LONDON -- When is a great share just too expensive? It's a question that has been taxing investors on one of our most popular discussion boards in the last few days.
The share in question? Drinks giant Diageo (LSE: DGE.L ) . And the reluctant conclusion is that Diageo, while a bombproof business, is too richly priced -- at least for income investors.
Put another way -- as respected poster valuemargin did -- if you bought Diageo today, you're buying a share on a forecast price-to-earnings (P/E) ratio of 17, and yield of just 2.4%. Extrapolating Diageo's most recent 10-year average annual dividend growth over the next 10 years, you'd be looking at a yield of 4.3% in terms of the price paid.
And, quite simply, there are good safe businesses out there offering that sort of yield right now. Sainsbury is on a forecast yield of 5.3%, for instance -- a whole percentage point higher. Royal Dutch Shell offers 5.1%. GlaxoSmithKline 5.0%.
In short, time and again you'll find decent blue-chip businesses on lower P/Es and higher yields than Diageo is offering in 10 years' time -- never mind today.
So what's an investor to do?
Bide your time
Not for the first time, valuemargin told us his own view -- which concurs with mine. Sit on your hands, keep some cash in reserve, and if an opportunity presents itself to lock in a lower P/E and a higher yield, grab it. If it doesn't, don't.
In valuemargin's case, the stock in question -- or at least, the one that I most vividly recall him mentioning in this context -- was Cobham (LSE: COB.L ) , a first-class business, yet an expensive one. But given the chance, he grabbed it, having, what's more, waited a decade for the opportunity.
In my own case, Rolls-Royce (LSE: RR.L ) comes to mind. It's coming up for two years, for example, since shares in the aero-engine manufacturer plunged 15% or so in the space of a week.
The cause? The emergency landing of a Qantas Airbus A380 -- the world's largest passenger jet -- in Singapore, after an engine lost one or more turbine blades over western Indonesia, an event that attracted headlines around the world.
Passengers, investors and airline executives alike were spooked. Something, somehow, had gone badly wrong. And so the share price underwent the same kind of emergency descent as the stricken jet had done.
At which point, I bought a decent chunk, for my SIPP, tucking them away at 598 pence. Since then, the FTSE 100 has more or less flat-lined, while Rolls-Royce is up 42%.
As it happens, another share I had my eye on also abruptly fell into bargain territory earlier this year. Needless to say, I've been loading up on that, too. As has an investor with a rather better track record than mine -- a certain Warren Buffett.
The name of the share in question is revealed in this free special report from The Motley Fool -- “The One UK Share Warren Buffett Loves” -- along with an in-depth analysis of the value that Buffett sees in it. Why not take a look? It can be in your inbox in seconds and, as I say, it's free.
In the meantime, why not share with us the stocks that you have your eye on, waiting for more attractive pricing?
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