As all Foolish investors know, usually you pay for what you get.
Indeed, companies that trade on large discounts to their respective sectors often trade as such a price level for good reason — normally because they have uncertain prospects or lack the quality of other companies in their sector.
Similarly, other companies sometimes deserve to trade on a premium to their peers due to strong fundamentals and encouraging future prospects.
However, the above does not always hold true and Reckitt Benckiser (LSE: RB) (NASDAQOTH: RBGLY.US) could be a company that has the characteristics of a premium-player and the price of a discount-deliverer.
Indeed, Reckitt Benckiser currently trades on a price to earnings ratio of 17.5, which is a discount of 8.4% to the Household Goods and Home Construction Sector P/E of 19.1.
Certainly, there are a number of high quality companies in that sector, but it seems rather unjust that Reckitt Benckiser trades at a discount to them, since it appears to have at least as much quality as any of its peers and, in fact, may deserve to trade at a premium, rather than a discount, to its sector.
One reason for this is the huge barrier to entry that Reckitt Benckiser currently enjoys. Its brand portfolio is extremely well-diversified and benefits from a large degree of customer loyalty. Although it is possible to compete with the brands it sells, and new companies could enter the marketplace, they would be highly unlikely to take a large chunk out of Reckitt Benckiser’s sales or profitability.
The main reason for this is the practical difficulty of competing with well-established brands. Although no brand is impregnable, those such as Dettol, Finish and Strepsils are viewed almost as products in their own right, with many repeat consumers giving little thought to switching to a different brand. This provides Reckitt Benckiser with the opportunity to deliver higher prices (and margins) because demand for their goods is less sensitive to changes in price (price elasticity of demand).
Due to this, new entrants are likely to compete solely on price, reducing their margins and making the industry suddenly seem far less attractive in the long run.
So, while any of the brands owned by Reckitt Benckiser could fall prey to a new rival, it’s unlikely, and this gives the company a high degree of stability going forward. As such, a premium to the sector of 8.4% (rather than a discount of 8.4% as is currently the case) could be warranted.
This would mean shares trade on a P/E of 20.7 and would price them at 5465p – over 18% higher than the current share price.
With a yield of 3% on top of this, gains of 20% or more seem achievable over the medium to long term.
Peter does not own shares in Reckitt Benckiser.