So far this year, both stocks have performed brilliantly. Unilever – which I actually tipped as my top stock for 2019 back in January – has surged 24% to around 5,100p, while Diageo’s share price has risen 22% to 3,400p. By comparison, the FTSE 100 is up just 12% for the year. This begs the question: is it too late to buy these stocks now after such a strong run?
At face value, both stocks do look quite expensive right now. Unilever currently trades on a forward-looking P/E ratio of 22.6 while Diageo trades on a multiple of 24.6. That’s not exactly bargain territory. The dividend yields on offer are also quite underwhelming at present. Unilever’s prospective yield is 2.9%, while Diageo’s is a low 2.1%.
However, in my view, Unilever and Diageo do deserve higher valuations than the average FTSE 100 company due to their ‘quality’ attributes. For example, both companies are highly profitable. Unilever’s return on capital employed (ROCE) over the last three years has averaged 25% while Diageo’s has averaged 16%. Both also have strong dividend growth track records. Over the last five years, Unilever has lifted its dividend payout by 35% while Diageo has raised its dividend by 38%. These companies also have significant brand power which should continue to provide them with economic moats, while each has substantial emerging markets exposure, which should drive growth in the years ahead.
So, I don’t think it’s unreasonable that these companies carry higher valuations. The question though is: are the current valuations too high?
I’d wait for a pullback
Personally, I think that both stocks look fully valued right now. With Unilever shares up 25% since March and Diageo up 16% in that time, I’m not seeing a lot of value on offer at the moment. At the current valuations, there’s not much in the way of a margin of safety, meaning there is risk to the downside.
At some stage, I would like to boost my position in each stock. However, I’m prepared to wait for an attractive buying opportunity. I’ve found over the years that the best time to buy these kinds of high-quality companies is when market volatility is extremely high, and investors are panicking and dumping everything. In these situations, you can often pick up top-quality companies at bargain prices. For example, during periods of high volatility in recent years I have purchased ULVR shares under 4,000p and DGE shares under 2,000p.
So for now, I think the key here is patience. I believe both companies are fantastic to own for the long run, however, at present, there’s not a lot of value on offer.
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Edward Sheldon owns shares in Unilever and Diageo. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.