There are some FTSE 100 stocks that almost everybody should consider for their portfolio, and the following two would always be high on my list. The trick is knowing when to buy them, and a good opportunity may have now presented itself.
That sinking feeling
Last time I checked out pharmaceutical giant GlaxoSmithKline (LSE: GSK) its valuation was heading towards 25 times earnings, which struck me as pricey even for this long-term income machine. However, Glaxo’s share price has fallen 10% over the last month reducing the valuation to a more amenable 20 times earnings. Does that make it a buy today?
Glaxo still isn’t cheap but the drop is surprising given that last month it reported a 23% year-on-year rise in profits from £538m to £808m. This expectations-busting result was driven by the falling pound, which makes overseas profits worth more once converted back into sterling. Profits rose 8% at constant exchange rates. More impressively, new product sales grew a whopping 79% to £1.21bn, driven by HIV and respiratory treatments, plus meningitis vaccines.
Run for cover
Despite that, sceptical voices were raised, pointing out that net debt has increased by 37% from the start of 2016 to £14.7bn with the weaker pound driving up the cost of dollar borrowings. Many investors buy Glaxo for its dividend and although that’s a generous 5.2% at the moment, cover is currently a weak 0.9. Nobody invests in Glaxo expecting the dividend to be cut but it can’t be completely ruled out.
Glaxo fans may also be surprised to see that the company has suffered four consecutive years of falling earnings per share (EPS), including hefty drops of 12% in 2014 and 21% last year. However, a turnaround is in sight, with a 31% rise forecast this year, followed by another 10% in 2017. The pharmaceutical sector has also got a lift from Donald Trump’s victory, as many feared Hillary Clinton would squeeze drug pricing. Today’s valuation is forecast to fall to 15 times earnings, helped by the strong EPS, so there may be an even better buying opportunity in the months ahead.
Household goodie
Household goods giant Unilever (LSE: ULVR) is another FTSE 100 favourite that regularly trades at valuations as high as more than 25 times earnings. But after dropping nearly 12% in the last month, it has now dipped to ‘only’ 21 times earnings. The company cashed in on the falling pound post-Brexit only to slump after suffering reputational damage in the Marmite war with Tesco.
Weaker sterling isn’t all good news as it drives up the cost of imported raw materials. Sales increased 3.4% at constant currency rates, but due to the negative 3.4% currency impact in the quarter turnover was virtually flat at €13.4bn. Trading conditions are also tough as demand remains weak in certain markets. An emerging market slowdown in the wake of the Trump victory could also hit the bottom line hard, and I don’t like to think what a trade war might do.
But in contrast to Glaxo, Unilever has delivered four consecutive years of EPS growth and this is set to continue with 8% growth this year and 10% in 2017. That reduces the forecast valuation to 19.7 times earnings. Unilever still looks a strong bet to me, and today’s valuation may be as good as it gets.
