Strong brands are great assets for any business — just ask legendary billionaire investor Warren Buffett. Furthermore, if those brands are bought by consumers over and over again (daily, weekly, monthly) — as opposed to occasional big-ticket items — and if they’re bought all around the world, you’ve got the makings of a fantastic “defensive” business.
Such businesses are relatively stable, with demand tending to hold up well even when economic conditions are less than ideal, making them highly desirable long-term investments. Unilever (LSE: ULVR) (NYSE: UL.US), Diageo (LSE: DGE) (NYSE: DEO.US) and Reckitt Benckiser (LSE: RB) are three outstanding examples of such businesses in the FTSE 100.
Unilever makes and sells products under more than 400 brand names in 180 countries. The company operates in the food and drink, home care and personal care sectors, and many of its brands will be instantly recognisable to probably every reader of this article: PG Tips, Marmite, Domestos and Brylcreem to name but a few. Unilever’s shares are trading close to their all-time high, putting the company on a rich earnings rating — the forward price-to-earnings (P/E) ratio is 22.5 — with a modest dividend yield of 3%.
Reckitt Benckiser sells in as many countries as Unilever and competes in some of the same categories, but has a more focused portfolio of brands, led by 19 “Powerbrands” — all market leaders — including Cillit Bang, Vanish, Strepsils and Durex. Reckitt Benckiser’s shares are also trading close to their all-time high. The forward P/E of 25 is even higher than Unilver’s, while the yield of 2.1% is lower.
Diageo is a world leading drinks group with a geographic reach to match Unilever and Reckitt Benckiser. Spirits are Diageo’s main focus, and the company owns seven of the top 20 premium brands, including Johnnie Walker and Smirnoff. The group’s stable also includes the only global stout brand — Guinness — and a small number of wine labels. Diageo is going through a spell of sub-par performance at the moment (it happens to the best of businesses), as well as a boardroom tussle at Indian liquor group United Spirits in which the UK company has a controlling stake. The shares are off their all-time high, although still retain a premium rating with a forward P/E of 20 and a yield of 3%.
Unilever, Reckitt Benckiser and Diageo are certainly among the FTSE 100’s outstanding companies in terms of the quality of their businesses, and worthy of a higher rating than the average firm. The big question is whether their ratings have now got too high to make them the Footsie’s best buys.
Undoubtedly, low interest rates and quantitative easing have been driving many investors out of safer investments such as bonds and cash and into equities in recent years. One suspects that many of these investors, who have moved reluctantly and cautiously into shares, have not gone chasing the riskier high yields of cyclical companies, but played it safer by opting for defensive stocks with more modest, but well-covered dividends. That’s to say exactly the type of stocks represented by Unilever, Diageo and Reckitt Benckiser.
Nevertheless, while the three companies are a long way from being bargains currently, I tend to think buying these great businesses on dips in the shares will still probably pay off for long-term investors. Part of the reason for that is that the P/E isn’t the be-all and end-all of valuation measures.