Are Unilever plc And Ocado Group PLC Safe Buys In A Tricky Market?

Unilever (LSE: ULVR) shares have beaten the FTSE 100 over almost any timescale you care to name. The group’s share price has risen by 6% over the last year, during a period in which the FTSE has fallen by 11%.

Looking further back, Unilever stock is worth 124% more than it was 10 years ago, plus dividends. By contrast, the FTSE 100 has only gained 2.6% plus dividends.

Under long-term boss Paul Polman, Unilever has delivered what investors want: sustainable, profitable growth. Today’s full-year results are no exception. Sales rose by 4.1% if currency effects are ignored, while core operating profit rose by 12%.

Free cash flow, a key attraction for income investors, rose by €1.7bn to €4.8bn. This comfortably covers the €3.9bn spent on dividends and interest payments last year.

Is Unilever a buy?

Unilever shares trade on a pricey forecast P/E of 20, but do offer a respectable 3.1% dividend yield. I’ve said before that Unilever’s high rating can be justified by its consistent long-term performance, and I still believe this.

However, we can’t ignore the fact that the FTSE 100 is going through a period of correction. We may now be in a bear market. Banking and commodity stocks have all fallen sharply, in some cases to record lows.

I believe there’s a risk that highly-rated growth performers such as Unilever, Reckitt Benckiser and Diageo could start to lose their premium valuations. While they’ve been impressive performers, they all carry quite high levels of debt and are heavily exposed to volatile emerging markets. Earnings growth could slow significantly.

Mr Polman warned today that Unilever is preparing for “tougher market conditions and high volatility in 2016”. I have no intention of selling my Unilever shares, but I won’t be buying any more just yet. I suspect there will be better buying opportunities later this year.

Ocado rocketing on bid rumours

As I write, shares in Ocado Group (LSE: OCDO) have risen by 18% so far today. The gains seem to have been triggered by a press report yesterday suggesting that Amazon may be planning to buy Ocado, in order to jump-start its grocery delivery service in the UK.

The logic behind an Amazon bid is that Ocado already has the infrastructure in place to offer a comprehensive home delivery service across most of the UK. Ocado appears to be good at what it does and Amazon’s marketing power ought to be able to improve sales growth.

On the other hand, Amazon might not bid and if it doesn’t, I don’t see anything to support Ocado’s valuation. The group has failed to sign up any other supermarkets to its home delivery service, despite boss Tim Steiner’s comments suggesting a deal was likely last year.

Ocado’s own grocery sales of around £1.2bn per year are too small to be a serious threat to any of the UK’s major supermarkets. The stock trades on 81 times 2016 forecast earnings. Yet Ocado pays no dividend and has an operating margin of less than 2%.

In my view, Ocado’s valuation can only be justified by hopes of an Amazon bid. If this fails to appear, the stock could fall much further. I believe the shares remain a sell, as they’re fundamentally overvalued.

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Roland Head owns shares of Unilever and Diageo. The Motley Fool UK owns shares of and has recommended 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.