It has been our observation that a company with a history of dividend increases over a full economic cycle (ideally more) will exhibit a characteristic of being especially undervalued when the stock has a high dividend payout ratio. In this posting, we’ll show how a well established company like Procter & Gamble (PG) can generate a high dividend payout ratio and exceptional total returns compared to low dividend payout ratios and mediocre investment returns.
On September 15, 2015, we made the claim that “the dividend payout ratio is an decent indication of the best times to consider a stock. Whenever the dividend payout ratio exceeded 80% the price of Helmerich & Payne was at a relative low.” Naturally, there are exceptions to this observation. However, when viewing many stocks in the Dividend Aristocrats and Dividend Achievers universe, you will find that our observation stands up to most critical examinations.
A reader mentioned that while this observation seems good in theory, the practice of the idea doesn’t necessarily hold up too well. The reader accurately pointed out that “…PG [Procter & Gamble] dividend payout ratio peaked at .91 in june 2015 and stock has underperformed market (and not be insignficant margin) since then.”
Let’s start with the reader’s general assertion: PG has underperformed the “market” by a significant margin.
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Dow Jones Industrial Average Total Return since 1/1/2015: +58.47%
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Procter and Gamble Total Return since 1/1/2015: +7%
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Dow Jones Industrial Average Total Return since 9/11/2015: +74.61%
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Procter & Gamble Total Return since 9/11/2015: +38.48%
The data is very clear (as of January 26, 2018), Procter & Gamble (PG) has severely underperformed the market (we chose the most popular index with the largest percentage gain; the S&P 500 underperformed the DJIA in the same period).
Get to the Point
Getting these facts out of the way makes the argument very clear, when contrasted against the stock market, there appears to be no contest. However, as stated in our commentary regarding Helmerich & Payne, we’re only looking for the relative valuation levels.
With this in mind, we cannot and do not attempt to contrast the performance of a stock against the stock market. We’re only attempting to contrast the payout ratio to the prior price activity. With this in mind, we are taking the Value Line annual data representing the payout ratio for Procter & Gamble from 1982 to 2017.
In addition, we compare the total return of Procter & Gamble from the 1985 high payout ratio to the 1996 low payout ratio and contrast that to the total return of Procter & Gamble from the 1996 low payout ratio to the 2016 high payout ratio.
Payout Ratio 1982-2017 source: Value Line Investment Survey
Total Return 1985 to 1996: +980%
January 1, 1985 to December 31, 1996
Total Return 1996 to 2016: +572.08%
January 1, 1996 to December 31, 2016
Observations
On a relative basis, when PG is trading at a high dividend payout ratio, the price of the stock will perform better than when the stock is trading at a low dividend payout ratio. The +980% total return in the period from 1985 to 1996 is a night and day difference from the 1996 to 2016 total return of +572.80% for Procter & Gamble.
Also, different stocks have different cycles. When we look at Helmerich & Payne, it has shorter cycles of high and low relative payout ratio. In the case of Procter & Gamble, the full cycle of high and low payout ratios is extremely long. Without this perspective, it would be very difficult to gauge the relative performance of the stock.
Finally, the recent high payout ratio of PG coincides, in our opinion, with our view that the stock market has exited the secular bear market that began in 1999 and is entering a secular bull market. Therefore, the price of PG could confirm a greater level of gain in the next 10 years than the period from 1996 to 2016.
There will always be exceptions to our observations. However, it is worth eliminating this factor before making generalizations based on narrowly defined sets of data.