My bet is that if you asked a group of investors to name one FTSE 100 company that best represented the type of business beloved by Warren Buffett, Unilever (LSE: ULVR) would come out top.
The consumer goods giant has Buffett qualities in abundance. Global reach, fantastic brands, tremendous cash flows, a high return on equity … and the list goes on. Furthermore, Kraft Heinz, which is owned by Buffett’s Berkshire Hathaway group and private equity outfit 3G, actually made an offer for Unilever last February.
Given this ringing endorsement and the fact that Buffett’s favourite holding period for a stock he buys is ‘forever’, it may seem like thinking the unthinkable to pose the question: “Is it finally time to sell Unilever?”
How high a price is too high?
It pays to keep the valuation and prospects of companies we own under review, because it’s always possible for a share price to get so far above the intrinsic value of the business that selling up and switching to a more reasonably-valued stock is the only sensible thing to do.
Would you sell Unilever if it were trading today at 30 times earnings? How about 40 times or 50 times? The point I’m making is that at some valuation the prospect of investors enjoying much of a return, even over a long holding period, becomes distinctly unlikely. Of course, the market rarely makes a big enough mistake in rating a mature business that over-valuation is clear cut. With this in mind, what of Unilever?
Buy or sell?
When I last wrote about the company in October, the shares were trading at over 4,500p. The forward earnings multiple for 2017 was 23 and the forecast dividend yield was 2.8%. I didn’t consider this to be so over-valued as to rate the stock a ‘sell’. But I said, with an eye on the dividend, that “I might just be tempted to wait for a dip in the shares, as they can on occasion be picked up with a yield in the 3% to 4% region.”
As I’m writing, the shares are trading nearer 4,000p and the earnings multiple for 2017 is 21, falling to 19 for 2018. The dividend yield is 3.1%, rising to 3.4%. Now, while it can be argued that this valuation is still too high and that the shares are better sold, I personally rate the stock a ‘buy’ at this level.
Back to Buffett
Returning to Warren Buffett, one thing that buttresses my belief that Unilever is an attractive stock to buy right now is his well-known saying that “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” The proposed offer for Unilever from Kraft Heinz last year was pitched at around 4,000p a share. From this, I conclude not only that Buffett considers Unilever a wonderful company, but also that he considers 4,000p a fair price.
In fact, I believe Buffett would have been happy to pay somewhat more, because 4,000p was an opening gambit. As it happened, the pitch for Unilever came out as a hostile takeover offer, Buffett saying, “we did not intend that to be hostile but it turned out it was, and we immediately, the next day, called it off. It was a misunderstanding.” However, there was no misunderstanding about the price.