Zahir Shaikh
In the last issue we discussed investing in solid, well run and well known companies for the long term. This is all the more imperative during rocky economic times. Two such companies that merit our consideration are Procter & Gamble (NYSE: PG) and PepsiCo (NYSE: PEP). In this issue, I will discuss what makes P&G successful and why it has a “durable” competitive advantage. I will cover PepsiCo in our next issue.
P&G was founded in Cincinnati, Ohio over 175 years ago by two immigrants who married into the same family. Brothers-in-law, William Procter, a candle maker, and James Gamble, a soap maker, were encouraged by their father-in-law, Alexander Norris, to start a business venture. Whereas it took them 21 years to reach $1 million in annual sales, it is safe to say that P&G today has grown to a strength and stature beyond the founders’ wildest dreams: 2012 sales exceeded $83 billion, net earnings exceeded $10 billion, and it was ranked #27 on the 2012 Fortune 500.
So what makes P&G so successful? The short answer is P&G is all about brands and product innovation. The brand portfolio at P&G is incredibly far reaching. In 2012, P&G had 25 brands with over $1 billion in sales each! In fact, each of us currently has at least a few P&G products in our home: from Tide and Ariel laundry detergents, Crest oral care products, Pantene hair care, Oil of Olay beauty products, Gillette razors, to Duracell batteries, Bounty paper towels, and Pampers diapers.
Now, solid sales are wonderful but healthy margins are even better. These margins are the key to why P&G enjoys a sustainable, almost insurmountable, competitive advantage. The fundamental question is why do people pay a premium for P&G’s branded products?
Brand recognition – P&G spends billions to market and advertise their brands all over the globe. They live and breathe advertising so much so that several decades ago they created a company called P&G Productions to produce daytime programs called “soap operas” first for radio and then for television audiences in the 1950s and ’60s.
Brand quality – Another reason people have come to know and trust P&G brands is their product consistency, performance and quality. P&G products are market share leaders in their specific segments. Furthermore, as middle class purchasing power increases in Asia and South America, people are trading up to higher quality, branded household and personal products.
Product innovation – P&G also spends enormous sums of money on research and development to continue to improve existing product lines, add product line extensions, and create new products and categories. Historically, Crest toothpaste was the first with fluoride, Pampers the first disposable diaper, and Tide the first synthetic laundry detergent. More recent innovations include Crest WhiteStrips and Tide Pods. Consider the relatively new category of disposable mopping and dusting products under the Swiffer label. That category did not exist in the 90s, but it has completely changed the way many people clean their homes today.
Product portfolio management – When and where it makes sense, P&G has acquired and divested brands to focus on product margin growth. Consider both the acquisition of Gillette in 2005 and the divestiture of many food products over the years, including Crisco vegetable oils and shortening, Jif peanut butter, Folgers coffee and Pringles potato chips. As anyone who has recently shopped for razor blade refills can attest, they are very pricey. These products have very healthy margins for their companies. On the other hand, food products face a lot of competition and do not offer as much differentiation. As a rule, P&G is keen on achieving product differentiation in order to drive margin growth.
So all of this brings us to the valuation of P&G stock. In this day and age of Apple, Google, and Priceline.com, people want to hit home runs with their stock picks. A well-established company with a storied history is not going to surprise any investors over the short-term, and therefore its shares are traded at reasonable price-to-earnings multiples. However, those of us who invest for the long-haul and are looking for stable growth should strongly consider investing in P&G. In fact, billionaires Warren Buffet and Bill Gates are P&G investors. Currently at $77 per share, P&G’s share price would be all the more attractive after any future market correction.
Disclaimer: I do not have a financial position in any of the companies mentioned above nor do I intend to initiate positions within 72 hours of the date of this publication.