LONDON -- Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If the shares are bought when they're cheap, two drivers could move their price up: growth in earnings and an upward P/E 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 buying for gains like that or holding for the long term, we need to know whether 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, where the compound annual earnings growth rate has been just 0.7% over the last five years:
FTSE 100 Index
Aggregate Earnings per Share
Consistent, cash-flow-backed growth in profit 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 Pearson (ISE: PSON.L) , AMEC (ISE: AMEC.L) , Capita (ISE: CPI.L) , Admiral (ISE: ADM.L) , and AstraZeneca (ISE: AZN.L) . 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 of five):
EV/FCF = Enterprise value to free cash flow.
Although publisher Pearson is responsible for the Penguin and Financial Times brands, the company sees its future in the education sector, from which it currently derives about 75% of overall sales. 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. Business has been good, which bodes well for further growth.
International project management, consultancy, and engineering services company AMEC's lack of borrowings, positive outlook, and strong trading record make continuing earnings growth look likely. If net cash flow can keep up with that growth, the company's rosy prospects seem reasonably priced. AMEC works for the public and private sectors, serving industries like transportation, power, oil, and gas.
Mainly active in the U.K., Capita reckons it's the market leader in business-process outsourcing with a 23% market share. The company specializes in sorting out and running its clients businesses. I like to think of the process of managing an enterprise or organization as comprising two parts: strategic decision-making and execution. The execution element is so often lacking, but Capita has enjoyed considerable success since its establishment in 1987 by offering execution skills to organizations. The public sector accounts for well over 50% of the firm's revenue.
Since it launched in 1993, Admiral has grown from a small start-up to one of the largest car insurance providers in the U.K. By far its biggest source of revenue is U.K. car insurance, at 90% of the total, followed by international car insurance at 6% and comparison and other businesses at just 4%. The firm uses reinsurance partners to mitigate underwriting risk and returns much of its annual profit to shareholders in the form of special dividends.
AstraZeneca describes itself as a global, innovation-driven, integrated biopharmaceutical company with a business aimed at discovering, developing, manufacturing, and marketing prescription medicines for several areas of health care. Earnings have crashed by 18% recently due to the well-reported effects of the "patent cliff," where many of Astra's best selling drugs have come off patent, throwing the door open to generic competition. The company hopes to rebuild its patent moat with new brands, but the directors see pressure on the industry continuing to mount and ongoing headwinds for years to come. Consensus earnings forecasts call, for the time being, for a flat performance going forward.
Further ideas for capital gains
Those five shares have been among several stalwarts on the London stock exchange steadily growing their earnings, and if growth continues, each has the potential to deliver significant capital appreciation when purchased at a sensible price.
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The article Are These 5 FTSE 100 Stalwarts Good Values? originally appeared on Fool.com.
Kevin does not own any of the shares mentioned in this article. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.
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