This page is quite old hence its rather spartan appearance.
Why not check out our Latest Stories page for our newest articles or search our site for anything.
By
Rentokil Initial (LSE: RTO) and Unilever (LSE: ULVR) both have pedestrian sales growth prospects. Although there are cost-cutting exercises and the disposing of some operations and brands underway, to improve short term earnings, there are undoubtedly better opportunities elsewhere in the market for a superior longer term investment.
At 268p, Rentokil's price to earnings (P/E) ratio for expected 1999 earnings is 19.9. Or put a more informative way, the P/E ratio inverted gives an earnings yield of 5.0%. The earnings yield for earnings anticipated for 2000 is 5.6% (P/E of 18.0).
The first place to search for a new investment is your own portfolio. Always consider topping up an existing holding first rather than adding an extra holding. Concentrate your investment firepower in a just few stocks. PizzaExpress has jumped far out of reach of our indicated "buy price" (sorry Stuart!), but two other Qualiport constituents look to have undemanding valuations, given their underlying business quality -- Lloyds TSB (LSE: LLOY) and Independent Insurance (LSE IIG).
Although part of this feature covers old ground, I'd like to iron out some outstanding issues, before we start any portfolio reshuffle. One issue could be that we are throwing caution to the wind in terms of valuation when contemplating selling both Rentokil Initial (LSE: RTO) and Unilever (LSE: ULVR) at what seems like the drop of a hat. Are we selling out at undervalued levels and missing out on significant potential upside here?
And are there any other replacement investment opportunities close to hand, as potential top up candidate PizzaExpress (LSE: PIZ) jumps out of reach?
Selling out on the cheap?
A look at some short hand, but straightforward, valuations for Rentokil and Unilever.
Earnings Forecasts
Price 1999 2000
Rentokil 268p 13.5p 14.9p
Unilever 478p 25.5p 28.3p
At 478p, Unilever's earnings yield for expected 1999 earnings is 5.3% (p/e of 18.7). The earnings yield rises to 5.9% (p/e of 16.9) when considering anticipated earnings for 2000.
Compare these earnings yields to risk-free government bonds. Today's Financial Times reports the 5-year UK benchmark government gilt as yielding 6.3% and the 10-year bonds 5.7%. For simplicity, I'll suggest the long term risk-free rate is 6%, the average of both benchmark figures.
I consider using the risk-free rate of return quite appropriate in valuation comparisons with equities. It's a great way to get an easy, instant fix on immediate valuation of shares. If earnings are expected to grow materially in the future, say at a double digit annual rate, and the earnings yield equals the risk free rate, then the shares would look "cheap".
Cost-cutting aside, both Rentokil and Unilever's long term profit growth rates must be in line with their respective long-term sales growth rates. Given that both companies' organic growth rates are around 3%, their current earnings yield must offer a significant premium to that of the risk-free rate to present the Qualiport with any reason to hold the shares.
Under this "significant premium" scenario, we'll essentially be holding Rentokil and Unilever as quasi "value" stocks. That is, waiting for the market to recognise the predictable profit stream as the equivalent to that of risk-free gilts. Share price appreciation in this case would be solely based on a short term market re-rating of the static growth of earnings.
So, is there much immediate "value" left in Rentokil and Unilever? Comparing both companies' earnings yields to the risk-free rate doesn't suggest either company is extremely undervalued, or indeed extremely overvalued. Rentokil's prospective earnings yield is 5.0% this year, rising to 5.6% the year after. Both compare unfavourably with the risk-free rate of 6%.
The same is true, to a lesser extent, with Unilever. The prospective earnings yield of 5.3% this year, rising to 5.9% the year doesn't give an indication of any immediate value.
The above was a brief overview to get a handle on immediate valuations. There's no end of other factors that we could consider. For example, I've ignored the capital reinvestment requirements on earnings retained in the relevant businesses, and whether the accounting earnings I've used are actually reflected as cash earnings.
But at the end of the day, I not so sure that delving much further into Rentokil and Unilever, and poring over complicated calculations, will produce much overall benefit. If we spend time focusing on Rentokil and Unilever, looking for more in-depth valuation conclusions, that's less time spent on other searching more attractive replacements. Neither company fits the overall Qualiport criteria, and both look to be fairly valued at present.
So should we sell now or wait until we find a suitable alternative? If we wait, we could benefit from some unexpected corporate developments. And maybe there could be a lengthy repeat of last week in the near future, the so called "flight to quality". If there's a continuance of the New Year "technology decline", yet more nervous "tech" investors with fat profits could rotate into safe, defensive and dependable companies.
But predicting corporate activities and the actions of the stock market, and indeed other investors, is rather speculative. I agree with Stuart Watson's (TMFTiger) comment on Monday about the proposed switch.
"In my opinion, once a company does not suit your investment strategy it ought to disposed of sooner rather than later. Hanging on for months waiting for the best price possible is too distracting. And why should the market price respond to your belief of value in the short term? Isn't better to look for another company which will offer a better rate of return from this point in time?"
My opinion -- let's sell both Rentokil and Unilever now at these current fair values and focus our attentions on superior investment propositions elsewhere.
A Lloyds TSB top up?
For now, I'll just take a quick peek at Lloyds TSB. Being unfamiliar with the bank, and the industry as a whole, I'm having to go on archived Qualiport reports and old spreadsheets as Bruce does the downhill in the Alps. In fact, there's not a lot I can add to Lloyds TSB, apart from that nothing fundamental appears to have changed about the long term prospects for the bank since last September, when Bruce bought at 755.5p. Granted there's the ongoing hostile takeover bid for National Westminster Bank (LSE: NWB), one or two Internet banks setting up in competition, and Lloyds itself planning to start a pan-European Internet offering at some point. But nothing to suggest Lloyds has lost its overall number one slot in the banking industry.
Indeed profit forecasts for the two years ahead have remained steady over the last few months. But the Lloyds TSB share price has fallen quite noticeably in recent weeks. A combination of interest rate fears and the defection of Graham Pell, the director of Lloyds TSB Retail operations, to NatWest, may have given some concern lately to investors. From 868p last November the shares now languish at 670p. Interestingly, and very commendably, many long term Fools writing on the Lloyds TSB message board have taken the price dip as a buying opportunity.
There would seem a compelling argument to top up with Lloyds -- if Bruce was happy to buy at 755.5p, then an opportunity at a 10% discount is even more attractive. But the one subject I'm not entirely confident on at the moment is putting a "fair price" on Lloyds TSB. Reading the original Lloyds buy report ("Banks are notoriously difficult beasts to value, and evaluate"), and the financially intricate message board links within the report, do give me a start. But I'm not going to stick my neck out just yet on suggesting buying Lloyds. First, I'll have to write a "Dummies Guide to Valuing Banks" feature in this column; look out for it.
Related Links
Company Change Bid DELL(US)-1.30 42.70 EMA -1.16 15.49 IIG -0.04 2.80 MSY +0.04 8.40 PIZ +0.00 8.27 RTO +0.08 2.67 ULVR +0.08 4.77 LLOY +0.06 6.69 Qualiport Stocks Last Rec'd Total # Company Buy Current Change 17/04/98 301 Emap 10.20 15.49 51.8% 22/04/99 542 Misys 5.57 8.40 50.7% 27/10/98 1133 Indep Ins 2.60 2.80 7.7% 04/11/98 245 Pizza Exp 7.93 8.27 4.4% 19/12/97 783 Rentokil 2.55 2.67 4.7% 27/01/99 74 Dell (US) 44.63 42.70 (4.3%) 29/09/99 356 Lloyds TSB 7.56 6.69 (11.4%) 17/07/98 266 Unilever 7.53 4.77 (36.6%) Last Rec'd Total # Company In At Value Change 22/04/99 542 Misys 3065.85 4552.80 1486.96 17/04/98 301 Emap 3139.85 4662.49 1522.65 27/10/98 1133 Indep Ins 2990.63 3172.40 181.85 04/11/98 245 Pizza Exp 1966.34 2026.15 59.81 19/12/97 783 Rentokil 2046.53 2090.61 44.08 27/01/99 74 Dell (US) 2007.42 1915.03 (92.39) 29/09/99 356 Lloyds TSB 2723.20 2381.64 (341.56) 17/07/98 266 Unilever 2052.00 1268.82 (783.18) Cash: £ 57.27 Current Total : £22,127.21 Total Invested: £20,184.62 Profit/(Loss) : £1,942.59 Value Per Share Day Month Year History Qualiport -0.11% +1.34% +1.34% + 4.77% FTSE 100 +0.21% -5.73% -5.73% +11.05% FTSE All Share +0.06% -4.32% -4.32% +16.01%