There’s been a huge shift of capital into so-called ‘defensive stocks’ in the last three months and there’s no doubt that many stocks that could be considered core portfolio holdings are now trading at high multiples. Have the two FTSE 100 favourites below become too expensive?
Unilever
The quintessential defensive stock, Unilever (LSE: ULVR) has soared since Brexit as investors have rushed towards high quality companies with global revenue streams. Unilever has also enjoyed strong share price trading momentum over the last few years, as demand for stocks with bond-like features has risen.
In a world of zero interest rates, bond investors have been forced to seek out alternative investments and ‘bond proxies’ like Unilever, with its strong balance sheet and consistent cash flow and dividend growth have been in demand. There’s no question that a market leading company with a defensive revenue stream and growing dividend has appeal in this environment.
But after a 20% share price rise since the EU Referendum and close to a 50% share price increase in the last three years, has Unilever now become too expensive?
It’s a question that divides the market, with some analysts arguing that the significant rerating of bond-like stocks is deserved, while others argue that these stocks are in bubble territory.
At the current share price, Unilever trades on a P/E ratio of 23 times next year’s earnings. Usually, when a stock trades at that kind of multiple, it implies that decent levels of growth are on the cards. Yet city analysts have pencilled-in earnings and dividend growth at Unilever of just 2.19% and 0.84% for FY2016 which is a little underwhelming in my opinion. Furthermore, the rise in the share price has pushed the dividend yield down to around 2.93%, a yield that looks a little on the low side for income investors. Weighing up these factors, it could definitely be argued that the stock currently looks expensive.
British American Tobacco
Another classic bond proxy type stock, British American Tobacco (LSE: BATS) has also enjoyed a significant share price rerating in recent years. A favourite of fund manager Neil Woodford, the tobacco giant has risen around 16% since Brexit and 51% in the last three years.
That results in the stock now trading on a P/E ratio of 20 times next year’s earnings, quite a lofty valuation. And given that tobacco stocks are generally known for their healthy dividend yields, the current yield of 3.16% looks a little disappointing.
Analysts have forecast earnings and dividend growth of 6.06% and 7.14% respectively for FY2016, which are better growth figures than Unilever, but the big question is whether the tobacco giants will be able to continue to increase their profits in the face of government intervention towards smoking? I’m not sure if it’s worth paying a high multiple for a stock for which there are question marks over the long-term sustainability of revenues across the sector.
I can see why demand for bond proxies such as Unilever and British American Tobacco has pushed their share prices to record highs in the current low interest rate environment, however the bottom line is that both stocks look a little pricey right now. Patience is vital when it comes to investing, and I’m convinced there will be better opportunities to buy these stocks in the future.
