Why I’m not buying Unilever plc or Reckitt Benckiser Group plc…yet

Image: Unilever. Fair use.

The FTSE100 has delivered around a 6% annually over the long term. It’s an impressive rate for a low-risk, diversified basket of stocks, but its not going to transform your wealth anytime soon.

Stock pickers recognise that and knowingly take on more risk to accelerate the growth of their savings. Today I’m going to explain why Reckitt Benckiser (LSE: RB.) and Unilever (LSE: ULVR) are unlikely to beat that 6% total return over the next few years, in spite of their ‘safe-haven’ status.

In fact, that’s half the problem and you’d be better off buying the FTSE.

Dividend Distractions

Anyone who keeps half an eye on the bond markets will have noted the historically low yields on offer in recent years.

Low bond yields force investors to’reach for yield’ by investing in riskier or pricier prospects (including stocks) to fulfil their income needs. In my opinion, low yields have pushed these investors towards consumer goods giants such as Unilever and Reckitt, running up the share prices.

This makes a lot of sense. These companies sell an incredibly high volume of small-ticket items under dominant brands, which results in consistent sales and cash generation. Plus, we tend to buy toothpaste, deodorant and other such products no matter what the economy is doing.

These defensive qualities appeal to those desperately scrabbling for income, but since the US voted for Trump, bond yields have been climbing rapidly. The yields on even safer vehicles have resulted in a flight of capital out of consumer goods giants and back to the credit markets.

The Fed recently announced the first interest rate rise of the year (and only the second in the past decade) and has predicted further hikes in 2017. If they come to pass, those rate rises will drive bond yields higher still and even more investors will dump so-called safe-haven shares.

Steep price for a cheery consensus

While it’s true that both Unilever and Reckitt are great businesses, it’s also true that this is no secret. Investors and analysts alike have long-championed these companies as suitable core holdings. The underlying businesses are wonderful, I agree, but investors are likely to earn sub-par returns based on current prices.

Unilever trades on a PE of 22 and Reckitt on a PE of 28, which in my opinion is far too high considering lacklustre growth. Reckitt has only grown earnings per share by 1.6% since 2011, while Unilever has barely grown earnings since 2013.

There are short-term headwinds facing these businesses too, including weak sterling that will likely increase the cost of importing raw materials.

These factors could place significant downward pressure on the share prices of these widely-loved companies. Investors would therefore be better served by sitting on their hands and waiting for a better entry point than the 2.7% and 1.9% yields on offer at Unilever and Reckitt respectively. At the very least, I’d expect these companies to yield significantly more than the FTSE 100’s 3.8% before considering a purchase.

But if you’re looking for a solid yield you can buy right now, I recommend you download our free investment report detailing a top income share. Unlike Unilever and Reckitt, the market hasn’t quite warmed up to this company, which is why you can purchase the 3% yield on a PE of 10.

What’s more, the dividend has been growing rapidly, up 45% in 2015 and 10% in 2016.

Click here to get your free copy of the report.

Zach Coffell has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended 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.