LONDON -- Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If shares are bought when they're cheap, two drivers could move the price up: Growth in earnings and an upward price-to-earnings rerating.
Highly successful fund manager Peter Lynch classified steady growers as "stalwarts," which he typically traded for 20% to 50% share price gains. But whether we're buying for gains like that or holding for the long term, we need to know if shares are cheap and that steady earnings growth can continue.
Seeking steady growth
Not all companies achieve steady earnings growth, as you can see by the aggregate performance of those in London's premier FTSE 100 (INDEX: ^FTSE) index, where the compound annual growth rate over the last five years has been just 0.7%:
FTSE 100 Value
Aggregate Earnings per Share
Steady earnings growth is a promising characteristic in today's markets, so in this series I'm examining firms with annual earnings growth between 4% and 20%.
One contender is Pearson (ISE: PSON.L) , which earns its living as an international publisher and is well-known for its Penguin and Financial Times brands. This table summarizes the company's recent financial record:
Revenue (millions of pounds)
Adjusted Earnings per Share (pence)
So earnings have grown at an equivalent 22% compound annual growth rate, putting the firm just above the stalwart category but close enough to warrant consideration.
Pearson likes to describe itself as "the world's leading education company." It derives around 75% of overall sales from its education sector. Within that sector, its most important market is the U.S., accounting for about 44% of overall company sales. The firm supplies curriculum materials, multimedia learning tools, and testing programs across the educational spectrum.
In the recent full-year results statement, the company said, "In North America, we anticipate modest growth in higher education as rapid take-up of our technology and services is partially offset by lower college enrolments and challenging conditions in the market for printed textbooks."
The Penguin sector, which produces quality novels and classics, through to cookbooks and other publications around the world, accounts for about 18% of sales. The Financial Times sector delivers just 7% of sales.
The firm's statements and promotional materials suggest the directors see the future of the business revolving around education.
Pearson's earnings growth and value score
I analyze five indicators to determine whether earnings growth can continue and the shares offer good value:
Growth: Revenue, earnings per share, and net cash from operations are all growing. Score: 5/5
Level of debt:At the last count, net gearing was around 11%. Score: 4/5
Outlook and current trading: It's currently "in line" with a cautiously optimistic outlook. Score: 4/5
Enterprise value to free cash flow: A figure of about 14 compares well with past growth rates. Score: 4/5
Price to earnings: A ratio of about 14 for adjusted earnings compares well with past growth rates. Score: 4/5
Overall, I score Pearson 21 out of 25, which encourages me to believe this stalwart can continue earnings growth that outpaces the wider FTSE 100, but the shares look generously priced compared with the FTSE's P/E ratio of around 10 and predicted future earnings growth rates.
Pearson's cautiously positive outlook and recent good trading are encouraging. Debt seems to be modest, and cash flow supports profits. There is an impressive record of recent growth, but forward predictions are less robust.
Right now, forecast earnings growth is 8% for 2013, and the forward P/E ratio is around 13 with the shares at 1,230 pence. Considering that and the other factors analyzed in this article, I think the firm is a good candidate for my watchlist.
Pearson is one of several steadily growing stalwarts on the London stock exchange, each with the potential to deliver significant capital appreciation when purchased at sensible prices.
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The article Is FTSE 100 Stalwart Pearson a Good Value? originally appeared on Fool.com.
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