Is FTSE 100 Stalwart G4S a Good Value?

LONDON -- Capital appreciation is the goal of many investors, and one method to achieve it 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 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:

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%. One contender is G4S (LSE: GFS.L), which is an international security-services firm. This table summarizes the company's recent financial record:

So, earnings have grown at an equivalent 14.4% compound annual growth rate, putting G4S in the stalwart category.

Despite the company's newsworthy difficulties over its London Olympics contract, growth appears to be on the agenda for 2013 and beyond. G4S has around 657,000 employees and operations in more than 125 countries. It derives about 47% of its revenue from Europe, 23% from North America, and 30% from what it calls "developing markets," which include places like the Middle East, Latin America, Africa, and the Asia-Pacific region.

The company has grown both organically and by acquisition. Now, its sheer size makes it one of the few bidders capable of servicing some big contracts. If reputational fallout from the summer's Olympic disaster is manageable, further steady earnings growth seems likely, despite what looks like a flat financial performance during 2012.

G4S's earnings growth and value score
I analyze five indicators to determine whether earnings growth can continue and the shares offer good value:

1. Growth: Revenue has grown steadily; cash flow and operating profits peaked in 2009. Score: 2/5
2. Level of debt: Net gearing is around 119%, with borrowings about six times earnings. Score: 1/5
3. Outlook and current trading: Mixed recent trading and a cautiously positive outlook. Score: 4/5
4. Enterprise value to free cash flow: 26 and above adjusted earnings growth rate. Score: 2/5
5. Price to earnings: A trailing 11-or-so and below historic adjusted earnings growth rate. Score: 3/5

Overall, I score G4S 12 out of 25, which inclines me to be cautious about this stalwart's ability to continue earnings growth that outpaces that of the wider FTSE 100. The price of the shares seems fair when compared to the FTSE's P/E ratio of around 11 and the firm's growth predictions.

Foolish summary
G4S's acquisition program continues to boost top-line growth. However, debt has been increasing, and recently margins have softened. Cash flow seemed to peak during 2009. The positive outlook is reassuring.

Right now, forecast earnings growth is 13% for 2013, and the forward P/E ratio is 9.7 with the shares at 249 pence. Considering that and the other factors analyzed in this article, I think that looks like a fair price, but G4S can stay on my watchlist for the time being.

G4S is one of several stalwarts on the London Stock Exchange that are steadily growing earnings, each with the potential to deliver significant capital appreciation when purchased at sensible prices. If you, like me, are serious about capital gains, I recommend you now read "The One U.K. Share Warren Buffett Loves," which is a time-limited Motley Fool free report discussing the British stalwart that has recently attracted some of the American super-investor's millions. Click here to access the report while you still can.