LONDON -- One method of achieving capital appreciation -- the goal of most investors -- is to buy companies with steady earnings growth. If the shares are bought when 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 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 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%.
One contender is Intertek Group (ISE: ITRK.L) , which is a testing, inspection, and certification services company. This table summarizes its 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, although forward growth may decline.
About 33,000 employees in more than 100 countries help Intertek's customer companies with the quality and safety of their products, processes, and systems. The firm reckons it's the industry leader, doing more than just testing, inspecting, and certifying products. It also offers a service aimed at improving performance, developing efficiencies in manufacturing and logistics, overcoming market constraints, and reducing risk.
Intertek is organized into five divisions, each serving a particular industry, and it analyzes its revenue accordingly. Roughly, 30% comes from commodities, 27% from industry and insurance, 18% from consumer goods, 17% from commercial and electrical, and 8% from chemicals and pharmaceutical.
It's a cash-generative business that's seeing strong growth, particularly in energy and commodity end-markets. Judging by past performance, that growth in revenue is likely to result in continuing earnings growth, too.
Intertek'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, cash flow, and earnings are growing steadily. Score: 5/5
Level of debt: Net debt is around three times earnings with net gearing of about 105%. Score: 3/5
Outlook and current trading:Recent trading is good, with a cautiously positive outlook. Score: 4/5
Enterprise value to free cash flow: Looks high at more than 30 and above growth rate. Score: 2/5
Price to adjusted earnings: Around 25 -- just above historic growth rate. Score: 3/5
Overall, I score Intertek 17 out of 25, which encourages me to believe this stalwart can continue earnings growth that outpaces that of the wider FTSE 100. The shares appear to be pricing in some future growth when compared to the FTSE's P/E ratio of around 11 and the firm's growth predictions.
Cash-backed growth is consistent across both the top and bottom lines. There's a good chunk of debt, which the company manages easily with its solid flows of cash. The outlook is encouraging.
Right now, forecast-earnings growth is 14% for 2013, and the forward P/E ratio is around 19 with the shares at 2,773 pence. Considering that and the other factors analyzed in this article, I don't think investors are undervaluing the company. It can stay on watch for now.
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The article Is FTSE 100 Stalwart Intertek Good Value? originally appeared on Fool.com.
Kevin does not own any shares mentioned in this article. 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. Try any of our Foolish newsletter services free for 30 days.