Tread carefully; recent FTSE rally inflates already hard-to-justify valuations

A stock picker’s market?

• Stock prices — when did 25x EPS & a 2% yield become ‘cheap’?
• Recent and regular profit warnings hint at a degree of fragility re. stretched valuations.
• Restaurant Group, Whitbread, Next, and Sports Direct have all seen their share prices come undone after being rated in the high-teens to mid-twenties on a PER basis.
• In such a deceptive market, the discernment of a good stock picker is more important than ever.

Polarised markets: are stretched ratings acceptable?

• Memories are short, leading some to suggest that Unilever deserves to be on a forecast PER of 20.5 because ‘that’s where it’s always been’.
• But the underlying drivers of this premium are arguably as a result of the past few years’ exceptional global markets environment.
• The relentless hunt for yield and a hunger for ‘bond proxies’ with international exposure appear to have turned the issue of valuation into a footnote.

Market distortions and the mispricing of risk:

• At 3477p, Unilever’s shares trade on 20.5x forecast earnings and 13.9 times EV/EBITDA.
• Premier Foods, meanwhile, trades on 5.6 times forecast earnings and 8.5 x EV/EBITDA.
• Of course Unilever is a more operationally resilient and financially robust company than Premier Foods.
• But elephants can’t jump and as a smaller company Premier Foods has the whole world to aim at, leading us to question whether such a substantial discount in terms of valuation is really merited?