LONDON -- Capital appreciation is surely the goal of many investors. One method of achieving that goal is to buy companies with steady earnings growth. If they're bought when the shares are cheap, two drivers could move the share price up:
growth in earnings
an upward 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 (INDEX: ^FTSE) , where the compound annual earnings-growth rate has been just 0.7% over the last five years:
Year to June
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 Associated British Foods (ISE: ABF.L) , which is a diversified international food, ingredients, and retail group. This is its recent financial record:
Revenue (million pounds)
Adjusted earnings per share (pence)
So, earnings have grown at an equivalent 8.8% compound annual growth rate, putting the company in the Stalwart category.
ABF owns several well-known food brands including Silver Spoon, Jordans, Ryvita, Twinings, Ovaltine and Allinson. However, its grocery sector provides only 33% of the company's revenues.
There's also a thriving retail sector, which includes the Primark brand, that delivers around 27% of revenue; a sugar-processing sector that contributes 19%; an agriculture sector producing animal feeds, grains, and oil seeds that delivers 11%; and an ingredients sector producing baking ingredients that contributes 10%.
The firm has grown mainly through acquisition and operates within 46 countries, employing more than 100,000 people. It derives, roughly, 43% of revenues from the U.K., 25% from Europe and Africa, 21% from the Asia-Pacific region and 11% from the Americas. The company continues to expand and recent upbeat outlook statements suggest further earnings growth is likely.
Associated British Foods' earnings growth and value score
I analyze five indicators to determine whether earnings growth can continue and if the shares offer good value:
Growth: Revenue and earnings both growing steadily, cash flow a little bumpy. 4/5
Level of debt: Net gearing is around 26% with borrowings around twice earnings. 4/5
Outlook and current trading: Good recent trading and a positive outlook. 4/5
Enterprise value to free cash flow: Free cash seems low, although set to improve. 2/5
Price to earnings: A trailing 18, and above historic growth rates. 2/5
Overall, I score the firm 16 out of 25, which encourages me to believe this Stalwart's earnings growth can continue to outpace that of the wider FTSE 100. When compared to the FTSE's P/E of around 11 and the firm's growth predictions, positive expectations seem to be priced in.
ABF's outlook is encouraging and cash flow is expected to strengthen going forward. Debt seems under control but the value indicators suggest investors might have to pay a full price for the shares at the current level.
Right now, forecast earnings growth is 8% for 2013, and the forward P/E ratio is around 15 with the shares at 1,367 pence. Considering that and the other factors analyzed in this article, I think ABF can stay on my watchlist, for now.
ABF is one of several steady, earnings-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 Associated British Foods a Good Value? originally appeared on Fool.com.
Kevin Godbold 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.
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