Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If bought when the shares are cheap, two drivers could move the share price up:
- growth in earnings, and
- an upwards 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 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
|
Year to June |
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
|---|---|---|---|---|---|---|
| FTSE 100 index | 6608 | 5626 | 4249 | 4917 | 5946 | 5571 |
| Aggregate earnings per share | 537 | 503 | 427 | 397 | 527 | 557 |
Consistent, cash flow-backed growth in profits is a promising characteristic in today's markets so, for this series, I'm examining companies with annual earnings growth between 4% and 20%.
One contender is Sage Group
|
Trading year |
2007 |
2008 |
2009 |
2010 |
2011 |
|---|---|---|---|---|---|
| Revenue (millions of pounds) | 1,158 | 1,295 | 1,439 | 1,278 | 1,334 |
| Adjusted earnings per share | 13.34 pence | 14.44 pence | 16.63 pence | 17.88 pence | 20.81 pence |
So, earnings have grown at an equivalent 11.8% compound annual growth rate, putting Sage in the Stalwart category.
Sage provides financial management software, services and support to small and medium-sized businesses. From its establishment in 1981, the company has grown in parallel with the spread of desktop PC usage, to employ around 12,600 people serving an estimated six million businesses worldwide that now depend on Sage software to manage their operations. Last year, 60% of revenue came from Europe; 29% from North America; and 11% from Africa, Australia, the Middle East, and Asia.
One feature of Sage's business is its strong cash flow driven by solid repeat business. Last year, around 66% of overall revenue came from its Subscription business category. Subscription services are recurring in nature and a key growth driver for Sage.
Although cautious on Europe, the directors seem confident about progress in the rest of the world, which makes further earnings growth seem likely, in my view.
Sage's earnings growth and value score
I analyze five indicators to determine whether earnings growth can continue and if the shares offer good value:
- Growth: steady earnings growth with revenue and cash flow both a little bumpy. 3/5
- Level of debt: At the last count, there was net cash on the balance sheet. 5/5
- Outlook and current trading: satisfactory trading with a cautiously positive outlook. 4/5
- Enterprise value to free cash flow: a trailing 12 and close to historic growth rates. 3/5
- Price to earnings: trailing around 14 and slightly above historic growth rates. 2/5
Overall, I score Sage 17 out of 25, which encourages me to believe this stalwart can continue earnings growth that outpaces that of the wider FTSE 100, and that the shares offer reasonable value when compared to the FTSE's price-to-earnings ratio of around 11 and the firm's growth predictions.
Foolish summary
Sage has a record of strong cash generation and recently eradicated all its debt. With net cash on the balance sheet and a positive outlook, the current valuation seems fair.
Right now, forecast earnings growth is 11% for 2013, and the forward P/E ratio is around 13.5 with the shares at 300 pence. Considering that and the other factors analyzed in this article, I think that looks fair, but the shares can stay on my watchlist for now.
Sage 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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