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Is The Reward Worth The Risk With BT Group plc, Admiral Group PLC, Smith & Nephew plc And Associated British Foods plc?

BT (LSE: BT-A)Admiral (LSE: ADM)Smith & Nephew (LSE: SN) and Associated British Foods (LSE: ABF) look a bit pricey right now — their shareholders are not all in the same boat, however…

In fact, while investors should be comfortable with the valuation of BT and ABF, I am not sure why anybody should be particularly upbeat about S&N and Admiral. Here’s why. 

BT: Short-Term Vs Long-Term Value 

The risk/reward profile of BT still points to value for at least a couple of quarters. I know that’s not much for value investors, but there are obvious risks, spanning the integration of mobile operator EE and BT’s pension deficit. 

The headline news last week was the launch of new 4G mobile data bundles for its existing broadband customers. BT claimed to have moved back into the mobile market after more than a decade “with the launch of great value deals with bundles of 4G data, minutes and texts for as little as £5 a month for people living in a BT Broadband home”.

Investors love BT’s current strategy, and are happy to pay up for incremental earnings generation, with the stock up 25% since November, when first M&A rumours emerges. At 482p, the average price target from brokers is only 25p above BT’s equity valuation, so the shares may receive a fillip from upbeat reviews from analysts in the next few quarters. 

I expect prolonged weakness in Vodafone, so BT remains my top pick in the sector. 

ABF: Appealing At This Level, It’s Not A Bargain

ABF’s interim 2015 results are due in less than four weeks, and this may be a great time to add the shares of the Primark owner to your diversified portfolio. Whitbread is also a valid alternative: it trades in line with ABF based on cash flow multiples, but commands a 20% discount based on its net earnings multiple. 

The average price target from brokers stands at 3,200p, about 10% above ABF’s stock price. What’s interesting, perhaps, is that the spread between the share price and consensus estimates is widening because of a declining stock price, so either investors are undervaluing the stock or analysts are plainly wrong about ABF’s potential. 

I think that ABF is a very solid investment that will reward patient investors who do not want to worry too much about the value of their holdings on a daily basis, although I appreciate that, at 32 times forward earnings, there may be better value elsewhere — but then I wouldn’t opt for S&N and Admiral, which are cheaper. 

Admiral Trades Above Fair Value, Dividend At Risk

Admiral trades above fair value based on the value of its net assets, in my view.

It has been boosted by a slew of upgrades from brokers: most recently, UBS and Goldman Sachs raised their price targets to 1,450p and 1,500p, respectively. The shares currently trade at 1,546p, and have risen more than 20% since the end of last year, but until then Admiral had struggled to deliver value for more than three years. 

Its stock is expensive at 17 times forward earnings, and its payout ratio may have to come down if core operating cash flow deteriorates further, which is a distinct possibility. This is not an investment for me, and I am not a big fan of the broader insurance sector at this point in the business cycle, either — although I do not dislike Aviva and Prudential

Smith & Nephew: I Am Not Interested At This Price

My advice is to avoid Smith & Nephew if you can. This is not a bad business, but its valuation is still too high and the shares will go nowhere for some time, in my opinion. 

S&N might be a buy at 900p a share, which implies it should trade 15%-25% lower in order to be added to my wish list. Its share price is roughly in line with the average price target from brokers, but unless a break-up is being carried out, I struggle to see any reasons why value investors would invest in it. 

In fact, its fundamentals and a low dividend yield do not justify a valuation in the region of 25 times forward earnings…

I would forget about S&N and Admiral, but consider between 2% and 5% of BT and 3% of ABF for my diversified portfolio, which would also include these income and growth stocks, which have been included in our free report! 

Their average all-in return has beaten the FTSE 100 to the punch year to date, and one defensive pharma stock, in particular, could well reward shareholders with a 40% pre-tax return to the end of the year, if recent trends are anything to go by.

This value candidate has a strong balance and a 5% forward yield. To find out more, click here right away!

Alessandro Pasetti has no position in any shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.