Procter and Gamble Is Not Much of a Gamble

By Mike Hull, President Portfolio Mgr. and Greg Donaldson Director of Portfolio Strategy

Nearly 15 years ago Mike Hull oversaw the building of a plant for a Fortune 500 company in China and was instrumental in marketing the firm's nutritional products throughout the country. After his time in China, he came back to the US with the notion that the Chinese had gone too far down the road of capitalism to turn back, but they still had a lot to learn about the rule of law in property, both real and intellectual.

He says that the best way to understand China's business prospects is to understand that the Chinese government will do anything they can to keep economic growth going strong. They need economic growth to keep the millions of peasants that have come in from the countryside working. Any long-term disruption in economic activity would throw people out of work and be a threat to the Chinese Communist Party.

Mike believes that among foreign companies, Procter and Gamble, (PG) caught on to the Chinese way of doing business earlier than most other companies. He remembers early on PG sold shampoo in small tubes that might resemble samples in the US. Yet in China these small tubes of shampoo, which were still expensive to the average Chinese worker, were a sign that a family was moving up in the world, and Chinese women by the millions bought the tubes of shampoo almost as a status symbol. Today P&G does about 20% of their business in Asia and it is growing very rapidly.

PG now does less than 50% of its business in the US, and that figure will continue to fall as developing world growth, albeit slowing, continues to outpace US growth.

The chart above compares the dividend yield of PG versus the yield of a 10-Year US Treasury bond over the last 20 years. We have been showing these "yield" charts because we believe they tell a powerful story: many high quality companies are very cheap.

Our research reveals that in the case of companies that consistently raise their dividends, which PG has done for over 50 consecutive years, the long-term growth of their prices will mirror the long-term growth of their dividends.

The chart shows that 20 years ago, investors expected PG's dividend to grow about 5% (8.5% - 3.5%) That is what it would have taken for PG's total return to equal a T-bond's yield ( 3.5% dividend yield plus 5% price growth).

Looking at the right hand side of the chart, we see today that investors are only requiring dividend growth of 1.5% for PG yield to equal a T-bond's yield. We realize, of course, that there is great fear in the market, which has driven bond yields down and PG's dividend yield up, but we think it is highly probable that PG will grow its dividend by more than 1.5% over the next few years. Especially since they are doing more and more business in China and the developing world.

We believe PG will continue to build their businesses in the fast growing parts of the world, and that they will likely increase their dividend in the range of 8%-10% over the next decade, just as they have over the last 50 years. If we are right, PG's total return over the next 10 years will dramatically outperform that of T-bonds.

We own the stock. This blog is for information only. Please consult your own financial advisor about P&G.