Why You May Be Tempted To Sell Associated British Foods plc & NEXT plc To Buy Monitise Plc & Tullow Oil plc

I have been wondering for a month or so whether it would be a good time to sell high-quality names such as Associated British Foods  (LSE: ABF) and NEXT  (LSE: NXT) to add risk to a diversified portfolio by acquiring Monitise (LSE: MONI) and Tullow Oil (LSE: TLW). If I were invested I wouldn’t do the switch right now, but here are a few things you should consider about the valuations of these four companies before making up your mind.

More Upside For Associated British Foods As It Restructures

ABF is a strong business, with a strong balance sheet and declining debts. ABP is a solid long-term investment, which may struggle, however, to deliver short-term value from this level (£31), unless ABF manages to fix or sells its sugar business. ADB is downsizing its sugar unit, while proceeds from divestment could be used to further cut debt, which is manageable at present. 

The stock currently trades in line with the average price target from brokers, and is on a price-to-earnings (P/E) ratio of 32x and 26x for 2015 and 2o16, respectively. ABF has lost 6% of value since the all-time high it recorded in early December, but based on fundamentals it could comfortably hit £40 by the end of the year, and that’s my suggested price target.

NEXT Isn’t Overpriced

Similarly to ABF, NEXT has beaten market consensus estimates for several quarters now. The average price target from brokers is £68, for an implied downside of about 5% from its current level. Next stock trades at 17.5x, 16, and 15x earnings for 2015, 2016 and 2017, which seem reasonable forward trading multiples in the light of Next’s prospects for earnings and dividend growth, which will likely be supported by rising revenues and cash flows over the years. Of course, the risk is that Next, just like ABF, will continue to grow fast, but not fast enough to please investors. I doubt that will happen in 2015 and 2016.

If the bears are right, however, is it worth considering other risk profiles such as Monitise and Tullow Oil? 

Monitise/Tullow Oil On The Radar 

The shares of Monitise have been hammered in recent times, and rightly so. But do they offer compelling value at this price? 

It takes a huge leap of faith to invest in the company right now, but the cheaper the stock gets, the more likely is that Monitise will be taken over, in my view. That’s its main attraction, and I struggle to find any other reasons why anybody would hold a long position in the stock. Monitise said Friday it had been approached by third parties, in a move partly aimed at supporting its highly volatile stock price, in my view. 

Should you believe that? 

I am not sure, but short-term gains could be 50% or more: this is an opportunistic bet, and as such I’d advise any investor to add only 0.5% of Monitise stock to their portfolio. The stock is up more than 20% on Monday. 

A different story is Tullow, which has lost about 70% of value in the last two years. While Tullow appears to be convinced that its debt level and costs base are under control and that its assets could easily attract suitors — as the company recently pointed out in meetings with analysts — it remains unclear how its equity valuation could bounce back in the current market environment. 

Perhaps managers know more than we do about the appeal of the company’s assets to third parties….

Next and ABF still offer a better risk profile in this market, but I also believe this is a good time to invest in shares offering enticing yield prospects rather than growth or takeover potential. Hence, you should learn more about all the bargain opportunities identified in our free report -- one of them offers a market-beating yield of 4%, is a defensive play and will likely reward you with hefty capital gains for some time.

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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has recommended Tullow Oil. The Motley Fool UK owns shares of Monitise. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.