High-quality businesses, with histories of strong earnings and dividend growth, inevitably trade at premium valuations. I think buying shares in such companies on dips is a good strategy.
Right now, there are a number of top-notch FTSE 100 blue-chips trading at what I think are attractive discounts. RELX (LSE: REL), at 1,858p, is 8% below its high of 2,011p, while Unilever (LSE: ULVR), at 4,517p, is down 15% from a high of 5,324p. I’d be happy to buy a slice of both these businesses at their current discounts.
Valuable resources
RELX is an information and analytics group, with four divisions: scientific, technical, and medical (34% of revenue), risk and business analytics (28%), legal (23%), and exhibitions (16%). Its huge databases, and sophisticated analytical and decision-making tools have become indispensable for many industries and professions.
To take just one example, its flagship LexisNexis legal product, enables lawyers to access a database of news, case law and precedents, containing 109bn documents and records going back to the 18th century. Such valuable resources would be difficult to replicate by a new entrant to the market, and give RELX what Warren Buffett calls an economic moat. This represents a sustainable competitive advantage, leading to above-average rates of profitability over the long term.
RELX’s operating profit margin, which has averaged 25% over the last five years, and return on capital employed (ROCE), which has averaged 21%, testify to its economic moat. Meanwhile, shareholders have enjoyed an annualised total return (capital gains plus dividends) of 14% over the period, compared with less than 6% for the FTSE 100.
Attractive valuation
In a Q3 trading update last month, RELX reaffirmed its full-year outlook. City analysts expect the company to deliver a 9% increase in earnings per share (EPS) to 92.3p from last year’s 84.7p. This gives a price-to-earnings (P/E) ratio of 20.1. A predicted 9% increase in the dividend to 45.7p from 42.1p gives a 2.5% yield.
I think the valuation is attractive for a business I expect to continue delivering above-average rates of profitability. As such, I also expect it to continue delivering above-average shareholder returns.
Profits powerhouse
Anglo-Dutch consumer goods giant Unilever needs little introduction. On any day, 2.5bn people around the world use its products. Mentioning Dove, Hellmann’s and Domestos barely scratches the surface of the array of valuable brands it owns in beauty and personal care (42% of revenue), food and refreshment (38%), and home care (20%).
The competitive advantages provided by the group’s sheer size, and the strength and depth of its stable of brands, are reflected in its operating profit margin, which has averaged 17% over the last five years, and ROCE, which has averaged 26%. I’m confident Unilever will be a profits powerhouse for decades to come.
Excellent opportunity
There was no change to management’s full-year guidance in the company’s Q3 trading update last month. City analysts expect an 8% increase in EPS to €2.55 from last year’s €2.36, and a dividend increase of the same percentage to €1.68 from €1.55. At the current share price, and at current exchange rates, the P/E is 20.7 and the dividend yield is 3.2%.
Again, I see this as an attractive valuation for one of the FTSE 100’s premier blue-chip businesses, and an excellent buy-on-the-dip opportunity for investors.
