Like legendary investor John Templeton, I’m always looking to buy great shares that have been oversold. So at the moment, I’m scouring the FTSE 100 for shares whose prices have dropped to levels that are hard to ignore.
The Templeton Growth Fund founder famously said that “the time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell“. The mood is certainly pretty poor around Reckitt (LSE:RKT) of late. The Footsie share has lost 27% of its value during the past six months.
Contrarian (or dip) investing involves buying battered stocks with the expectation they’ll rise over time. By purchasing shares that are undervalued and out of favour with investors — and selling them when they become popular and rise in value — can lead to significant returns over the longer term.
However, investors can often get burned, with low valuations often reflecting a share’s poor investment prospects. Firms that sink often have much further to go before the turnaround begins, and dip buyers can be left with disappointing profits (perhaps even losses).
So which category does Reckitt fit into today? Let’s take a look.
Strong trading
Trading at Reckitt has remained largely stable of late. Like all major consumer goods firms, it benefits from a wide geographic footprint and popular brands. In this case Durex condoms, Nurofen painkillers and Dettol disinfectant are major money spinners.
Reckitt’s shares tumbled at the start of the year following weak 2023 results. But latest financials in April showed like-for-like sales rose 1.5% in the first quarter, with price/mix growth of 2% offsetting a 0.5% volume decline. This prompted it to affirm its full-year earnings forecasts.
Litigation worries
So why has it continued to tumble? Essentially, Reckitt’s investment case revolves around its likely success in fending off litigation action in the US. And in recent days, the company’s outlook in this regard have darkened.
In March, it was ordered by an Illinois judge to pay $60m to a mother whose child tragically died after consuming Enfamil baby formula. Reckitt has subsequently appealed the decision.
Mead Johnson — the unit which makes the product — has been accused of not warning parents that the food can cause necrotising enterocolitis (NEC), a dangerous bowel illness.
Industry rival Abbott Laboratories is accused of the same thing. And this week, a Missouri court ordered the company to pay $495m for claims related to its Similac product.
What next?
The legal wranglings create two big problems for Reckitt. That Abbott ruling suggests the FTSE business could face an eye-watering bill from the hundreds of cases it’s facing.
Analysts at Barclays have said the final cost to the company could be as high as £2bn. Those at Jefferies suggest a bill of £3bn. Its eventual penalties could well come out at zero, but it could also total several billion pounds. It’s difficult to predict at this stage.
The final problem is if that ongoing legal action scuppers Reckitt’s plans to sell Mead Johnson to slim down its product portfolio.
Today, the company’s shares trade on a forward price-to-earnings (P/E) ratio of 13 times. This isn’t cheap enough to make me consider buying it. The prospect of huge litigation bills and further share price drops make it a risk too far.
This post was originally published on Motley Fool
