You probably already know that shares in Reckitt Benckiser Group (LSE: RB) and Compass Group (LSE: CPG) have doubled over the last five years, while Bunzl (LSE: BNZL) has climbed by an outstanding 176%.
If you’re a recent buyer, you may also be familiar with the downside of these stocks, which is that they’re expensive. All three trade on a 2016 forecast P/E of at least 20 with a dividend yield of 2.5% or less.
Is there a risk that these firms’ growth will slow and their valuations will crumble? Or should you keep buying to lock in future gains?
As I’ll explain below, recent history suggests two of these stocks may still be worth buying, but one of them may be too expensive.
Improving outlook
One point in favour of all three companies is that City analysts have been steadily upgrading their earnings forecasts for 2016 in recent months.
Since January, 2016 consensus earnings per share forecasts have risen by 8.5% for Reckitt, by 3% for Compass, and by 5.9% for Bunzl. All three companies are expected to deliver adjusted earnings per share growth of at least 7% this year.
Strong trend
The future may not be the same as the past, but it’s usually a pretty good guide. I’ve taken a look at each firm’s earnings growth over the last few years, and there are some differences. Compass and Bunzl have both reported average earnings per share growth of about 7.5% per year since 2010. Dividends at both companies have grown by an average of about 10% per year over the same period.
In contrast, Reckitt Benckiser’s growth has been much more limited. The firm’s earnings have only risen by an average of 2.5% per year since 2010, while average dividend growth has been just 3.9% per year.
In my view, these figures suggest that Bunzl and Compass may be able to continue to outperform the market, but that Reckitt may not do. This is because the average long-term total return (share price plus dividends) from the FTSE 100 is around 7% per year.
If we assume that each company’s P/E valuation stays unchanged, then we can calculate the total return expected from each of these three companies by adding average earnings per share growth to the dividend yield.
For Reckitt, this calculation suggests that the shares may only deliver returns of about 5% per year, on average. Compass and Bunzl’s stronger track record of earnings growth means that they might be expected to deliver a total return of about 10% per year.
Of course, I’ve based these estimates on long-term averages, rather than forecasts. Reckitt’s earnings are expected to rise by 8% in 2016 and 2017, which could justify further gains.
What if profits fall?
However, there’s always the risk that something will happen to cause profits to fall at one of these companies. All three companies have recently issued positive trading statements, but surprises can happen. High valuations could mean that these firms’ share prices would fall fast if earnings went south.
That’s why if I was investing today, I would only consider Bunzl and Compass Group. I believe these firms’ track records of stronger growth make them a safer buy than Reckitt, where investors are relying on an improvement in performance to justify the current valuation.
