Why I wouldn’t buy these two FTSE 100 favourites right now

Diageo Baileys

Today I’m looking at two popular FTSE 100 stocks, one that has surged higher recently and another that has been trending downwards. I’m not a buyer of either at present.

Diageo

Drinks manufacturer Diageo (LSE: DGE) released full-year results last Thursday and the numbers were received very well by the market, sending the shares up a huge 7%.

Highlights included a significant 15% rise in reported net sales to £12.1bn, a huge 25% increase in operating profit to £3.6bn and a strong 18% lift in basic earnings per share to 106p. Free cash flow rose by £566m and the company said that it will start a £1.5bn share buyback programme during FY2018. Furthermore, the dividend was increased 5%, bringing the full-year payout to 62.2p. Chief executive Ivan Menezes was upbeat, stating: “Diageo is a strong company today and we are confident in our ability to deliver sustainable growth.”

While these results no doubt look excellent, personally I’m not seeing a great deal of value in Diageo shares at present. On earnings of 106p, the stock trades on a P/E ratio of a lofty 23.1, which doesn’t leave a huge margin of safety in my opinion. Furthermore, while Diageo has an excellent dividend growth track record, the current dividend payout of 62.2p equates to an underwhelming yield of just 2.5%.

I already own Diageo shares in my personal portfolio, having bought the stock last year at under 2,000p, and I will be looking to add to that position some time in the future. However right now, the valuation just looks a little too high to warrant buying more shares, in my view.

NEXT

At the opposite end of the momentum scale is fashion and interiors retailer NEXT (LSE: NXT) which has seen its share price drift considerably lower over the last 18 months. After falling from almost 8,000p in December 2015, to just 3,800p today, the stock is now down over 50% – a stunning fall for a company that just a few years ago was considered by many analysts to be in a league of its own.

There’s no doubt that fortunes can be made by purchasing stocks that are heavily out of favour and waiting for a turnaround, but in this case, I’m not so convinced about the long-term investment thesis.  

Yes, the business looks cheap on a P/E ratio of just 8.7. And yes, the stock has a decent dividend yield of 4.2%. However, what concerns me here is the level of competition from new online retailers selling fashionable clothes at very reasonable prices.

In recent years, we’ve witnessed an array of new entrants such as Zalando, Boohoo, Nasty Gal, Pretty Little Thing and Missguided come onto the market, all of which are scrambling for market share. Add in seasoned retailer ASOS, a company that offers an extraordinary selection of clothes and fast delivery, and the competitive landscape certainly looks tough for NEXT. In my view, its economic moat has been breached, and this threatens to derail profitability going forward.

A trading statement in May was poor, with retail full-price sales falling 8%, and City analysts expect earnings to fall around 10% in FY2018 to 396p per share. On top of this, the UK consumer environment remains challenging with wage growth having stalled in recent years. For this reason, despite the low valuation, I’m not interested in adding it to my portfolio right now.

For higher returns, avoid these investing mistakes

Cutting out large losses can make a big difference to your overall investing returns over time. After all, if a stock falls 50%, you need to make 100% to break even. 

With that in mind, if you’re serious about generating stronger stock market returns, I’d urge you to read the report The Worst Mistakes Investors Make

The report is FREE, comes with no obligation and can be downloaded within seconds, simply by clicking here

More reading

Edward Sheldon owns shares in Diageo. The Motley Fool UK owns shares of and has recommended ASOS. The Motley Fool UK has recommended boohoo.com and Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s