Ecolab’s R&D investments have created an incredibly strong business, one that can hold up very well even during economic downturns. For clear evidence of Ecolab’s competitive advantages, look no further than its performance during the Great Recession:
- 2006 earnings-per-share of $1.43
- 2007 earnings-per-share of $1.66 (16% increase)
- 2008 earnings-per-share of $1.86 (12% increase)
- 2009 earnings-per-share of $1.99 (7% increase)
- 2010 earnings-per-share of $2.23 (12% increase)
Ecolab’s growth during the Great Recession was truly remarkable. Not only did the company generate positive earnings growth in each year of the recession, but in three of those years, it achieved double-digit earnings growth. This growth came during arguably the worst economic downturn in the U.S., since the Great Depression. Ecolab’s recession performance makes it abundantly clear, that the company holds sustainable competitive advantages.
Valuation & Expected Returns
Based off of the current trading price of $149 and expected earnings-per-share of $5.25, Ecolab has a price-to-earnings ratio of 28.4. The company expects 8%-10% earnings growth in the coming years.
This is a high valuation, even for a strong company like Ecolab. The stock has a five-year average price-to-earnings ratio of 26.2. We have a target price-to-earnings ratio of 20. If shares of Ecolab were to return to our target valuation by 2023, this would reduce total annual returns by 6.8%.
The stock is in danger of experiencing contraction of the valuation multiple, which would negatively impact total returns. A breakdown of potential returns is as follows:
- 9% earnings growth
- 1% dividend yield
- 6.8% valuation reversion
We expect that Ecolab will offer a total annual return of 3.3% through 2023. This is a fairly weak expected return, due to the high valuation. The stock’s current valuation is well above our target, and a decline toward fair value would be a significant tailwind for investors buying at the current price.
Ecolab’s dividend is not likely to represent a large portion of total returns. This is because the current dividend yield is just 1.1%. This is about half the average dividend yield of the S&P 500 Index.
Final Thoughts
Ecolab is a time-tested Dividend Aristocrat, with an excellent track record of profitability and growth. However, now is not the best time to buy the stock, due to its high valuation and low dividend yield.
Ecolab is not likely to be an attractive stock for investors interested solely in high levels of income. That said, it is a very strong stock for investors interested in a recession-resistant business, and dividend growth.
