Is it worth paying a premium to own shares in high quality firms such as Diageo (LSE: DGE), Sports Direct International (LSE: SPD) and Unilever (LSE: ULVR) — or should you wait patiently for a cheaper buying opportunity?
Deciding how much extra to pay for a high-quality stock with growth potential isn’t easy, but it can have a big effect on your investment profits.
In this article I’ll ask whether these three firms are a buy in today’s market.
Diageo
Diageo issued an update today announcing the end of its partnership with Heineken, with which it has joint ventures in certain overseas markets. The deal will result in Diageo receiving a net payment of $780m, but is only expected to reduce next year’s earnings by around 0.6p per share.
Based on this information, the outlook for Diageo shares is unchanged, with a 2016 forecast P/E of around 20, and a prospective yield of 3.2%.
Is this cheap enough to buy? I’m not sure it is.
Diageo’s normalised earnings per share have fallen by nearly 15% over the last two years. Although earnings are expected to rise by around 3% this year and 8% next year, dividend growth seems likely to remain lower.
Diageo’s dividend rose by an average of 8.7% per year between 2012 and 2015. Current forecasts suggest growth will be limited to 4-5% per year over the next couple of years.
I’d be more comfortable paying 1,700p or less for Diageo, so I’m going to wait a little longer before topping up my own holding.
Sports Direct
Despite the controversy which seems to surround Sports Direct, there’s no doubt that the sportswear retailer has a strong financial track record. Sales have grown by an average of 14% per year since 2010, while post-tax profits have risen by an average of more than 20% over the same period.
Sports Direct hasn’t sacrificed profits or balance sheet strength for growth, either. Operating margins rose to a record 10.4% last year. Net debt has fallen steadily since 2010, and currently stands at just £59m.
Sports Direct shares currently trade on a 2016 forecast P/E of 18, falling to 16 in 2017. I wouldn’t buy these shares due to the firm’s refusal to pay a dividend, but I believe they could be a good buy for further growth.
Unilever
Like Diageo, consumer goods giant Unilever shares trade on around 20 times forecast earnings.
Unilever stock has maintained its premium valuation, despite a couple of years of slower growth. Investors’ patience is now being rewarded, and current forecasts suggest that Unilever’s earnings per share will rise by 11% this year, and 6% next year. Dividend growth is expected to be a little more modest, at 3% for 2015 and 5% for 2016.
This gives Unilever a prospective dividend yield for the current year of about 3.2%. That’s broadly in-line with the FTSE 100 average and looks reasonable. However, Unilever shares have climbed nearly 7% over the last month.
As with Diageo, I plan to wait for a better buying opportunity before adding to my Unilever shareholding.