The Most Important Number for Procter & Gamble Co.

By Markets Fool.com

Source: P&G.

Continue Reading Below

To say that Procter & Gamble's business is going through some turmoil right now would be a major understatement.

Revenue is down 10% over the last six months, earnings dove 40% in the fiscal year that ended in August, and the consumer goods titan is losing over 100 of its brands -- including powerhouse franchises like Duracell batteries and Coty's beauty products.

In that context, there's a good reason why executives use the word "transformation" to describe P&G's current situation. By fiscal 2019, the company will look very different than what shareholders see right now.

Those changes make it even more important for investors to follow the single metric that best expresses the health of P&G's operations: organic sales growth.

What and why
Executives define the figure as "net sales growth excluding the impacts of foreign exchange, acquisitions, and divestitures." In other words, the metric strips out the noise of currency swings (from P&G's huge international business) and brand sales (which are surging) to show an apples-to-apples picture of growth from one period to the next.

Continue Reading Below

There are two equally important pieces that make up organic sales growth: price and volume. Healthy organic growth includes a mix of both, since volume gains imply increased consumption while rising prices reflect healthy demand and pricing power.

Organic sales growth forms the foundation of P&G's entire growth strategy. In fact, its key operating goal, according to the 10-K report, is to achieve "organic sales growth above market growth rates in the categories and geographies in which we compete." P&G's two other long-term targets, around earnings per share and free cash productivity, flow directly from success on that overarching goal.

Recent trends
The biggest news for P&G lately is that its organic sales growth improved sequentially last quarter for the first time in almost two years. Whereas it was routinely booking figures like 4% in early 2013, the number fell to 2% for most of 2014 and even slipped into negative territory last year before rebounding in fiscal Q2:

Source: P&G investor presentation.

Part of the reason for that slowdown has been the unprecedented number of international hot spots that P&G operates in. Political and economic turmoil in countries like Venezuela, Brazil, China, and Ukraine have weighed on sales.

Still, P&G significantly trails rivals on this metric. Kimberly-Clark , whose Huggies diaper brand competes with P&G's Pampers franchise, saw organic growth of 5% in 2015 and Unilever's gain was 4.1%. Both of these giants said the global market was challenging last year, but they still managed to gain share.

In addition, P&G has seen lower quality organic growth than either Kimberly-Clark or Unilever. Its organic gains last quarter, for example, were entirely driven by pricing changes (volume was actually negative). In contrast, rivals' organic gains were powered by a healthy mix of both. Unilever's 4.1% gain last year came more from volume (2.1%) than pricing (1.9%).

What to watch
For the fiscal year that ends this August, P&G's outlook calls for flat organic sales growth at the low end of its forecast range, which leaves the door open for a third year of unusually low growth. Management's brand divestments should help boost the figure, though, since the company removed many of its slower-growing franchises in favor of the ones with the best potential.

P&G believes its expansion pace should improve by about a full percentage point once its portfolio is whittled down to about 65 core brands. Profits will likely surge in the coming years, mainly thanks to cost cuts, and cash returns to shareholders will spike as well. However, those positive trends won't be sustainable unless P&G raises its organic growth back up to the market-beating 3% to 5% range.

The article The Most Important Number for Procter & Gamble Co. originally appeared on Fool.com.

Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool recommends Kimberly-Clark, Procter & Gamble, and Unilever. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.