Friday, May 19, 2006

CL - Colgate-Palmolive

How to play the falling dollar? Everyone from Warren Buffett to Joe Kernan thinks that the dollar is headed lower against othe currencies. Treasury Secretary John Snow wants "currency flexibility" by which he means a weaker dollar - as a matter of government policy. They cite many reasons to justify their position: trade deficits, a slowing economy, easy money, and a negative savings rate. In seeming confirmation of their view, the dollar has definately taken lumps lately.

I will leave the economics of the dollar to another post, but suffice it to say, I believe that easy money from the Fed has very probably devalued the dollar, so further weakness would not be surprsing.

What to do? How do I protect myself from the ravages of a weaker dollar and lower purchasing power? Buy foreign currencies? Purchase commodities? Foreign equities?

While I do invest in international equity through my 401(k) I do not generally pick international stocks myself, even though I speak two languages, and many international stock reports are available in English. I don't invest directly, because the reporting and accounting rules for foreign companies are different than those in the US, and I have no expertise in those systems. I may consider studying them in the future, but I would probably choose to invest in other US assets before investing directly in foreign stocks. The only exceptions are those companies that also list their shares on US exchanges (ADRs), and therefore make filings with the SEC.

Similarly, I realize that the commodities and currency markets are outside of my expertise. So, what do I do? Invest in US equities with lots of overseas exposure!

Here's the thing - a weaker dollar is far from a certainty, only a possibility. As an investor, I want to be prepared whatever happens, and by investing in good US businesses with extensive foreign sales, I am. If the dollar strengthens, I make money, if the dollar falls, I make lots of money.

For the same reason, I like consumer staples. Here, the international operations help again - if the global economy continues booming, or even simply keeps growing, rising incomes in Asia mean growing sales, while, if the economy stalls, well, Westerners will keep buying basic necessities. Either way, I make money.

All I need is the right company, and in Colgate-Palmolive I found it. In my mind, this is about the most perfect business anywhere. Not only does it offer upside potential with downside protection, it also demostrates the following characteristics.

  • A simple, understandable, profitable business, with a wide moat. This is a business that manufactures and distributes a host of household, personal care, and pet care products. The business has strong and rising margins (over 50%, excluding the temporary effects of their restructuring program). These products and margins are protected by the strong moat of their brands, including the eponymous Colgate and Palmolive brands, Irish Spring, Ajax, Softsoap, and Science Diet. People are remarkably loyal to brands. My girlfriend swears by Colgate Total, and the price differential that you would have to offer her to switch is huge. I'm not sure you could get her to switch if you gave your brand away.
  • Honest, effective, shareholder-friendly management. What do these numbers mean to you? 591, 585, 578, 567, 551, 536, 534, 527, 516? They are the number of common shares outstanding from 1997 to 2005. The company has just committed to repurchase 30 million more shares over the next two years. What about these numbers? 0.53, 0.55, 0.59, 0.63, 0.675, 0.72, 0.90, 0.96, 1.11? That is the cash dividend per share over the same period. Management takes every excess dollar and returns it to shareholders. It keeps equity compensation to a minimum, and has consistently reduced the amount of convertible preference stock. As far as honestey is concerned, the company regularly gets top billing from Institutional Shareholder Services, for the independence of the board. Finally, in the best measure of management effectiveness, return on equity is over 100% (because of all the capital regularly returned to shareholders), and return on assets is in the double digits. Management does not uses shareholder's money to fund its pet projects, only the profitable ones.
  • Good growth potential. Household products may not seem like a growth category, but on a worldwide basis, they are. As incomes rise, people chose to invest in more preventive medicine (good dentistry being one of the most important indicators of health, since it influences diet and other health issues), invest in larger homes (that require more cleaning) with modern appliances and the like. The company's ability to continue to grow revenue at a high single digit basis, or better, is likely.
  • A good price. When I purchased the stock in October of 2004, the stock was near a 52-week low, and trading at about 20x trailing earnings that were hampered by older factories with higher costs (due to lower efficiency). Still, the stock was attractive, the dividend yield had risen to 2.5%, earnings were clearly at a nadir, and opportunities to improve margins abounded. Shortly thereafter, in fact, the company announced a new restructuring program (first in 10 years), and, after a charge in the 4th quarter, began a process of modernization of facilities. That program is in its second year (it is a four year program), and so far, results have been exemplary. Still, the stock has experienced both increased earnings and multiple expansion, and at 24x earnings, no longer looks cheap.
In short, I own shares in a well run company, with good growth prospects, excellent management, and good downside protection. Revenue is likely to grow 6-8% per year, margins should expand, pushing overall earnings to 7=10% per year, and share repurchases should increase EPS at 8-12% per year, with dividends increasing at a comparable rate.

Downside risk is small, the stock rallied in the middle of last week's commodity and market meltdown (lower commodity prices mean lower costs and better margins) though the higher multiple invites more price volatility.

Still, the question remains, does it fit in my portfolio at $60+? My goal is to grow at 20% per year, and while the stock has achieved this over the last 19 months, I don't expect it be able to maintain this rate going forward. On the other hand, it helps to prevent losses (guaranteeing a positive portfolio return, and from my first post, recall that losses kill compounded returns).

Your thoughts?


  1. This comment has been removed by a blog administrator.

  2. I could swear by Colgate too. I've been trying to use Crest since I own shares in Procter & Gamble, but I really think Colgate is a better toothpaste (my dentist thinks so too). I realized it was kind of silly to use products because I own the company rather than owning a company that makes the products I use. I still use lots of P&G products, but for toothpaste, I stick with Colgate.

    Procter & Gamble is a very similar company, except that they aren't pursuing a restructuring plan or buying back shares. I think it is a great way to play a weak dollar, and I also think consumer staples are a good industry (historically outperforming the market according to Siegel's "The Future for Investors"). It's also nice knowing that Berkshire Hathaway owns 3% of the company.

    I have looked at Colgate-Palmolive as an investment, but decided that its too similar to P&G. I look at P&G as more of a way to keep my money safe than grow it rapidly. If CL is similar, then as far as growing your portfolio at 20%/year, it is probably a good stock to prevent losses and complement any riskier growth stocks.

  3. Thanks for the great feedback.

    Do you think that holding assets like CL or PG, that are likly to underperform my objective, but produce consistently positive returns, are helpful or harmful?

    They mitigate bad choices in growth stocks, but they also set the bar for performance higher, inasmuch as the returns on the growth stocks have to compensate for the underperformance of the capital tied up in underperforming assets, don't they?

  4. great post!
    i've inherited some shares of Colgate-palmolive. they're good shares to own in any economic climate.

    I personally feel the dollar might drop another 20% over the next two years.

    I'm looking at foriegn mutual funds to invest in like RNE, IIF. they recently had major corrections. might be a good time to get in. I'm also looking to invest in oil and gas projects. One of the projects i'm currently invested in looks like it will have spectacular returns[100%+]. lets see how that works out.

    let me know if you want to do a link exchange with my site.