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Experian plc isn’t the only Footsie stock on my watchlist for 2018

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Experian (LSE: EXPN) issued a Q3 trading update today. It reported “good progress” during the period, with organic revenue growth of 5% at constant exchange rates and total growth of 8% at actual rates.

The shares are not far below their all-time high, trading at around 1,650p as I’m writing. I’ve never been altogether confident about what kind of valuation this FTSE 100 firm merits. To provide some comparison, I’m first going to discuss a blue-chip peer, whose shares have also recently made record highs.

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Popular tipple

Diageo (LSE: DGE) is the world’s largest producer of spirits. The likes of Johnnie Walker, Smirnoff and Captain Morgan are internationally renowned, of course, but the group owns a truly outstanding collection of 200 brands. It can rightly boast that “old and new, global and local, the breadth of our portfolio is second to none.”

The strength of its brands, customers in mature and emerging markets the world over, and the ‘defensive’ nature of the business (alcohol consumption isn’t hugely impacted by economic cycles) mean Diageo is a rare and valuable company. These characteristics help it earn a profit margin of near to 30% and make it a highly desirable business for investors to own shares in.

All well and good, but how much should we be willing to pay for the shares? Analysts are expecting the company to post earnings of 116.2p a share for its financial year to 30 June, with a 9% increase to 126.7p in fiscal 2019. At a share price of 2,600p, we’d be paying 22.4 times current-year earnings and 20.5 times next year’s.

These earnings multiples are towards the higher end of Diageo’s historical range, so ideally I’d be looking for a bit of a dip in the shares to consider buying. A prospective dividend yield of 2.6% also tells me to hold off for a lower price, because a yield of nearer to 3%, or even above, has been gettable on occasions in the past when the stock hasn’t been quite as popular a tipple with investors as it is today.

Credit where credit’s due

Returning to Experian, analysts are forecasting earnings of 70.7p a share for its financial year to 31 March, with a 9% increase to 77.3p in fiscal 2019. At a share price of 1,650p, we’d be paying 23.3 times current-year earnings and 21.3 times next year’s. These multiples are somewhat higher than Diageo’s, while earnings growth is similar, and I note also that Experian’s prospective dividend yield of 2% is significantly lower than the drinks giant’s.

Does Experian merit such a premium rating? My Foolish colleague Ian Pierce has argued that the characteristics of the company mean the rating isn’t too lofty. He pointed out that Experian is by far the largest of three giants in the industry and that there are incredibly high barriers to entry for new competitors. I agree it is an attractive business but I’m not convinced it merits quite the premium it currently trades at.

Its profit margin is excellent at 25%, but not as high as Diageo’s, and parts of its business may not be quite as defensive. Today’s update reported flat revenue in the UK and Ireland, with growth in business-to-business undermined by a decline in consumer-facing sales. For these reasons, I’d be looking for a somewhat lower entry price.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo and Experian. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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