Diversification is a very important consideration for all investors. That’s because it reduces company-specific risk and can mean that returns are less volatile and major losses are kept to a minimum.
As such, it makes sense to have a range of companies within a portfolio, in terms of the sectors in which they operate, their geographical exposure and, perhaps most importantly, with regard to the type of return which they may offer.
In other words, while some companies such as United Utilities (LSE: UU) can be expected to offer much of their future returns via income, others such as Tesco (LSE: TSCO) are more likely to boost an investor’s profits through their growth prospects.
In fact, Tesco is forecast to grow its bottom line by a staggering 23% next year which, for most investors, may come as something of a surprise. That’s because the UK supermarket sector is forecast to see competition increase, rather than decrease, in the next couple of years. For example, Aldi and Lidl are planning a major push into London which could lead to a ramped-up price war in the capital.
Tesco, though, seems to be doing all of the right things to turn its fortunes around. It is improving customer service, reducing the range of products sold in its stores so as to improve efficiency, while it is also mothballing large supermarket store building. In addition, it is also focusing almost exclusively on UK food in future, which should allow it to drive through further efficiencies and trim some of the fat that has made the company look rather bloated in recent years. And, with the stock trading on a price to earnings growth (PEG) ratio of 0.7, its strong growth potential appears to be on offer at a very reasonable price.
Meanwhile, consumer goods company, Reckitt Benckiser (LSE: RB), provides diversification for investors. That’s because it operates across the globe and so, unlike Tesco, is not highly dependent upon the performance of the UK economy. And, looking at the long term growth potential for consumer staples and consumer discretionaries, the emerging world seems to offer stunning prospects.
Of course, Reckitt Benckiser’s shorter term appeal is somewhat less impressive. For example, earnings growth of 3% this year and 7% next year is hardly exceptional and, while the company has a very bright long term future, much of this potential appears to already be priced in via a price to earnings (P/E) ratio of 24.3. And, with a dividend yield of just 2.1%, Reckitt Benckiser lacks income appeal, too.
So, while it is a great means of diversifying geographically and, over the next handful of years is likely to post encouraging growth numbers, Reckitt Benckiser lacks appeal compared to the likes of Tesco and, on the income front, to United Utilities.
That’s because United Utilities, following its recent share price fall which has seen it shed 8% of its value in just three months, now yields a hugely enticing 4.4%. Looking ahead, it is expected to increase dividends by 2.2% next year, which is likely to be well ahead of inflation. Furthermore, United Utilities is a very stable business that is very likely to continue to make rising shareholder payouts over the medium to long term. This is evidenced by its track record of having increased dividends per share in each of the last five years, with them having risen by a total of 28.5% during that time period.
So, while Tesco and United Utilities offer excellent growth and income potential respectively, Reckitt Benckiser remains a high quality, diversified stock for the long term. But, with a relatively rich valuation, it may be worth waiting for a keener price before adding it to Foolish portfolios.
