The forward price-to-earnings (P/E) ratio — share price divided by the consensus of analysts’ forecasts for earnings per share (EPS) — is probably the single most popular valuation measure used by investors.
However, it can pay to look beyond the consensus to the spread between the most bullish and bearish EPS forecasts. The table below shows the effect of different spreads on a company with a consensus P/E of 14 (the long-term FTSE 100 average).
| EPS spread | Bull extreme P/E |
Consensus P/E |
Bear extreme P/E |
|---|---|---|---|
| Narrow 10% (+ and – 5%) | 13.3 | 14.0 | 14.7 |
| Average 40% (+ and – 20%) | 11.7 | 14.0 | 17.5 |
| Wide 100% (+ and – 50%) | 9.3 | 14.0 | 28.0 |
In the case of the narrow spread, you probably wouldn’t be too unhappy if the bear analyst’s EPS forecast panned out, and you found you’d bought on a P/E of 14.7, rather than the consensus 14. But how about if the bear analyst was on the button in the case of the wide spread? Not so happy, I’d imagine!
Unilever
Today, I’m analysing consumer goods giant Unilever (LSE: ULVR) (NYSE: UL.US), the data for which is summarised in the table below.
| Share price 2,635p | Forecast EPS |
+/- consensus |
P/E |
|---|---|---|---|
| Consensus | 131p | n/a | 20.1 |
| Bull extreme | 153p | +17% | 17.2 |
| Bear extreme | 105p | -20% | 25.1 |
As you can see, the most bullish EPS forecast is 17% higher than the consensus, while the most bearish is 20% lower. This 37% spread is a little narrower than the 40% spread of the average blue-chip company.
Unilever’s business stretches across foods, household cleaning and personal care. These products — fast-moving consumer goods, as they’re called — are bought over and over again by consumers. This characteristic, together with the strength of Unilever’s brands — think Marmite, Domestos and Dove, for example — makes for relatively good earnings predictability.
In fact, Unilever’s current EPS spread is actually quite wide for the company. I think the range of plausible earnings scenarios for this year has expanded partly because emerging markets, responsible for nearly three-fifths of group turnover, are going through a phase of slower demand and economic volatility, and partly because exchange rates in the world’s currencies are also moving around quite rapidly (there was a 9% negative currency impact on Unilever’s turnover for the first quarter of the year).
Nevertheless, the market is giving Unilever a premium P/E rating: 20.1 on the consensus EPS forecast, rising to 25.1 at the bearish extreme. Even on the most bullish forecast, the P/E of 17.2 is well above the FTSE 100 long-term average of 14.
Unilever is rated even more highly than the world’s leading drinks group, Diageo, another company noted for strong brands (Johnnie Walker, Smirnoff and others) and exposure to emerging markets. Diageo’s forecast P/E ranges from 16 to 20, with a consensus of 18.