These "Expensive" Shares Might Just Be Cheap

LONDON -- To no one's great surprise, this week has seen another set of solid results from Unilever . In a tough market, sales revenue increased by 10.5%, operating margins rose by 30 basis points to 13.8%, and earnings per share rose by 11%.

And to see the value of Unilever's twin strategy of focusing on 400 core brands -- spread across food, health, and well-being -- and the world's fast-growing emerging markets, consider the following: Underlying sales growth of 6.9% was made up of volume growth of 3.4% and price growth of 3.3%.

No wonder, perhaps, that emerging markets now represent 55% of turnover -- and that annual sales topped 50 billion euros for the first time, helped by growth of more than 11% in these same emerging markets.


Strength and resilience
Now, many investors think that Unilever is a great business: resilient, defensive, throwing off cash -- yet positioning for growth with a strong presence in some of the world's fastest-growing economies.

And without much thought, it's easy to bracket Unilever with some other companies sharing those same powerful characteristics. I'm thinking of Diageo , for instance, and Reckitt Benckiser . But I could also throw in ARM Holdings, as well as Apple. All are strong businesses -- and with shares that have delivered strong outperformance. Unilever, for instance, has beaten the FTSE 100 by 54% over the last 10 years. Diageo has outperformed by 165%, and Reckitt Benckiser by an incredible 270%.

Expensive?
And if the share price performance has been lofty, so too have been valuations. Pretty much anytime I've looked at any of these three businesses, they've seemed expensive.

Today, for instance, all three companies are on prospective price-to-earnings ratios of about 16 and offer yields close to, or below, that of the FTSE 100 as a whole. And yet all three companies are popular with investors and rated as "buys" by many analysts -- despite the fact that they're expensive and offer investors relatively little by way of dividend income.

Company

Forecast P/E

Forecast Yield

10-Year Share Price Growth

Unilever

16.9

3.8%

113%

Diageo

16.4

2.8%

195%

Reckitt Benckiser

15.4

3.4%

274%

"E" number
Coincidentally, just the other day I heard Motley Fool co-founder David Gardner talk about just such a phenomenon. And he made it clear that he likes shares that go on delivering a strong outperformance, constantly hitting new highs -- supposedly "overvalued" stocks that, in fact, might be no such thing.

How come? Because a simple P/E ratio doesn't really tell investors enough about the quality of the "E" denominator.

"E" is a number, in short, and doesn't reflect such things as the quality of a world-leading clutch of powerful consumer brands, a strategy that will see a sales drive into largely untapped markets, a chief executive with a stellar record, a commanding technology, a powerful supply chain, or marketing strengths. For those things, you have to look at the business -- not at a crude valuation indicator. Buy on a dip? Sure, if one comes along. But buying on long-term strength and outperformance, too, might not be such a bad idea.

Follow the money
One investor who looks beyond simple valuation metrics is Warren Buffett, whose Berkshire Hathaway investment vehicle has delivered returns of more than 20% per annum since 1965 and turned Buffett himself into the world's third-wealthiest person. As it happens, Buffett recently took advantage of weak results and a dip in the share price to top up his holding in one particular FTSE 100 share -- an unusual move for an investor who rarely ventures outside the U.S. As a result, he now owns more than 5% of this company, which he first began buying back in 2006. Its name? Simply download this free special report from The Motley Fool -- "The One U.K. Share Warren Buffett Loves" -- to find out. Inside, you'll discover just why Buffett has invested over 1 billion pounds in this business and why you could consider taking a stake, too.

As I say, the report is free and can be in your in-box in seconds. Click here to download it.

The article These "Expensive" Shares Might Just Be Cheap originally appeared on Fool.com.

Malcolm owns shares in Unilever and Reckitt Benckiser but does not have an interest in any other shares named. The Motley Fool has recommended shares in Unilever and Diageo. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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