On New Year's Day, a popular investment site ran an article picking its top six consumer goods stocks for 2010. All of them are good companies. In fact, Scotts Miracle-Gro is one of the most promising mid-caps in the coming years. It's interesting to look at each of the six in terms of capital allocation and, more specifically, how each has fared when repurchasing its shares over the last three fiscal years. Companies that wisely allocate free cash often make better investments than those that don't.

IN PICTURES: World's Greatest Investors

Six Consumer Goods Stock Picks
Company Three-Year Return
Stock Repurchases
Scotts Miracle-Gro (NYSE:SMG) -27.6%
Clorox (NYSE:CLX) -1.2%
Procter & Gamble (NYSE:PG) -7.4%
Philip Morris (NYSE:PM) -2.6%
Johnson & Johnson (NYSE:JNJ) 0.1%
Pepsico (NYSE:PEP) -8.5%

A Caveat to These Findings
It's important to remember that share repurchases are just one of four options companies have with their free cash. The others are dividends, acquisitions and debt repayment. Every business chooses its own preferred course of action with the results of these decisions often not felt for several years. Dividends are the easiest way to keep score, but share repurchases aren't too far behind. The table above makes me question my choice of Scotts Miracle-Gro. If it can't accurately assess the value of its own shares, how confident should I be that it wouldn't overpay when making acquisitions? While it is something to keep in mind, Scotts also paid a special dividend of $8 a share ($508 million) in February, 2007, in addition to its $246.8 million share repurchase, as part of a recapitalization move. It could just as easily have used the half-billion to repurchase a larger number of shares. But it didn't, and that's the important thing. To me, it shows a reasonable level of restraint.

Companies Moving to Repurchases
Interestingly, Procter & Gamble's 2009 10-K states, "Our first discretionary use of cash is dividend payments." Yet, if you look at its last three fiscal years, it paid out $13.9 billion in dividends while repurchasing $22 billion of its stock. Would shareholders be better off if it stuck to its guns and put more towards dividends and less to buying back stock? At this moment in time, yes.

Of course, a good year in 2010 could change all that. P&G spent 158% more on share repurchases in the last three years than it did dividends. In fact, all the companies listed above with the exception of Scotts Miracle-Gro spent more on share repurchases than on dividend payments. Unfortunately, none of them were very good at picking up their stock cheap. The worst offender was Pepsi, which spent almost double dividend payouts only to see its stock lose 8.5% on the average price paid for its shares. It would be interesting to know if Pepsi shareholders believe the company is paying a reasonable price for Pepsi Bottling Group (NYSE:PBG) and Pepsi Americas (NYSE:PAS).

The Bottom Line
Allocating capital isn't easy. Most corporate boards in recent years have chosen share repurchases over dividends because they aren't locked into a cash commitment. If a company announces a new $5 billion share repurchase program, the markets barely notice. However, if a company reduces or eliminates a dividend payment, you can kiss the stock price goodbye. Therefore, it's understandable why most are hesitant to payout more. Perhaps, the best solution is to use a special dividend when times are good. It's not something routinely expected, but nice to receive nonetheless. As for this group of stocks, they all could definitely do a better job of allocating capital, but then again, who couldn't? (To learn more, check out How Buybacks Warp The Price-To-Book Ratio.)

Related Articles
  1. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  2. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  3. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  4. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  5. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  6. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  7. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  8. Stock Analysis

    Top 3 Stocks for the Coming Holiday Season

    If you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
  9. Investing News

    Could a Rate Hike Send Stocks Higher?

    A rate hike would certainly alter the investment scene, but would it be for the better or worse?
  10. Investing News

    Corporate Bonds or Stocks: Which is Better Now?

    With market volatility high, you may think it is time to run for corporate bonds instead of stocks. Before you do take a deeper look into which is better.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!