The old saying ‘you get what you pay for’ is usually true. Whether it’s a house, a car, clothes or food, if you pay more then you tend to receive a better product or service. Of course, it’s not always the case, and there are most certainly a number of exceptions but, generally speaking, it tends to hold sway in most walks of life.
Where it certainly does not have relevance, though, is in the world of investing. That’s because, while many investors will become more and more excited if a company’s share price is high, and will speculate to a greater extent, the chance of making a better return from your investment does not improve. In other words, paying a higher price can limit your upside, and increase your downside.
As such, stocks such as ASOS (LSE: ASC) are relatively unappealing. Clearly, investors in the online fashion company are getting excited; its shares have risen by 50% since the turn of the year, after all. And, while they do have considerable future potential via an improving UK economy and the scope to further expand abroad, ASOS’s valuation could limit future returns. For example, the company currently trades on a price to earnings growth (PEG) ratio of 2.7, which indicates that unless its bottom line begins to grow at a much faster rate, its share price may come under pressure.
In fact, Reckitt Benckiser (LSE: RB) is in a similar position. Certainly, it is a top quality business with excellent long term prospects in emerging markets, but its current PEG ratio of 2.8 indicates that its share price could come under pressure in the short term.
Of course, earnings growth is set to pickup next year following a number of challenging years, but the company’s price to earnings (P/E) ratio appears to be too high relative to other global consumer stocks, such as Diageo (LSE: DGE) (NYSE: DEO.US). It trades on a P/E ratio of 20.8, which is 10% lower than Reckitt Benckiser’s P/E ratio of 20.2. And, with Diageo’s outlook set to improve in-line with that of Reckitt Benckiser, Diageo appears to offer much better value than its consumer goods peer.
In addition, Diageo may prove to be an acquisition opportunity for one of its beverage peers. That’s at least partly because of its wide range of premium brands and strong position in the Asian market, with it having joint ventures in China and India, where growth in premium spirit consumption is set to increase dramatically over the medium to long term.
Likewise, Wolseley (LSE: WOL) appears to have sufficient potential to back up its premium rating. For example, it is forecast to continue to benefit from an improving US and UK economy, with the building materials company forecast to increase its bottom line by 15% this year, and by a further 14% next year. As such, its P/E ratio of 17.6 appears to be good value for money due to it equating to a PEG ratio of just 1.1. Therefore, while Wolseley’s share price has soared by 22% in the last year, it appears to be worth buying at the present time.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has recommended ASOS and Diageo (ADR). The Motley Fool UK owns shares of ASOS. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.