Are These 5 FTSE 100 Stalwarts Good Values?

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 we're 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:

 

2007

2008

2009

2010

2011

2012

FTSE 100

6,608

5,626

4,249

4,917

5,946

5,571

Aggregate EPS

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 firms with annual earnings growth between 4% and 20% (you can see all of the companies I've covered so far on this page).

Over the last few weeks, I've looked at Smith & Nephew (LSE: SN.L  ) , Associated British Foods (LSE: ABF.L  ) , Experian (LSE: EXPN.L  ) , G4S (LSE: GFS.L  ) , and Diageo (LSE: DGE.L  ) . Let's look at how each of them scored against my five earnings growth and valuation criteria (each score in the chart is out of a maximum five):

 

Smith & Nephew

AB Foods

Experian

G4S

Diageo

Growth

3

4

5

2

2

Debt

5

4

3

1

3

Outlook and current trading

4

4

4

4

5

Enterprise value/free cash flow

1

2

2

2

1

Price/earnings

2

2

2

3

2

Total (out of 25)

15

16

16

12

13

It seems to me that none of these five share prices undervalues its underlying company! Nevertheless, these are quality operations worth keeping on watch, and once again, there's plenty of industry diversification available in the selection.

Medical equipment
Global sales of replacement knees, hips, and shoulders account for 54% of Smith and Nephew's revenue. With people living longer, that strikes me as a business likely to have strong ongoing demand. The company also enjoys brisk business in advanced wound-dressings, endoscopy equipment, and many of the small parts used in trauma surgery. Further earnings growth seems likely, but investors have noticed the firm's attractions and pushed the shares up to reflect positive expectations.

Food and retailing
Having grown mostly by acquisition, Associated British Foods now has a global reach. Its food brands include Silver Spoon, Jordans, Ryvita, Twinings, Ovaltine, and Allinson, but grocery is only part of the firm's story, delivering some 33% of revenue. The company also owns the Primark clothes retailing operation and has interests in sugar-processing, agriculture, and food ingredients. The firm scores well on the indicators that appraise its business, but the shares are not cheap, in my view.

Information services
When you think of Experian, you probably think of credit-checking, and that is, indeed, the area that provides the company with around 47% of its revenue. But, under the banner of "information services," the rest of the revenue comes from activities centered on marketing, consumers, and decision analytics. North America is important to Experian, providing nearly half of its turnover. The firm scores well on my "quality of business" criteria, but the price of the shares seems to value them fairly, accommodating positive expectations.

Security services
Will reputational damage stymie G4S's forward growth prospects after its headline-worthy London Olympics gaff? In the medium term, that's still an open question, but following what looks to be a flat financial performance in 2012, City analysts are penciling in earnings growth of about 12% for 2013. Despite skidding on that British banana peel in the summer, G4S remains a world player in security services with more than 50% of revenue derived from outside Europe. The firm has grown both organically and by acquisition; now, its sheer size makes it one of the few bidders capable of servicing some big contracts. That said, it could rapidly shrink if red pens start scoring the company's name from worldwide tender lists. Perhaps one slip is forgivable. Any more could see the company permanently on its butt. It's your money to invest -- you decide!

Alcoholic beverages
Diageo describes itself as the world's leading premium-drinks business and is responsible for well-known brands such as Johnnie Walker, Bushmills, Smirnoff, Baileys, Captain Morgan, and Guinness. Growth around the world has been impressive, and the share price reflects that success. In recent years, the shares have enjoyed a jolly good run and now, just like alcoholic beverages these days, they are not cheap, and that fact shows in my valuation criteria. Nevertheless, Diageo seems to be a business with undeniable quality, just like the drinks it produces, and it's worth keeping an eye on, in my view.

Further ideas for capital gains
Those five shares have been among the several stalwarts trading on the London Stock Exchange that are steadily growing earnings, and if growth continues, each has the potential to deliver significant capital-appreciation when purchased at sensible prices.

If you are serious about capital gains, as I am, 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 billions. This one U.K. share ticked the boxes for Warren Buffett on growth prospects and cheapness, so maybe it will for you, too. Click here to access the report while you still can.

Kevin does not own shares in any of the companies mentioned. The Motley Fool owns shares in Smith & Nephew. 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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