When people start building a stock portfolio, they tend to gravitate towards brands that they are familiar with–brands like The Coca-Cola Co (NYSE:KO), Procter & Gamble Co (NYSE:PG), and McDonald’s Corporation (NYSE:MCD).
These are top companies with strong brand recognition. However, even the greatest companies shouldn’t be bought anytime. Specifically, investors shouldn’t buy them when they’re too expensive.
At US$45, Coca-Cola trades at 22.7 times its earnings, which is expensive even for a top beverage company. Normally, it trades at about 20 times its earnings. So, it’s about 12% overvalued today.
Additionally, it has been expanding its payout ratio for the last few years. It’s paying out about 70% of its earnings, which are expected to grow 5% annually in the medium term. With a high payout ratio, Coca-Cola is likely to continue slowing down its dividend growth as it has since 2013.
However, it’s still phenomenal that Coca-Cola could potentially grow by 5% per year because it is a huge company with a market cap of almost US$194 billion. So, although it’s not a buy, it’s still a potential hold if you bought shares at a reasonable valuation.
If it dips under US$39 with a 3.6% yield, it’ll be time to load up the truck.
Procter & Gamble
Procter & Gamble sells its umbrella of household product brands in more than 180 countries and territories. However, at US$82.60, it trades at 22 times its earnings, which is a tad bit expensive.
Most importantly, the company is experiencing a multi-year transformation by selling half of its brands. Last year its earnings per share (EPS) fell 5%, and this year its earnings are anticipated to continue to decline.
After shedding its non-core brands, the giant company should be able to focus its efforts on its core brands for higher growth. The company has a market cap of more than $217 billion!
If it dips under $67 with a 4% yield, it’ll be time to buy.
At US$129, McDonald’s trades at 24.8 times its earnings, which is simply too expensive for one of the world’s largest fast-food restaurant chains. Even though it’s expected to grow its EPS by 10% in the medium term at a rate faster than it has in the last four years, its share price rose too quickly. Now earnings need to catch up to the expensive multiple.
If the company performs as expected, its share price would probably go sideways. However, if it misses that 10% growth expectation, it will likely experience price dips.
If it dips to about US$92 for a 3.8% yield, it’ll be worth it to buy some shares.
If you buy expensive companies, they’re likely to underperform. So, even for the greatest brands in the world, only buy when they’re priced at reasonable valuations, and you can get a higher dividend yield to reduce your risk. And just because they aren’t buys today doesn’t mean they’re not holds.