Such companies have powerful brands, strong margins and prodigious cash flows. They perform relatively well when economic conditions are challenging. And, with their entrenched positions in developed markets, and increasing expansion into higher growth emerging markets, they have a structural tailwind for long-term growth. As such, investors are happy to pay a premium price.
“Buy on the dips” has been good advice over the years for these quality businesses, whose shares have risen without the great peaks and troughs that characterise cyclical companies.
With the world fretting about a Grexit, the FTSE 100 is down some 8% since hitting an all-time high in April. Unilever, Reckitt and Diageo have performed a little better than the wider market, but have certainly dipped significantly. Unilever and Diageo are both down 7% from their 2015 highs, while Reckitt is off by 6%. So, is now a good time to buy?
When I looked at Unilever back in April, the forward price-to-earnings (P/E) ratio was a rich 22.5, with a prospective dividend yield of 3%. By May, the P/E had come down to 21.4 and the yield had edged up to 3.1%. I said at that time I thought Unilever could deliver decent long-term returns, but that, ideally, I’d be looking for an opportunity to buy a bit lower.
Despite the share price now being lower, the valuation is little changed — the P/E is 21.2 and the yield is still at 3.1% — due to some downward revisions in analysts’ earnings and dividend forecasts. As such, I have to reiterate my view on Unilever from May.
In April, Reckitt Benckiser’s forward P/E of 25 was even higher than rival Unilever’s, while the yield of 2.1% was lower. By May, Reckitt’s P/E had come down to 23.8. I thought the rating was still a little high, but did note that Reckitt has often surpassed analysts’ earnings forecasts in the past.
Like Unilever, Reckitt has seen some recent downgrades to earnings and dividend forecasts, so the valuation is little changed from May, with the P/E at 23.9 and a yield of 2.2%. Once again, despite the dip in the shares, I have to reiterate my previous view on Reckitt.
Global drinks group Diageo is another consumer goods company I looked at in April. At that time Diageo appeared somewhat better value than Unilever and Reckitt, being on a forward P/E of 20, with a yield of 3%. And I was bullish on Diageo’s prospects, when writing in May with the stock on a similar valuation.
Unlike Unilever and Reckitt, whose financial years coincide with the calendar year, Diageo has a June fiscal year end. When I was writing in April and May, my valuations were based on forecast earnings and dividends for June 2015. While Diageo hasn’t released its results for the year yet (they’re due on 30 July), I think it’s now appropriate to look to forecasts for the year to June 2016. The P/E is 19.6, with a yield of 3%, so, while I’m modestly positive about Unilever and Reckitt, I remain more attracted by Diageo’s valuation.
G A Chester has no position in any shares mentioned. The Motley Fool UK owns shares of Unilever. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.