The Best Capital Allocator In Consumer Goods

By Will Ashworth | January 10, 2010 AAA

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.

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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.)

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