1

Procter and Gamble (NYSE: PG)

Recommendation: BUY 1,100 shares at NAV of $69,333 • Increased dividends every year for past 55 years • Increased R&D efforts to drive innovation ($2B in 2011) • 24 brands each with over $1B in annual revenue • Balance between Domestic and International Exposure •Strong sales despite the Great Recession

Rachel Garrett Steven Mickey Jake Reynolds November 8, 2011

Annual Revenue by Segment

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Table of Contents

Qualitative Analysis

Investment Thesis………………………………………………………………………………………………………….………………………..1

Company Overview………………………………………………………………………………………………………………………………….2

Operating Segments

Business Model

SWOT Analysis……………………………………………………………………………………………………………………………….…...…..4

Recent News……………………………………………………………………………………………………………………………………………5

Macroeconomic Analysis…………………………………………………………………………………………………………………..…….6

Industry Analysis……………………………………………………………………………………………………………………………....…….8

Porter’s Five Forces………………………………………………………………………………………………..……………………………..13

Competitors…………………………………………………………………………………………………………………………………….…….14

Competitive/Comparative Advantages………………………………………………………………………………………….………16

Company Recognition……………………………………………………………………………………………………………………………17

Quantitative Analysis

Market Analysis…………………………………………………………………………………………………………..……………….……….17

Financial Statement Analysis………………………………………………………………………………………..……………..……….18

Pro Forma Income Statement…………………………………………………………………………………………..……….………….20

Valuation …………………………………………………………………………………………………………………………………..………….21

Technical Analysis……………………………….…………………………………………………………………………………………………23

Conclusion…………………………………………………………………………………………………………………………………………….24

Appendix A: Financial Statements……………………………………………….………………………………….…………………….25

Appendix B: Value Line………………………………………………………………………………………………………………………….27

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Investment Thesis

Qualitative:

24 brands each with over $1B in annual revenue

Consumer staples therefore defensive industry

Mature company in a mature industry but leader in market share with innovation and balanced

expansion into emerging markets providing ample growth opportunities

Steady sales despite financial gloom and uncertainty

Product lines covering multiple price tiers to ensure strong demand in all economic climates

Stable relationships with both suppliers and customers

Quantitative:

Low beta

Strong financial ratios

Increasing dividends at an increasing rate

Undervalued by Constant Dividend Growth Model, Breakup Analysis, and Price Multiples

Analysis

4

Company Overview1

Proctor and Gamble is a company focused on providing branded consumer packaged goods of superior

quality and value to improve the lives of the world’s customers. The company began in Ohio in 1905,

stemming from a business founded in 1837 by William Procter and James Gamble. The company

operates in over 180 countries today.

The company is organized into two Global Business Units: Beauty and Grooming and Household Care.

The company also operates in six separate segments. These include Beauty, Grooming, Health Care,

Snacks and Pet Care, Fabric Care and Home Care, and Baby Care and Family Care. The Net Sales and Net

Earnings for each of these segments in the past quarterly report are presented below:

Operating margins for each of these individual businesses vary as a result of the nature of materials and

processes used to manufacture the products, the capital intensity of the businesses and differences in

selling, general and administrative expenses as a percentage of net sales. None of these operating

segments is highly seasonal, though some do show some seasonal behavior. These segments include

Batteries (Fabric Care and Home Care), Appliances (Grooming) and Prestige Fragrances (Beauty). Also,

the anticipation or occurrence of certain natural disasters (such as hurricanes) can lead to unusually high

demand for batteries.

Business Model

The business model of Proctor and Gamble relies on the continued growth and success of existing

brands and products, as well as the creation of new products. P&G operates in highly competitive

market and industry segments, and competes with super-premium, premium, and mid-tier value

products. P&G works to win both the “first moment of truth” (when a consumer is shopping in the

store) and the “second moment of truth” (when a consumer uses the product, evaluates how well it met

1 P&G 10-K and 10-Q

5

his or her expectations and whether it was a good value. Of high priority for P&G in the past year was

research and product development activities, which were designed to enable sustained organic growth.

Key Product Categories

The largest product categories for P&G in 2011 were laundry (16% of net sales in 2011, 17% in 2010 and

2009) and diapers (11% of net sales in 2011, 2010, and 2009).

Key Customers

The main customers for P&G include mass merchandisers, grocery stores, membership club stores, drug

stores and high frequency stores. Sales to Wal-Mart Stores, Inc. and its affiliates represent ~15% of total

revenue in 2011 (16% in 2010 and 2009). No other customer represents more than 10% of net sales.

The top ten customers account for about 32% of total unit volume in 2011 and 2010. P&G operates

without any material backlog orders or contracts with the government.

Sources and Availability of Materials

Most of the raw and packaging materials are purchased from others including some single-source

suppliers. Raw materials (mainly chemical) are produced by P&G to be used further in the

manufacturing process. Also, fuel, natural gas and derivative products are important commodities used

by P&G.

Trademarks and Patents

P&G owns licenses under patents and registered trademarks used in connection with activity in all

businesses, and some of these patents cover significant product formulation and processes used to

manufacture products. These trademarks are important to the overall marketing and branding of P&G’s

products.

Research and Development Expenditures

Expenditures in research and development have allowed P&G to develop technologies and to obtain

patents in many categories to meet the needs and improve the lives of its consumers. Total research

and development expenses were $2001 mill in 2011 ($1950 mill in 2010, $1864 mill in 2009).

Net sales by region

The net sales by region for the past three years are presented below:

6

Net sales and assets in the United States and internationally:

“Billion Dollar Brands” served:

SWOT Analysis

Strengths

Diverse range of business segments (6 operating segments)

Most products are not highly seasonal

Operates with high end (super-premium and premium) products

Large amount of patents/trademarks owned

Other than Wal-Mart, no other customer represents more than 10% of net sales

Many “billion dollar brands” served

Weaknesses

Ability to achieve business objectives dependent on how well can respond to local and global

competitors

Face risks with significant international operations

A failure of a key information technology system, process or site could have a material adverse

impact on our business

Price paid for commodities and other materials subject to fluctuation

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Opportunities

Research and development efforts ($2001 million spent on R&D in 2011) to develop technology

and obtain patents

Worldwide reach and potential to expand into even more countries

Threats

A material change in consumer demand for products could have a significant impact on business

Business is subject to legislation, regulation, and enforcement in the U.S. and abroad

Recent News2,3

P&G Raises Profit Outlook on Pringles Sale November 3, 2011

“Sees FY GAAP EPS $4.52-$4.83 vs prev $4.17-$4.33.”

P.&G. Settles Trademark Suit Against Start-Up Business October 15, 2011

“Proctor & Gamble settles trademark suit against entrepreneur Christy Prunier over use of her daughter's

name Willa for line of skincare products aimed at teenage girls; P&G had claimed that name was too close

to its Wella brand of cosmetics; battle is latest case of small-business owner claiming 'trademark-bullying'

by large corporation.”

Emerging Markets Lift Results at Procter & Gamble August 6, 2011

“The Procter & Gamble Company said Friday that its quarterly profit rose 15 percent as sales gained in

emerging markets, and forecast annual revenue that topped some analysts’ estimates.”

From Proctor & Gamble, Direct Disaster Relief June 3, 2011

“After tornadoes in Missouri and Alabama, Procter & Gamble provided Tide- and Duracell-branded

trailers and crews for cleaning clothes and supplying batteries, flashlights and more to stricken areas.”

Procter & Gamble and Colgate Earnings Rise April 29, 2011

“Procter & Gamble and the Colgate Palmolive Company said they anticipated rising costs for

commodities, and ultimately for consumer products.”

Pringles Is Sold by Procter & Gamble April 6, 2011

“Procter & Gamble’s sale of Pringles, which began as such a dud that some called for the company to

dump the brand, concludes a sometimes zany 50-year experiment in engineered food.”

Procter & Gamble Advice Site Is Aimed at Men January 13, 2011

“After learning that men often turned to women’s Web sites for advice on recipes and relationships, P. &

G. started the Web site ManoftheHouse.com.”

2 NYTimes.com

3 PG 2011 10-Q

8

Macroeconomic Analysis4,5,6,7,8

Due to the nature of the industry (targeting the household consumer), we decided to focus our

economic analysis on Household metrics. This principal trend this most recent quarter (September

2011) is that consumer spending rose in as Americans saved less, which has contributed to momentum

of GDP growth (sitting at a 2.5% annual rate, which is up from the 1.3% pace of the past 3 months).

Wages and Salaries: Private wages and salary disbursements increased $17.9 billion in September,

which is a considerable figure when compared to the $9.8 billion decrease in August. If this trend

continues, it is a positive sign for a consumer staples company like P&G, because it means that

consumers have more money to spend on household and personal products.

Disposable Personal Income (DPI): DPI increased 0.1% in September which is up from the 0.1%

decrease in August. Real DPI (which takes into account price changes) decreased by 0.1%, as compared

to the 0.4% decrease in August. Trends in annual sales of household and personal products tend to

mirror trends in disposable income. It is true that that the quantity of these products consumed

remains steady throughout the economic cycle since they are consumer staples. So with the economic

uncertainty that the United States is facing, a defensive industry will still see returns even during

economic downturns. However this recent trend of an upwards bump in real disposable income is even

better news for Procter and Gamble because with more money in their wallets, consumers are more

likely to favor and buy even more of the private label products that P&G has to offer.

4 Bureau of Economic Analysis

5 Bureau of Labor Statistics

6 Federal Reserve Board

7 Dallas Federal Reserve

8 S&P NetAdvantage Industry Analysis

9

Personal Consumption Expenditures (PCE): PCE increased in September by $72.1 billion (0.6%) as

compared to the $27.6 billion (0.2%) increase in August. Real PCE increased by 0.5%, which is also up

from the decrease of less than 0.1% in August. Personal saving as a percentage of disposable income

was 3.6% in September, which is down from the 4.1% in August, indicating that people are spending

more of their money rather than putting it into savings, which is another good sign for P&G product

sales.

Consumer Price Index (CPI): The index for all items less food and energy increased by 0.1% in

September, which is its smallest increase since March (the 12-month change stayed at 2% for the second

straight month). This indicates that price changes associated with the cost of living are fairly steady as

of now. This can be seen both positively and negatively for P&G. Consumer staple companies like P&G

are not passing increasing costs (from rising commodity prices) along to consumers. However, this

steady retail price inflation also means that since companies are not significantly raising their prices,

consumers will be tempted to substitute away from the name brand consumer staple offerings or forgo

purchases all together.

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Foreign Exchange: Since international sales accounting for 63% of P&G revenue, it beneficial to look at

the value of the dollar as compared other currencies. The dollar has begun to appreciate a bit which

could potentially make U.S exports less attractive, but the value is still relatively low in historic terms.

Industry Analysis9,10,11,12,13,14

Procter and Gamble operates in the nondurable

consumer goods sector. These manufactured products

can be divided into two categories: household and

personal care. Household and personal care product

companies are mostly conglomerates, which is the case

for P&G. Companies in this industry compete on brand

recognition, product quality, and the level of service

they provide to their customers (in the form of retailers

9 Value Line

10 PG 2011 10K

11 S&P NetAdvantage Industry Survey

12 Grocery Manufacturers Association (GMA)

13 SymphonyIRI Group

14 Fidelity

11

and wholesalers). This industry is large and fragmented. P&G and Unilever account for about half of

worldwide sales. The primary markets for the companies in this industry include industrialized nations

in the United States and Europe, which are mature and highly competitive.

Nondurable consumer goods are a mature industry and revenue and earnings are relatively steady throughout the business cycle. It is also classified as a defensive industry. These stocks perform well during good economic times and provide good downside protection during rough or uncertain times, such as the period we are facing right now. This can be seen in the fact that he sector and sub- industry (household goods) continues to outperform the S&P 1500 index. Year to date through October 14, the S&P Household Products Index rose 5.0%, compared to a 3.0% drop for the S&P 1500 Index. In 2010, the sub-industry index advanced 4.4%, versus a 14.2% rise for the S&P 1500.

Current Environment

So far in 2011, there has been improved demand in higher-priced products and discretionary items.

However, there has also been a renewed fear that increased commodity costs pressures would force

companies to compensate by charging higher prices for their products. However, the steady consumer

price index (as discussed in the Macroeconomic Analysis) indicates that this does not appear to be the

case as of now.

Industry Outlook

The industry outlook is neutral. Although we are seeing trends of increased demand for higher-priced

products, consumers are expected to remain fairly price sensitive for the next couple of years. Success

in defending high market share against suppliers of lower priced products will depend on a company’s

marketing and product innovation ability. The market looks to remain highly competitive due to the

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maturity of the industry in developed countries. For this reason, there has been recent interest in

venturing into emerging markets. The economic growth and changing lifestyles of populations in these

emerging international markets looks to present great growth opportunities for established companies

in the industry. Other ways that companies have been coping with the challenge of stimulating sales in

a mature market are: creating new product categories, adding new distribution channels, and acquiring

(and divesting) businesses.

Drivers of Success in the Industry

New Product Offerings: Because of the mature nature of this industry, product innovation drives a company’s future sales growth. This can be achieved through upgrades/adding value to offerings or developing new complimentary items. Successful new products tend to carry higher profit margins than established products. In the past 16 years, P&G has had 132 products on SymphonyIRI Group’s list of each year’s 25 most successful new products, more than their six largest competitors combined. In addition, P&G invests about $2 billion a year in R&D — about 50% more than their next closest competitor and more than most of their closest competitors combined.

Brand Equity: Building consumer awareness and establishing a brand name through marketing

and advertising is initially very costly, but nonetheless important. Mature products also require

upkeep in this area to ensure customer loyalty. The establishment of the brand’s reputation

and customer loyalty is important because only in the most difficult of times will a long-time

customer consider switching from a reliable product they have used over the years to a cheaper

alternative. P&G is a dominant global marketer, spending $8.6 billion on advertising and

marketing in its 2010 fiscal year (ended in June), up $1 billion (14%) over 2009. According to

Advertising Age, P&G was ranked first in total US advertising spending in 2009. Through

advertising, P&G raises the profile of its brands as a way to increase brand equity and drive

consumer demand.

Product Mix: for each product, offering a number of name brands available at different price

points captures consumers at every income level. P&G’s success with this tactic can be seen in

its various detergent offerings (Tide, Cheer, and Gain), which is why the company has 60.3% of

the market share in this category.

Market Share: establishing a high stake in the market share gives a company power over

retailers and ensures prime shelf space for their products. Also, stronger demand for a product

means that it can be produced in higher quantities, which allows for manufacturing and

production efficiency. P&G is the market leader (U.S) in 7 of the 8 categories, as shown on the

next page.

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40%

39%

21%

Batteries

P&G Energizer Other

65% 30%

5%

Razor Blades

P&G Energizer Other

60% 13%

12%

6% 9%

Laundry Detergent

P&G

Sun Products Corp

Church and Dwight Co

Henkel

42%

30%

28%

Toothpaste

P&G Colgate-Palmolive Other

37%

29%

10%

24%

Deodorant

P&GUnileverColgate-Palmolive

29%

28% 24%

19%

Toilet Tissue

Kimbery-Clark P&G

Koch Industries Other

37%

13% 13%

37%

Shampoo

P&G L'Oreal Unilever Other

48%

34%

18%

Disposable Diapers

P&G Kimberly-Clark Other

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Emerging Markets

With the saturation in U.S and Western European markets, developing markets are looking to be

lucrative business opportunities. In many of these emerging markets, GDP, disposable income, and

population are outpacing that of the United States and Western Europe. In addition, by 2020, four of

the ten largest economies (in terms of GDP) will be emerging markets: China (#1), India (#3), Brazil (#7),

and Mexico (#10). P&G has been, and looks to continue, to take advantage of emerging market

opportunities, with 34% of their sales coming from emerging markets in 2010 (up from 20% in 2000).

Competition with Private Labels

With uncertainty about the future of the economy, consumers may be looking to buy lower cost

products, which would make private labels more attractive options for consumers. In fact, private label

products on average remain 29% lower in cost than national brands (2011). However, this price gap has

been shrinking and will likely contribute to private label share losses this year. Private labels currently

hold 22.9% of sales of consumer packaged goods, which is the first decline since the beginning of the

economic downturn. National brand manufacturers have been focusing on protecting and growing

shares in their own brands. These efforts have been met with success as shown by the recent private

label shares decline this year.

Private labels still garner a sizable share of consumer spending. However, the private label product

momentum is not evenly distributed across channels, and sales are declining across most consumer

packaged goods departments.

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For now, it looks as if it looks as if name brands will continue to enjoy the majority of the household

goods market share despite the lower prices offered by private labels.

Green Revolution

Green products are holding strong even as the economy struggles. Before the recession, green products

were among the fastest growing sectors in the U.S economy. This growth has since slowed, but

customers are still committed to sustainability and buying green. Companies have begun to tap into the

green market (P&G’s Tide Coldwater was the first detergent to be awarded the Green Good

Housekeeping Seal in 2010) and there is still much opportunity for growth in this area. In addition to

green product launches, companies in this industry are looking to make their own operations more

sustainable.

Porter’s Five Forces15,16

Threat of New Entrants: Low

The enormous portfolio of products distributed under P&G’s name makes it difficult for new entrants to

compete. Since P&G garners a significant amount of the market share in this industry, a potential

entrant would need a great deal of capital for manufacturing, as well as a large budget for marketing,

research and development, and advertising in order to compete on the same level as the big companies

15

Procter and Gamble 10K 16

Reuters

16

like P&G. This establishes a substantial barrier that keeps the threat of new entrants low for this

industry. Patents on products also serve as a barrier to entry.

Buyer Power: High

The profitability of P&G depends heavily on its buyers. P&G relies greatly on stores like Wal-Mart to

generate a sizable portion of its revenue. For the past 3 years, about 16% of P&G’s total sales were to

Wal-Mart. Losing Wal-Mart as a customer would put a sizable dent in P&G’s revenue. This high

dependence reduces the bargaining power of P&G.

Power of Suppliers: Low

P&G does not have a strong reliance on any specific suppliers, which makes the power suppliers low.

Consumer products companies like P&G might incur some costs from switching suppliers. However,

supplier cost is still limited due to the sheer size of P&G, which gives the company substantial bargaining

power over suppliers.

Competitive Rivalry: High

There are a considerable number of substitutes for P&G’s product offerings. In the markets that P&G

sells its products, it has to compete against other branded products, as well as private labels. There are

many different options when it comes to product offerings in this industry. Operating in the

oversaturated and mature American and Western European markets does not make things any easier.

Top companies must rely on brand recognition and product innovation to gain market share.

Threat of Substitutes: Low-Medium

The majority of products in the P&G portfolio are consumer staples, and therefore classified as

necessities that do not really have substitutes. For example, there is no substitute for laundry

detergents other than different types of laundry detergent. The same is true for most of their products

(i.e. batteries, shaving cream, etc…). However, substitutes do exist for some of their products lines like

snacks and fragrances. In terms of substituting for readily available comparable products, the threat

does exist but through rigorous marketing and ad campaigns, it is likely that P&G’s brand recognition

will keep customers’ loyalty.

Competitors17,18,19

Church and Dwight Company: This company develops, manufactures,

and markets a range of household, personal care, and specialty

products. Best known for ARM & HAMMER, it is the top marketer of

baking powder worldwide. Some of the company’s other products

include bathroom cleaners, carpet deodorizers, air fresheners,

17

S&P NetAdvantage 18

Yahoo Finance 19

Hoovers

17

toothpaste, and cat litter. Consumer domestic products accounted for 73% of Church and Dwight’s sales

in 2010, while international sales accounted for 17% and specialty products 10%.

Clorox: Divested from Proctor and Gamble in 1969 and has since

focused on building big-share brands in mid-sized categories. Clorox

reports four segments which include cleaning, household, lifestyle, and

international. Clorox products are sold in over 100 countries. Some of

the Clorox’s name brand offerings include 409, Tilex, Brita, and Glad.

Colgate-Palmolive (CL): A global consumer products company that

operates in the oral, personal and household care, and pet food markets.

The company operates in over 70 countries and sells its products in more

than 200. About 75% of Colgate-Palmolive’s net sales come from outside

the U.S, the biggest portion of which comes from Latin America. Colgate-

Palmolive is Procter and Gamble’s biggest competitor when it comes to

oral care with products including toothbrushes, toothpaste, and pharmaceutical products for oral health

professionals. Some of their other products include Hills Pet Nutrition (which makes Science Diet and

Prescription Diet pet foods), as well as personal and homecare items which include Ajax brand cleaner,

Palmolive dishwashing liquid, and Speed Stick deodorant.

Energizer Holdings: One of the world’s largest manufacturers of

primary batteries and flashlights. Energizer also distributes

batteries for non-consumer industrial applications, including

lithium batteries for cameras and camcorders as well as miniature

batteries for watches, calculators, hearing aids etc… Its products

are sold in more than 165 countries. In 2003, the company acquired from Pfizer the Schick Wilkinson

Sword shaving product business. The company also provides sun care (Banana Boat), feminine care

(Playtex), and infant care (Diaper Genie) products. The two main operating segments for Energizer are

Household products and personal care.

Johnson & Johnson (JNJ): A global company engaged in

research and development, manufacture, and sale of various

products in the health care field. Johnson & Johnson operates

in three segments: consumer, pharmaceutical, and medical

devices. The consumer segment makes up 24% of sales,

primarily focusing on personal care products including prescription drugs (Tylenol), adult skin and hair

care (Neutrogena), infant care, first-aid (Band-Aid) and nutritional products. Johnson & Johnson is the

closest in market cap to Procter and Gamble.

18

Kimberly-Clark (KMB): A global consumer products company

that is a top producer of personal paper products. It has

manufacturing facilities in more than 40 countries and sells its

products to over 150 countries. In more than 80 countries

KMB’s products are at the hold the first or second position in their respective product area. The

company has had over 30 strategic acquisitions and 20 divestures since 2002. Some of the company’s

best known brands include Kleenex, Scott, and Huggies. In addition to tissue, KMB also manufactures

personal care and healthcare products.

Unilever (UNA): Based in London and made up of 2 parent companies (Unilever

Plc and Unilever N.V) that operate as a single entity. Unilever is a global

supplier of consumer goods across a wide range of food, home, and personal

care product categories. Unilever was the world’s #1 consumer products maker

until 2005 when Procter and Gamble purchased Gillette. The home and

personal care segments of the company accounted for 49% of sales in 2010.

The group sold its underperforming North American laundry business in 2008 to Sun Products

Corporation. Some of its well-known brands include Snuggle, Surf, Axe, Dove, and Vaseline.

Competitive Advantages20,21,22

Broad portfolio with product lines satisfying multiple price tiers, allowing P&G to cater to

varying income levels and capture more market share.

Large scale operations with sizable distribution network and go-to market capabilities that give

P&G a first mover advantage.

Superior brand management and brand leadership capabilities, which allow for maximization of

customer loyalty and market penetration.

Supply chain continues to maintain record of excellence, ranking #3 overall in Gartner’s Top 25

global supply chains, and #1 in the consumer product goods industry.

Leader in product innovation

o Spends nearly $2 billion annually in R&D, which is about 50% more than their closest

competitor and more than most other competitors combined

o Each year P&G invests another $400 million in foundational consumer research to

discover opportunities for innovation, conducting over 200,000 studies in more than

100 countries

o Has significantly improved the percentage of innovations meeting revenue and profit

targets

20

P&G 10K report 21

Harvard Business Review 22

The Motley Fool

19

In 2000 only 15% of innovations were meeting targets

Connect and Develop program was launched in 2001

This past year, about 50% of innovations were meeting targets, making it one of

the most productive innovation years in P&G’s history

Company Recognition23

Market Analysis24,25

Upon first glance it seems PG has

underperformed the market within the past year,

but with a longer time horizon in mind it vastly

outperformed the S&P 500. It is important to note

that PG’s returns do not include its dividends,

which are above average as well. PG’s P/E ratio is

comparable to that of the S&P 500. Long term

performance and a high dividend yield make PG

seem attractive at first glance and worthy of more

research.

23

www.pg.com 24

Google Finance 25

http://online.wsj.com/mdc/public/page/2_3021-peyield.html

• Ranked #5 among the "Global Most Admired Companies"

• Consistant #1 ranking within industry on "Most Admired" list for 26 of 27 total years and for 14 years in a row Fortune

• Ranked #10 on the "World's Most Respected" Barron's

• Ranked #25 on the "World's Most Innovative Companies" Bloomberg Businessweek

• Named to list of Global 100 Most Sustainable Corportations in the world, with top ranking for 2000-2011 Dow Jones Sustainability Indexes

• "Outstanding Acheivment in Innovation" award, recognizing P&G as the most innovative manufacturer in the consumer packaged goods industry for the last decade

• Recognized for using innovation to launch 4 of the 10 most successful new products in 2010 SymphonyIRI Group

• Ranked #3 in the "Research Supply Chain Top 25" AMR

20

Financial Statement Analysis26,27,28,29,30

Liquidity: Average

PG’s current and quick ratios are

both less than 1, which might initially be

cause for concern, but PG has credit ratings

of AA- and Aa3 from S&P and Moody’s,

respectively. Additionally, data from the

most recent quarter shows improvement

since the financial crisis, which is always

reassuring.

When compared with its peers,

however, PG still seems to have liquidity

problems. This could be attributed to

PG’s extensive use of derivatives to

hedge against foreign currency exchange and interest rate risk. These

derivatives are not classified as current assets even though they may protect

funds used to pay current liabilities.

The Z score is a highly reliable metric of solvency within a two year

time period. A Z score above 3 falls within the “safe” area, so in this case PG

is not in danger of bankruptcy. This effectively negates some of the concerns

about PG’s current and quick ratios, but it still underperforms its peers.

Debt Management: Average

PG’s debt ratios are all average. Current ratios do not differ much

from historical patterns, but given the aforementioned credit ratings PG has

no problems repaying its debts.

Equity here is presented at par value

in order to maintain consistency with

PG’s financial statements and except

where noted “Debt” considers all

liabilities in order to present more

conservative ratios. When

calculated at market value, PG’s LT

Debt / Equity is 0.129 and its Debt /

26

PG 2008, 2009, 2010, and 2011 10-K’s 27

PG 2011 10-Q 28

CL, JNJ, KMB, UN 10-K’s 29

http://online.wsj.com/mdc/public/page/marketsdata.html?refresh=on 30

“Market Risk Premium Used in 56 Countries in 2011: A Survey with 6,014 Answers” by Pablo Fernandez

21

Equity is 0.409. Unlike its peers, PG finances more of its activities from equity. They have similar debt

ratios, however, once again indicating that short term solvency is not a problem.

Asset Management: Average

PG’s asset management ratios

are also average because while its TATO

could be higher, its FATO is not overly

impressive either. This is to be expected

of a mature company in a mature

industry, however, as its peers have similar ratios.

Extended DuPont and Profitability Margins: Average

PG’s return on equity matches

its other ratios for similar reasons. Lately

though the whole industry’s margins

have been hurting due to pressure from

commodity prices. Over the most recent

period PG increased revenues by 6.4% in

order to make up for poorer margins,

which are slightly below their historical

averages. Once commodity prices

stabilize return on equity should

increase to 2009 and 2010 levels.

PG once again stays close to its

peers in terms of each individual margin

and the total ROE overall with the

exception of Colgate-Palmolive, whose

equity multiplier significantly boosts its ROE and thus skews the peer average. PG’s ROE is far less than

that of its peers but this should change given the recently announced stock repurchase program.

22

Economic Value Added: Excellent

Despite the ho-hum picture painted by the other analyses of PG’s financial statements, it

reported economic profit of $3.30 per share over the past twelve months. The bulk of this information

was taken from annual and quarterly financial statements. The risk free rate is equal to the yield on 30

year treasuries as of market close on November 4, 2011 while the risk premium is rounded up from the

results of the research paper “Market Risk Premium Used in 56 Countries in 2011: A Survey with 6,014

Answers” found online and cited by other analysts. The beta is from Google Finance. R&D Expense was

capitalized for the NOPAT calculations.

Pro Forma Income Statement31

31

PG 2011 10-K and 10-Q

23

Assumptions:

Pessimistic revenue growth of 1% per year; Most Likely revenue growth equal to the five year

average of 3.9% per year.

Margins are calculated according to their averages from the preceding section in which the most

recent quarterly data is weighted as a full year to account for the fact that short-term results are

likely to be more similar. The margins for both Pessimistic and Most Likely scenarios are the

same.

Most Likely Shares reflect the recently announced $4B - $6B stock repurchase program for

FY2012; Pessimistic Shares assume this program will be abandoned.

Basic EPS calculation reduces NI to account for preferred stock and minority interests, but

doesn’t account for dilution.

DPS calculation slightly extrapolates historical averages to arrive at a payout ratio of 50%.

P/E calculated using Friday’s closing price of $63.03.

Valuation32

Constant Dividend Growth Model

This model is rarely used because it assumes constant rates of

growth for both revenues and dividends of a company, neither of which

are very realistic. However, it is applicable to PG because of its relatively

stable revenue and increasing dividends. The fact that PG’s dividends

grow at an increasing rate instead of a constant one results in a slightly

lower expected return when compared with other valuation methods,

but the positive alpha is the most important metric from this model. The

positive alpha means that PG’s expected return is more than worth the

relative risk.

Breakup Analysis

32

PG 2011 10-K and 10-Q

24

PG operates under 6 distinct business segments, as

mentioned in the company overview. PG clearly reports per-

segment results as part of each 10-K, almost as if they are

inviting investors to perform a breakup analysis by making it

easier. For this reason the necessary calculations were

relatively simple. In order to find the value of each individual

segment, we compared Net Income with average applicable

P/E ratios as follows: Avon, Estee Lauder, and L’Oreal for

Beauty; Church & Dwight (Arm & Hammer products) for both

Grooming and Health Care; Colgate-Palmolive for Snacks &

Pet Care (this is a bit of a stretch but Colgate’s rather large

Science Diet brand is equivalent to PG’s Eukanuba and Iams

brands while PG is selling Pringles, its last Snacks brand);

Ecolab and Church & Dwight for Fabric Care & Home Care; and Summer Infant for Baby Care & Family

Care. Many of these companies are smaller than PG, explaining the high P/E ratios, so like the Constant

Dividend Growth Model this margin of safety is not precise enough in and of itself to warrant

investment. The margin is also grossly conservative as it deducts all liabilities from the combined value

of the segments instead of just corporate debts, pension liabilities, etc. It does, however, indicate that

the sum of PG’s parts is greater than the market value of its whole.

Price Multiples Analysis

25

The top three valuations were calculated using data from the 2012 Pro Forma Income Statement

above multiplied by 5 year average multiples where available. The Pessimistic assumption has a

probability of 25% instead of the customary 20% to reflect our slightly-more-bearish-than-normal

outlook. For EV/EBITDA most data was again taken from the 2012 Pro Forma Income Statement where

available. EV was calculated backwards using historical EV/EBITDA multiples. Cash & ST, Total Debt, Prfd

Equity, and Minority Interest were all lifted from the most recent quarterly report with Market Cap

calculated according to predicted shares outstanding. Each valuation price is weighted evenly to

produce a target price of $72.77 which provides a 15.45% margin of safety and an expected return of

18.99% with the expected dividend.

Technical Analysis33,34

Bollinger Bands

Bollinger Bands show how a stock is trading compared to its recent range, in this case 10 days. In

three of the pictured four dividend payments, including the most recent one, PG immediately fell to the

lower end of this band, indicating that recent price trends probably have more to do with historical

trading activity than anything else. Nevertheless, PG is still subject to the same market swings in

reaction to news from Greece and Europe regarding the global economy.

33

Google Finance 34

Wikipedia

26

Below the volume chart is the Moving Average Convergence / Divergence indicator (MACD),

which shows changes in the strength, direction, momentum, and duration of a trend in a stock’s price.

According to Wikipedia, “the MACD is a computation of the difference between two exponential moving

averages (EMAs) of closing prices. This difference is charted over time, alongside a moving average of

the difference.” In the chart shown, the two EMAs are for 15 and 30 day periods, respectively.

Simple Moving Averages

Simple Moving Averages are another way to analyze trading trends. The two shown are for 20

and 50 day averages. Generally if the price of a stock rises above its SMA people believe it will continue

to rise and vice versa until the SMA changes direction. However, this is a lagging indicator, meaning that

it tries to do exactly what all investment professionals have a liability disclaimer for: use past results to

guarantee future performance. In summary, PG’s stock may be experiencing a slight hiccup, but no more

than it normally does after dividend payments, and will most likely continue its long-term upward trend.

Conclusion

We recommend buying 1,100 shares of Procter & Gamble at a Net Asset Value $69,333. Steady

sales stemming from a healthy amount of international exposure and growth, 24 brands each with over

$1B in annual revenue, product lines covering multiple price tiers to ensure strong demand in all

economic climates, and leadership in innovation make PG a great company. Furthermore, its low beta,

downright impressive dividend payouts, and valuation metrics make it an attractive stock in these

uncertain times.

27

Appendix A: Financial Statements

28

29

Appendix B: Value Line