Investors like to classify them as defensive companies. That’s because their operations tend to exhibit some immunity to the ups and downs of the wider economy. In many ways, the goods they supply are essential rather than discretionary. People tend to keep buying cleaning, food and personal care products, whatever the economy is doing.
However, customers are free to use goods produced by other suppliers, such as supermarket own-brands and other options. But to combat that tendency, these companies work and reinvest hard to promote and maintain their brands. And brand strength can make the difference between a good business and a poor one.
Two of the best stocks to buy?
I’d want these two stocks in my diversified portfolio. The underlying businesses tend to produce consistent cash flow, which is good for servicing shareholder dividends. But which one is the best buy now?
At the end of April in the first-quarter trading statement, Unilever delivered an optimistic long-term outlook statement. Chief executive Alan Jope said the business made a “good” start to the new trading year. And he’s “confident” of underlying sales growth in 2021 of between 3% and 5%.
And in the same week, Reckitt’s chief executive, Laxman Narasimhan, said the new trading year started “well” with like-for-like net revenue growth of just over 4%. Looking ahead, he reckons the balance in the company’s portfolio of products positions it well. And he’s “confident” in the outlook for both 2021 and the medium term.
There isn’t much difference in the recent trading performances and outlook statements for the two businesses. But Unilever’s valuation looks a little lower. With the share price near 4,346p, the forward-looking earnings multiple for 2022 is just over 19. And the anticipated dividend yield is around 3.5%.
Meanwhile, with its share price near 6,642p, Reckitt’s forward-looking multiple is just under 20. However, the anticipated yield is only 2.7%. But City analysts expect earnings to grow by just over 6% in 2022 for Unilever and by almost 10% for Reckitt.
However, those valuations are quite full when compared with anticipated growth in earnings. And that’s one risk shareholders face with both these stocks. If earnings fail to grow as expected, we could see the valuations contract and I’d lose money on the shares. The market may also decide to downrate the valuations, even if earnings do hit the targets. All shares come with risks.
Unilever has the edge regarding historical quality indicators because of its return on capital running near 18% and its operating margin of just over 16%. Those numbers compare with Reckitt’s return on capital of almost 9% and its operating margin just above 15%.
Reckitt’s business appears to be improving fastest. But Unilever’s valuation looks a little lower and the dividend yield is higher. Meanwhile, both stocks are trading below recent highs. If I really did have to pick just one, Unilever would be my choice by a whisker. However, I’d be comfortable owning either stock right now.
Kevin Godbold owns no share mentioned. The Motley Fool UK has recommended Unilever. 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.