the stock would be fairly valued at about $37 per share, 9% below the current price. The stock has already fallen from a little over $42 per share, so if the price gets into the mid-30’s, things will get interesting. But right now, it is still too expensive.
The bottom line
Many dividend stocks which have been overvalued for some time are falling back to earth, and an opportunity may arise to buy them at a discount. It’s a good idea to keep a watchlist of high-quality dividend stocks which you’d like to buy and the price which you’d be willing to pay. Johnson & Johnson (NYSE:JNJ) needs to fall to $81 per share, The Procter & Gamble Company (NYSE:PG) to $68 per share, and The Coca-Cola Company (NYSE:KO) to $37 per share for the stocks to be fairly valued based on my assumptions. At the right price, these stocks would make good additions to a dividend portfolio.
The article A Dividend Watchlist for the Pullback originally appeared on Fool.com and is written by Timothy Green.
Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola, Johnson & Johnson, and Procter & Gamble. The Motley Fool owns shares of Johnson & Johnson. Timothy is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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