A key element of successful investing is ensuring that you don’t overpay for companies. Having the patience to wait for a pullback before investing can make huge differences to your overall long-term returns.
Today I look at what I believe to be three core portfolio holdings, but explain why I think it’s now worth waiting for such a pullback before buying these companies.
Drinks manufacturer Diageo (LSE: DGE) is a favourite stock for both UK and US investors, being listed in both countries.
Over the last five years, Diageo has rewarded UK shareholders well with total annualised returns of over 13%, beating the FTSE 100 return comfortably. But with the stock spiking higher since Brexit and now up almost 15% year-to-date, investors will be wondering whether now is the time to buy.
Personally, I believe it’s worth waiting for a better opportunity to buy Diageo. The stock is trading on a P/E ratio of 24 times next year’s earnings, which seems a little lofty for a company that saw its net sales fall 3% and earnings per share drop 6% in FY2016.
Another indicator that tells me Diageo isn’t trading cheaply is its dividend yield. When it was at around 1,800p back in June, the FY2016 dividend payout of 59p equated to a yield of 3.3%. However with the stock jumping to above 2,100p, the yield has been pushed down to 2.7%. That’s a little below what I generally look for as a dividend investor, so for that reason, I’ll leave Diageo on my watchlist and look to buy when turbulent markets provide an opportunity.
There’s been a huge rush to so-called ‘defensive’ stocks since Brexit, and Unilever (LSE: ULVR), the owner of brands such as Domestos, Flora and Dove is seen as a classic defensive stock due to the nature of its recession proof earnings.
Demand for the stock has seen its share price jump over 10% since Brexit, taking its year-to-date gain to an impressive 26%. So is it too late to buy?
I’ve no doubt that Unilever is a high-quality company, however I won’t be pulling the trigger on a buy order for this consumer goods champion just yet. City analysts expect revenue growth to be flat for FY2016 and dividends to grow at under 2% for the year, an underwhelming performance for a company trading on a P/E ratio of 23 times next year’s earnings.
As much as I believe Unilever would make an excellent core portfolio holding, I’ll continue to monitor the stock for a more attractive entry point.
In a similar fashion to Unilever, Reckitt Benckiser Group (LSE: RB) manufacturers products that consumers buy irrespective of the business cycle. The owner of Dettol, Veet and Durex has performed admirably over the last five years with total annualised returns of a huge 20% per year. And demand for this high-quality stock has seen its share price spike post-Brexit, with the company now up 17% this year.
But with the stock trading on a P/E ratio of 25 times next year’s earnings, I think it looks a little pricey, especially given its low dividend yield of 1.99%, which is around half the average FTSE 100 yield.
Reckitt Benckiser could make an excellent long-term holding, but at the current price I believe it’s overvalued.
A dividend stock going cheap
While the stocks above are all looking quite expensive, there are definitely still bargains to be had.
If you’re looking for a stock that offers a healthy dividend yield at an attractive valuation, I’d urge you to read this free report from The Motley Fool: A Top Income Stock.
Edward Sheldon has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended Diageo and Reckitt Benckiser. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.