Like most private investors, I drip-feed money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.
However, the FTSE 100 is up by 90% on its March 2009 low, and the wider market is no longer cheap. It’s getting harder to find shares that meet my criteria for affordability.
In this article, I’m going to run my investing eye over Unilever (LSE: ULVR) (NYSE: UL.US), to see if it might fit the bill.
The triple-yield test
Today’s low interest rates mean that shares have become some of the most attractive income-bearing investments available.
To gauge the affordability of a share for my portfolio, I like to look at three key trailing yield figures — the dividend, earnings and free cash flow yields. I call this my triple yield test:
| Unilever | Value |
|---|---|
| Current share price | 2,450p |
| Dividend yield | 3.6% |
| Earnings yield | 5.3% |
| Free cash flow yield | 5.5% |
| FTSE 100 average dividend yield | 2.8% |
| FTSE 100 earnings yield | 5.8% |
| Instant access cash savings rate | 1.5% |
| UK 10yr govt bond yield | 2.7% |
A share’s earnings yield is simply the inverse of its P/E ratio, and makes it easier to compare a company’s earnings with its dividend yield.
Unilever’s earnings yield of 5.3% is slightly below the FTSE 100 average, but Unilever’s underlying financial strength and quality is illustrated by its free cash flow yield of 5.5%, which highlights the consumer goods giant’s ability to convert paper profits into surplus cash.
A dividend yield of 3.6% is nearly 30% higher than the FTSE 100 average, and Unilever’s payout is covered 1.5 times by the firm’s free cash flow, making it very safe. Unilever has increased its dividend payout every year for more than 20 years, and to have done so while retaining strong free cash flow cover is impressive, suggesting this firm is a prince amongst dividend payers.
Is Unilever a buy?
Unilever’s share price has fallen by around 15% from last year’s peaks, and the firm’s stock now looks much more sensibly priced, in my view.
My only reservation is that Unilever’s shares still trade at a fairly lofty P/E of 18 times 2014 forecast earnings, ahead of the FTSE average of 14.8 times forecast earnings. I think that Unilever’s superior quality justifies this premium, but such a strong rating could leave Unilever’s share price exposed if the emerging market slowdown affects Unilever’s sales or margins more seriously than expected.
