Investing Basics: Is P&G King?

In Part 1 of this series , we ran Procter & Gamble (NYS: PG) through the merciless gauntlet of Motley Fool co-founder Tom Gardner's seven criteria for "rule maker" businesses. We determined that while P&G is a potential rule maker, it can't ascend the throne just yet.

First it has to pass another Tom Gardner-devised series of tests. By looking at many of the same metrics as before, here measured over time, we'll assess P&G's business momentum and determine once and for all whether it's worthy of the rule maker throne, and your investment.

1. Holding the line
We like a big gross margin and we like to see it going up. For the quarter ending June 30, the gross margin is 48.3%. For the same quarter last year, it was 49.5%, for a decrease of 1.2%. Not ideal, but not bad, and fully attributable to the company's quest for growth abroad.

2. Inching forward
When we have a rising net margin, we get more and more out of every dollar of revenue. P&G's is currently 12% and was 11.5%, for an uptick of 0.5%. Well done, P&G.

3. Inching backward
The Foolish flow ratio should get smaller over time. At this time last year it was 0.65, and now it's 0.70 -- still an excellent number, but trending ever so slightly in the wrong direction. It could be just a blip, or a sideways move, but to be safe keep an eye on it in the quarters ahead.

4.Tears of joy
When a company buys back shares of its own stock, it shrinks the size of the ownership pie, making the shares you own more valuable. In 2011, P&G repurchased $7.0 billion of its own stock, enough to make any investor weep for joy.

5. Money is cheap
P&G's long-term debt went up while cash went down, but as we explained in Part 1 of this series, P&G uses debt to fuel its acquisitions. Peers Colgate-Palmolive (NYS: CL) and Clorox (NYS: CLX) have similar cash-to-debt ratios for the same reason. With money as cheap as it is right now, it's a reasonable move.

6. It's P&G's world; we just live in it
The final metric is a subjective one and depends on your answers to the following questions:

a. You know and love the company's products, but do your friends?
b. Is worldwide expansion believable?
c. Is the company accurately reflecting its performance through conservative accounting?

My answer to all these questions is a resounding "yes." P&G's brands are iconic, the company is already growing them around the globe (growth abroad is P&G's primary growth driver), and the books look to be in good order.

King of the world, ma!
P&G has done it. With a bit of a pass on the Foolish flow ratio and an understandably inverse cash-to-debt ratio, P&G has passed all the tests Tom Gardner could throw at it, leaving no doubt it's a rule maker and worthy of your investment.

The metrics we used here and in the article preceding should be applied to all of your rule maker investments each quarter, when the company reports earnings. For a look at rule makers in even greater detail, pick up a copy of The Motley Fool's Rule Breakers, Rule Makers. Otherwise, sit back and relax. When your money is with a rule maker, it's in good hands.

At the time thisarticle was published Gillette razors leave Fool contributorJohn Grgurich's face feeling smooth and silky, but he owns no shares of any of the companies mentioned in this article. The Motley Fool owns shares of Clorox.Motley Fool newsletter serviceshave recommended buying shares of Procter & Gamble and Clorox. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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