Why Are Insiders Selling Colgate Shares?

Scott Olson/Getty Images

Scott Olson/Getty Images

Colgate-Palmolive (NYSE:CL) is considered to be a very attractive defensive stock to own. Not only does it operate in the very steady consumer products business, but it has exposure to several emerging markets that give it growth potential. As a result it has been an investor favorite for a long time. While similar stocks such as Procter & Gamble (NYSE:PG) have been flat over the past year or so, Colgate has performed in-line with the S&P 500 and has risen 18 percent — not bad for a company that sells toothpaste and deodorant.

But lately the stock seems to have gotten overheated, and insiders are beginning to take advantage of the company’s lofty valuation. In June, insider Andrew D. Hendry sold 10,000 shares for $67.72 each. He sold another 10,000 shares on July 8 at a slightly higher price. More recently, the company’s CTO Patricia Verduin sold about 2,300 shares. Now these aren’t enormous trades for a company valued at $64 million, but they do indicate that despite the general tendency for insiders of a company to be bullish, we are seeing insiders take profits.

This doesn’t necessarily mean that we should take profits too. After all, insiders sell stock for all sorts of reasons, and we should keep in mind that your typical insider has a large portion of his or her net worth tied up in shares of the company, and so a rising price could induce selling as the insider wants to diversify. As investors, we can understand and respect this as prudent wealth management.

But at the same time, we are seeing multiple insider sellers at Colgate without seeing any insider buying. Given the relatively strong run the stock has seen, this could very well be a “sell” signal.

Aside from insider selling, we are seeing other signs that the stock is worth selling. For instance, the shares trade at 30 times earnings. Now this isn’t necessarily a bad thing assuming that the company is growing quickly enough, but we simply haven’t seen this with Colgate. In fact, despite the company’s exposure to emerging markets, its sales and earnings growth has been mediocre. In the past couple of years, sales growth has come in at just 2 percent – 3 percent. Profits last year were actually down from the previous two years, and operating cash-flow grew at a negligible rate in 2013.

The point is that we have a company priced for growth that isn’t generating growth, and unless this changes investors are eventually going to give up on the company and start to unload their positions. After all there are plenty of consumer product companies trading at a significant discount to Colgate that aren’t trading at 30 times earnings. In fact, Church & Dwight (NYSE:CHD) has shown signs of growth over the past few years and yet it trades at just 24 times trailing earnings. Now this is still expensive in my opinion, but it is substantially cheaper than Colgate.

Given these concerns, I think that despite its status as a “defensive” stock, Colgate is a very risky investment given its valuation. Investors may be willing to pay up for the shares for a little while, especially with interest rates so low and given that the company has been buying back its own stock, which generates demand. However, at some point investors are going to realize that it doesn’t matter how consistent the company’s earnings are and that valuation matters. Furthermore, we haven’t even considered the possibility that Colgate’s business could shrink. If this happens, there is no justification for the current valuation, and value investors might only be willing to pay 15 – 20 times earnings. If this takes place not only can the price to earnings multiple fall by 33 percent – 50 percent, but the fact that earnings are falling means that the stock can fall even further.

With this in mind, I think there are very few catalysts to drive the stock higher and a lot of hidden risks that make this defensive company not so defensive.

Disclosure: Ben Kramer-Miller has no position in Colgate Palmolive or in any of the stocks mentioned in this article.

More From Wall St. Cheat Sheet: