A week ago, I looked at a simple way to separate the wheat from the chaff in the stock market. The analysis focused on four areas -- earnings growth, valuation, dividends, and share growth -- and yielded an idea of what kind of returns you can expect from a given stock.
The next logical step, of course, is to actually put the formula into action and see what stocks are worth your investment dollars. Today, I'm going to take on food distribution kingpin Sysco (NYSE: SYY ) .
But first ...
As I noted in my original article, it's important to remember that we're trying to predict the future here, which is -- to say the least -- a difficult task. For that reason it's best to try to play sharp-shooter and try to nail down one specific outcome. Instead, I like to look at a range of scenarios representing what could happen. That way we're not blind to downside risks nor are we ignoring potential upside surprises.
As I outlined in this article, a good way to get a baseline for growth expectations is to check on what Wall Street analysts expect and how fast the company has actually grown in the past.
|Metric||Annual Growth Rate|
|Last 12 months||1.6%|
Source: Capital IQ, a Standard & Poor's company.
Now comes the tough part: How fast do we actually believe Sysco can grow? What's great about Sysco is that it operates in a huge, relatively stable and enduring market. And while the company has significant market share versus its competitors, it still has a small absolute market share. This tells me that the potential for further growth is real.
However, I think analysts have been a bit aggressive in their growth assumption. A 10% growth rate would mean an acceleration over the past three and five years, and while an improving economy might help make that achievable, there are also headwinds. PepsiCo (NYSE: PEP ) , Starbucks (Nasdaq: SBUX ) , and other food companies could all be heard bemoaning commodity costs in recent earnings releases and Sysco hasn't been able to dodge that bullet either. Additionally, the company is affected by fuel costs and so skyrocketing oil is no friend of Sysco's bottom line.
For those reasons, I assume that analysts' estimates represent the optimistic scenario, while a more realistic case would be a continuation of the 7.5% growth rate over the past three years. For a downside case, I assumed the company would grow 4% per year.
Pinning down valuation
Valuation multiples are a witches' brew of investor sentiment, company growth, interest rates, and a heap of other herbs and spices. If you want a good way to drive yourself crazy, try to figure out what the "right" earnings multiple is for a given stock. Just make sure you have Advil handy.
To get an idea of what kind of multiple a stock might fetch in the future, a good place to start is where it's trading right now and what the stock's historical trading range has been. In Sysco's case, the stock currently changes hands at 14.4 times its trailing earnings. Over the past decade it's had a wide trading range with an average annual P/E as high as 32.7 in 2000 and as low as 13.5 in 2009.
For broader context we can also look at how similar companies trade. That's a little tough for Sysco since there aren't any other major, publicly traded food distributors, but we can also check out companies in adjacent industries.
|McDonald's (NYSE: MCD )||Restaurants||16.4||10%|
|Kroger (NYSE: KR )||Grocery stores||13.7||8.9%|
|Yum! Brands (NYSE: YUM )||Restaurants||20.7||12.1%|
Source: Capital IQ, a Standard & Poor's company.
Not only does Sysco's current earnings multiple fall toward the low end of its historical range, but it's also below the multiples that investors are paying for the companies above. Granted, some may have better growth prospects and the consumer-facing brands at companies like McDonald's, Yum!, and Starbucks may entitle them a slightly higher multiple.
Taking all of this into account, my mid-case scenario calls for Sysco's earnings multiple to expand slightly to 15. On the upside, I could see investors paying as much as 20 times, while a market chill could drag the multiple down to 10.
Dividends and share growth
When we used earnings per share above we actually saved ourselves some work. Because that includes the impact of share count, so we don't have to consider that separately.
As for dividends, Sysco currently pays out at an annualized rate of $1.04 per share. The company is a longtime dividend payer and grower, which gives us less to worry about when it comes to the continuation of the dividend. Notably though, the pace of the dividend growth has slowed -- from a 16.2% rate over the past 10 years, to a 10.2% rate over the past three years, and a measly 5.3% bump in fiscal 2010.
My assumption is that dividend growth will continue to slow a bit in the coming years, to a rate of 8% per year. In my upside case, I allow for growth to continue at a 10% pace, while in my downside case I see it declining to 4%.
The verdict please!
The end result of all of this is the returns we can expect under the various scenarios. Here's what my three scenarios would look like.
Annual Earnings-per-share growth
Annual Dividend Growth
Expected Annual Returns
Source: Author's calculations.
I see the mid-case scenario as very reasonable and think that there's also more likelihood of the upside case coming to pass than the downside. As such, I'm happy to count Sysco as part of my own personal portfolio.
Of course the future is an ever-changing picture, so you need to keep on top of what's going on at Sysco to see whether the company is able to deliver. And you can do just that by adding Sysco to your Foolish watchlist.