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Hi,

I spent the better part of the weekend reading about P&G, as you may be aware, P&G is part of my watchlist for 2006 (http://boards.fool.com/Message.asp?mid=23187284 ).

This is an amazing company where 17 of its 300 brands are already billion dollar revenue generators (or 22 brands post-merger), and it has further targeted a futher 9 brands as billion dollar potentials (eg. Vicks).

Despite its inroads into Asia ( Pampers, Crest, Pringles, Head & Shoulders, its immensely popular SK-II, Pantene, etc), it is only getting 23-26% of its revenues (and 22% of profits)from emerging countries. The current king of the hill of consumer staples for emerging countries is Unilever. This is a half-fill / half-empty situation, I choose to believe that this represents a hugh opportunity for P&G to gain marketshare in the BRIC countries (brazil, russia, india and China), and through its acquisition with Gilette, it will have better coverage and exclusive distribution infrastructure than any of the its competitors.

In my opinion, Wall Street is somewhat cautious about the acquisition and the supposed synergies that it will bring. This may represent an opportunity for us investors to buy this stock while the majority of Wall Street is rating P&G a "Hold".

Let's take a closer look at P & G's numbers and investigate whether P&G is cheap, expensive or fairly priced.

Before that, I will refer several sources of data on P&G can be found, for earnings and financial statements, Morningstar is a good start,
http://quicktake.morningstar.com/Stock/Income10.asp?Country=USA&Symbol=PG&stocktab=finance
I like to also refer to Morningstar's Analyst estimate consensus for the next five years, found here,
http://quicktake.morningstar.com/Stock/EarningsEstimates.asp?Country=USA&Symbol=PG&stocktab=owner
Lastly, ValueLine Report provides the ValueLine Survey of the Dow Compoenents free, and P&G's data can be found here, http://www.valueline.com/dow30/f7291.pdf what is interesting is that VL's data for earnings adjusts for one time charges.

Method A: A quick comparison of reported Intrinsic Values.
This is a quick and dirty way to compare the existing IV out there, given that this is a blue chip company with a hugh following of analysts tracking it.

Morningstar: $58
S&P Research: $53 (usually provided free for online brokerage, I use Ameritrade)
Fool.com Monster Stock: $55 (by TMF Admiral)

Using my trusty and simplistic IV Calculator (found here: http://boards.fool.com/Message.asp?mid=22949063 ), I see that my earlier assumptions of earnings growth of 12% was a little too optimistic. Using M*'s analyst, the estimates is around 11.2%, or as I have found myself recently doing is discounting the analyst growth estimates by 15 ~ 20%, giving it an approximate 9% earnings growth. This brings my calculation of IV to around $61 ~ $63, while Benjamin Graham's IV calculator gave an IV result of $63.

Sidetrack: BennyG's Original formula: IV = EPS * (2 * EPSGrowth + 8.5), the Forumula was modified to adjust for inflation, IVF = IV * 4.4/Corp.Bond, which Corp. Bond is around 5.2%. So, calculation for IVF = 2.82 * ( 2 * 9 + 8.5) * 4.4/5.2 = $63.2

So, while IV estimates range from $53 to $63, the estimated EPS growth is a conservative 9% to 11%. P&G is likely to bust this numbers, well, according to this optimistic CEO announcement : http://seattlepi.nwsource.com/business/apbiz_story.asp?category=1310&slug=Procter%20~%20Gamble.

Conclusion: According to this method, P&G would appear to be fairly valued to slightly over-valued right now. Indeed, using this BMW visual method seems to validate it. ( http://www.retro.ms11.net/bmw-pg.pdf )

Having piqued my interest, it was time to dig deeper....

Method B: Timothy Vick's 15% Buy-in price method

For a explanation on this method, I would like to refer to an earlier post, http://boards.fool.com/Message.asp?mid=23043733

Data & Assumptions:

Five Year Analyst Est: 11.20%
Round it after 20% Discount for Analyst Hubris: 9%

Year 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996
PayoutRatio 39% 40% 45% 49% 68% 52% 44% 39% 37% 37%

Removing the "68%", the average payout ratio becomes 42%

P/E High 22 25 27 31 39 48 45 37 34 26
P/E Low 19 21 22 24 27 21 32 25 21 19

Average P/E High without highest "48" & "45" is 30.10

Average P/E Low without the "32" & "27" is 21.4

EPS 2.66 2.32 2.04 1.79 1.56 1.48 1.43 1.28 1.14 1

** I used NAIC data for EPS Calculation

Constructing Future EPS with Future EPS = (Present EPS * (1 + 0.09)^ year)

Year Future EPS
0 2.66
1 2.90
2 3.16
3 3.44
4 3.75
5 4.09
6 4.46
7 4.86
8 5.30
9 5.78
10 6.30

Total EPS 46.71
Total Div Payout is average payout ratio multiplied by total EPS.
Total Div Payout = 42% of 46.71 = 19.62 worth of dividends paid out in the 10 years.

Share Price at the end of ten years = EPS of 10th year * P/E ratio. This ranges between 134.76 (average low PE) and 189.55 (average high PE). But the actual returns for holding P&G includes the dividends for the 10 years as well, total returns ranges from $154.38 to $209.16.

Now, If the returns of P&G at the end of ten years is between $154.38 to $209.16, what is the buy in price if we expect a 15% return on investment (Share price appreciation + dividends) annually ? Using the PV equation, I derive a range of values which we should buy below, ie. $38.16 to $51.70. Comparing against last Friday's closing price of $54.81, it would seem that P&G is slightly above the buy-in price range.

Now, assuming last Friday's close at $54.81, what would the ROI be if the ten year returns range between $154.38 to $209.16 ? Again using the PV equation, the ROI range would be 10.91% to 14.33%

Conclusion: P&G price has to fall below the range of $38.16 to $51.70 to enjoy at least 15% return on investment.

Method C: ROE Method

This method is adapted from the Buffettology workbook. The basic premise is that some companies have very ROE. If you were to look at P&G, earnings is quite linear, and ROE for the last ten years is beautiful,

Year 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996
EPS 2.66 2.32 2.04 1.79 1.56 1.48 1.43 1.28 1.14 1.0
ROE 45.7 42.5 39.1 38.9 28.0 34.0 36.4 36.7 34.1 33.0

Average ROE Less "45%" & "42.5%" is 35.03

And if ROE is predictable, then perhaps, it can be used to estimate the future EPS if we know how much of the profits is retained and ploughed back into the business versus paid out as a dividend.

For more information, I would suggest that you check out the book. Validea also attempts to capture this method as well.

Yr Equity Eq/Sh ROE Earnings EPS Payout Dividend Div/Sh RetEarnings
0 17477.00 6.99 35% 6116.95 2.45 42% 2569.12 1.03 3547.83
1 21024.83 8.41 35% 7358.69 2.94 42% 3090.65 1.24 4268.04
2 25292.87 10.11 35% 8852.51 3.54 42% 3718.05 1.49 5134.45
3 30427.32 12.17 35% 10649.56 4.26 42% 4472.82 1.79 6176.75
4 36604.07 14.64 35% 12811.43 5.12 42% 5380.80 2.15 7430.63
5 44034.70 17.61 35% 15412.14 6.16 42% 6473.10 2.59 8939.04
6 52973.74 21.18 35% 18540.81 7.41 42% 7787.14 3.11 10753.67
7 63727.41 25.48 35% 22304.59 8.92 42% 9367.93 3.75 12936.66
8 76664.08 30.65 35% 26832.43 10.73 42% 11269.62 4.51 15562.81
9 92226.88 36.88 35% 32279.41 12.91 42% 13557.35 5.42 18722.06
10 110948.94 44.36 35% 38832.13 15.53 42% 16309.49 6.52 22522.63

Sum of Dividends for 10 years is 32.56

High PE of 30.1 multiply by EPS of 15.53 = PX = 467.35 High in 10 Yrs
Low PE of 21.4 multiply by EPS of 15.53 = PX = 332.27 Low in 10 Yrs

Add in Dividends of 32.56, the returns range from $364.83 to $499.91

Working out rate of return based on last px of 54.81 gives between 20.87% to 24.74%

Conclusion: The numbers look very nice indeed, one potential problem is the assumption that all profits not paid out as dividends is ploughed back to the business.

** You can download the spreadsheet and diddle and fiddle with the numbers here: http://www.retro.ms11.net/PG.xls

raytoei
who unlike Risky investments, heartily recommends the La Camargue restaurant in Saigon, and the sinful pan-seared Foie Gras on toast
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