This Just In: Upgrades and Downgrades
At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
Emerson Electric: Insufficiently overpriced?
It's been a rough year for Emerson Electric (NYS: EMR) shareholders, who've watched their stock sink 10% over the past 52 weeks even as the S&P 500 has tacked on 7%. But that's all at an end now, it seems. Shareholders are smiling this week, having just become the recipients of an upgrade to buy from the good folks at Nomura Securities.
According to Nomura, investors are still worrying too much about problems at the company's network power division, "exaggerating" the company's "issues ... to the point that Emerson's ability to build businesses (such as Process Management) is being questioned." In Nomura's opinion, this is the reason Emerson has lagged so far -- but the good news is that after underperforming for so long, its shares have finally become "inexpensive" at $51 and change. With the company's P/E relative to the rest of its industry now sitting at "10-year lows," now's the time to buy and ride Emerson all the way back up to $64.
This time it'll be different
Is Nomura right? I'm not so sure. You see, key to Nomura's buy thesis is the fact that, historically, Emerson has traded for anything from "a 0-20% premium" to its peers. Instead, the stock's 16.3 P/E is now right in line with what other big-league industrialists are fetching. Indeed, it even seems to be selling for a discount. United Technologies (NYS: UTX) costs only 15 times earnings, and General Electric (NYS: GE) sports a 16.1 P/E, and overall, companies in the industrial equipment industry are averaging about a 16.6 P/E. If it's true, as Nomura argues, that Emerson deserves a premium P/E just because it's always been so in the past, then the analyst is probably right that the stock will outperform going forward.
But is it true? While I can't argue with the historical record, I do wonder why it is that Nomura thinks Emerson deserves a premium valuation to its peers -- all the time and in every circumstance. Simply because that's the way it's always been? That seems like a thin reed to support a bull thesis.
On the one hand, yes, Emerson boasts an operating margin of 17%, superior to the profit margins at both United Technologies and GE -- and superior to just about any other industrial rival you can name. Viewed from that perspective, you can argue Emerson is a superior company and deserves a superior valuation.
On the other hand, though, the size of the revenue streams that these firms are earning their profits on are far from identical. Both United Technologies and GE boast annual sales that are multiples higher than what Emerson produces. And when valued on their annual sales, in fact, Emerson still scores a higher P/S ratio than either United Technologies or GE.
When you get right down to it, though, I don't think you can say Emerson should cost X, just because somebody else costs Y. You have to weigh the stock on its own merits.
And viewed in that light, I have to say that I disagree with Nomura that Emerson is so vastly undervalued as to necessitate buying it today. Priced at 16.3 times earnings, and paying a 3.1% dividend, Emerson isn't crazy overpriced. Indeed, it almost looks fairly valued (or at worst, slightly overpriced) for the 11.9% long-term growth rate for which Wall Street has it pegged. Free cash flow at the firm is (about 8%) better than reported income, true. But the discrepancy isn't so great as to shift Emerson from hold to buy in my book.
My advice: Emerson is a great company and deserves a place on your watchlist as a stock to buy... later, i.e., after a market pullback creates a bit of a margin of safety for the investment. At today's price, the stock's still too richly priced to buy.
Planning to buy Emerson when the price is right? Add it to your watchlist.
In the meantime, if you want to find a stock whose price is already right, take a look at our latest list of "The Stocks Only the Smartest Investors Are Buying."
At the time this article was published Fool contributor Rich Smith does not own shares of any company named above -- but Motley Fool newsletter services have recommended buying shares of Emerson Electric. You can find Rich on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 364 out of more than 180,000 members. The Motley Fool has a disclosure policy.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
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