CL is undervalued
Colgate-Palmolive is my stock pick of the week as well as one of November’s Most Attrac-tive Stocks in my monthly newsletter. Colgate-Palmolive is a new addition to our attractive stocks list this month.
Like all of our Most Attrac-tive Stocks the com-pany has (1) high and ris-ing eco-nomic prof-its (as dis-tinct from account-ing prof-its) and (2) a cheap val-u-a-tion. As shown in our free report on CL, the company’s return on invested capital (ROIC) (21.2%) is in the top quin-tile of all the com-pa-nies we cover and its eco-nomic earn-ings are grow-ing. This increase in profits comes while revenues declined during the last fiscal year.
Most people may not have noticed the strong increase in net operating profit after tax (NOPAT) because it comes primarily from removing about $250 million in non-operating expenses (after-tax), which cause reported earnings to be understated.
Note that the net non-operating expenses are not readily discernable on the company’s income statement. We had to dig through the financial footnotes and the management’s discussion and analysis to get them.
At the same time, the stock’s val-u-a-tion implies that CL’s prof-its will decline by 7% and never grow again. In other words, the stock mar-ket is pre-dict-ing a per-ma-nent decline of more than 7% in CL’s prof-its. Given that most investors are not aware that the company’s operating profits are as strong as they are, the market is probably not giving CL appropriate credit for its profitability.
In summary, the mar-ket is set-ting the profit growth bar quite low for this?stock.
HIDDEN GEMS:
- About $250 million in non-operating expenses (after-tax) cause reported earnings to be understated
- Our dis-counted cash flow analy-sis shows that CL’s cur-rent val-u-a-tion (stock price of $77.52) implies that the company’s prof-its will decline by 7% and never grow?again.
- The com-pany grew its eco-nomic earn-ings by $229mm (14% increase) dur-ing its last fis-cal?year.
For details on what causes the dif-fer-ence between eco-nomic ver-sus account-ing prof-its, see Appen-dix 3 on page 10 of our report on CL. See Appen-dix 4 to learn how CL increased net operating profit after tax (NOPAT) by cut-ting costs and increased its NOPAT mar-gin from 15.1% to 16.7%. See Appen-dix 5 for details on how CL grew invested cap-i-tal while revenue dropped and lowered invested cap-i-tal turns from 1.32x to 1.27x. Appen-dix 7 (in the ROIC sec-tion) shows how the com-pany’s increase in NOPAT mar-gin outweighed the decrease in invested cap-i-tal turns to result in an increase in ROIC (from 20.1%% to 21.2%) and Eco-nomic Earnings, which rose by $229mm.
In summary, CL is an attractive stock because its economic earnings are strong and growing while its valuation implies economic earnings will decline permanently by 7%.
As per Invest-ment Strat-egy 101 and How to make money pick-ing stocks, CL fits the risk/reward pro-file of a great stock to?buy.
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