Can growth continue with these stalwarts, and are the shares cheap?
Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If bought when the shares are cheap, two drivers could move the share price up:
- growth in earnings, and
- an upwards P/E re-rating.
Highly successful fund manager Peter Lynch classified steady growers as Stalwarts, which he typically traded for 20% to 50% share-price gains. But, whether buying for gains like that or holding for the longer term, we need to know if reliable earnings growth can continue, and whether the shares are cheap.
Seeking durable growth
Not all companies achieve stable growth as you can see by the aggregate performance of those in London's premier FTSE 100 index (UKX), where the compound annual earnings-growth rate has been just 0.7% over the last five years:
|Year to June||2007||2008||2009||2010||2011||2012|
|FTSE 100 index||6608||5626||4249||4917||5946||5571|
|Aggregate earnings per share||537||503||427||397||527||557|
Consistent, cash flow-backed growth in profits is a promising characteristic in today's markets so, for this series, I'm examining firms with annual earnings growth between 4% and 20% (you can see all of the companies I've covered so far on this page).
Over the last few weeks, I've looked at Smith & Nephew (LSE: SN), Associated British Foods (LSE: ABF), Experian (LSE: EXPN), G4S (LSE: GFS) and Diageo (LSE: DGE). Let's look at how each of them scored against my five earnings growth and valuation criteria (each score in the chart is out of a maximum five):
|Share||Smith & Nephew||ABFoods||Experian||G4S||Diageo|
|Outlook and current trading||4||4||4||4||5|
|Enterprise value/Free cash flow||1||2||2||2||1|
|Total (out of 25)||15||16||16||12||13|
It seems to me that none of these five share prices undervalues its underlying company! Nevertheless, these are quality operations worth keeping on watch and, once again, there's plenty of industry diversification available in the selection.
54% of Smith and Nephew's revenue comes from supplying replacement knees, hips and shoulders around the world. With people living longer, that strikes me as a business likely to have strong on-going demand. The company also enjoys brisk business in advanced wound dressings, endoscopy equipment, and supplying the nuts, bolts, plates and nails used in trauma surgery. Further earnings growth seems likely but investors have noticed the firm's attractions and pushed the shares up to reflect positive expectations.
Food and retailing
Having grown mostly by acquisition, Associated British Foods now has a global reach. Its food brands include Silver Spoon, Jordans, Ryvita, Twinings, Ovaltine and Allinson, but grocery is only part of the firm's story, delivering some 33% of revenues. The company also owns the Primark clothes retailing operation and has interests in sugar-processing, agriculture and food ingredients. The firm scores well on the indicators that appraise its business but the shares are not cheap, in my view.
When you think of Experian, you probably think of credit checking and that is, indeed, the area that provides the company with around 47% of its revenues. But, under the banner of 'information services', the rest of the revenue comes from activities centred on marketing, consumers and decision analytics. North America is important to Experian providing nearly half of its turnover. The firm scores well on my 'quality of business' criteria, but the price of the shares seems to value the shares fairly, accommodating positive expectations.
Will reputational-damage fallout stymie G4S's forward growth prospects after its headline-worthy London-Olympics gaff? In the medium term, that's still an open question, but following what looks like being a flat financial performance in 2012, city analysts are penciling in earnings growth of around 12% for 2013. Despite skidding on that British banana skin in the summer, G4S remains a world player in security services with more than 50% of revenues derived from outside Europe. The firm has grown both organically and by acquisition; now, its sheer size makes it one of the few bidders capable of servicing some big contracts. That said it could rapidly shrink if red pens start scoring the company's name from worldwide tender lists. Perhaps one slip is forgivable. Any more could see the company permanently on its butt. Your money to invest, you decide!
Diageo describes itself as the world's leading premium drinks business and is responsible for well-known brands such as Johnnie Walker, Bushmills, Smirnoff, Baileys, Captain Morgan, and Guinness. Growth around the world has been impressive and the share price reflects that success. In recent years, the shares have enjoyed a jolly good run and now, just like alcoholic beverages these days, they are not cheap, and that fact shows in my valuation criteria. Nevertheless, Diageo seems to be a business with undeniable quality, just like the drinks it produces, and is worth keeping an eye on, in my view.
Further ideas for capital gains
Those five shares have been among the several steady-earnings-growing stalwarts trading on the London stock exchange and, if growth continues, each has the potential to deliver significant capital appreciation when purchased at sensible prices.
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> Kevin does not own shares in any of the companies mentioned. The Motley Fool owns shares in Smith & Nephew.