LONDON -- Capital appreciation is the goal of many investors, and one method of achieving 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 longer 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 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% (you can see all of the companies I've covered so far on this page).
Over the last few weeks, I've looked at Sage Group (SGE 2.27%), Morrison (WM) Supermarkets (MRW +0.00%), Reckitt Benckiser Group (RB 0.15%), Burberry Group (BRBY +2.56%), and Babcock International Group (BAB 2.34%). 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):
|
Criterion |
Sage |
Morrison |
Reckitt |
Burberry |
Babcock |
|---|---|---|---|---|---|
|
Growth |
3 |
5 |
3 |
5 |
4 |
|
Debt |
5 |
4 |
4 |
5 |
3 |
|
Outlook and current trading |
4 |
4 |
4 |
5 |
5 |
|
Enterprise value/free cash flow |
3 |
2 |
2 |
3 |
2 |
|
Price/earnings |
2 |
3 |
3 |
3 |
3 |
|
Total (out of 25) |
17 |
18 |
16 |
21 |
17 |
This relatively high-scoring collection of stalwarts is capable of providing more useful industry diversification for investors' portfolios and watchlists.
Business software and support
With the release of its full-year results on Dec. 5, financial-management software provider Sage posted another satisfactory set of numbers, with revenue up 2% and pre-tax profit up 4% for the year. The directors remain focused on the firm's strategy to accelerate growth, despite the continuing presence of a difficult macroeconomic environment. Sage's latest results are encouraging, and with strong cash flow driven by solid repeat business, the outlook for further earnings growth seems positive.
Food retailing
The battle for supermarket supremacy in Britain seems based around fresh food these days. The countries fourth-largest chain, Morrison, has a strategy of sourcing and processing most of its fresh food through its own manufacturing facilities, giving it tight control of availability and quality. The company's in-store "Fresh Format" is performing well, according to the sales-performance figures and customer feedback. Morrison aims to roll out the concept to 100 stores by the end of the fiscal year. That, and other initiatives, could drive growth, and although recent trading has been difficult, earnings progress seems possible going forward.
Consumer brands
Reckitt works hard to ensure that what it calls its "power brands" keep topping consumers' shopping lists. Who'd be without some of the company's famous names like Cillit Bang, Finish, Vanish, Calgon, Durex, Nurofen, and Strepsils? Right now, 24% of revenue arrives from emerging markets, which are showing spritely growth characteristics. Older markets are a little flat, but the share price indicates that expectations are for steady growth to get back on track soon.
Fashion brand
Sales and profits are up at Burberry. That's become something of a familiar cry as the firm continues to make stellar progress in emerging markets abroad. The fast-growing Asia-Pacific region currently contributes an exciting 37% of sales, for example. It seems a little bit of Englishness has wide global appeal, which has caused the share price chart to adopt stunning form recently -- jolly good show! Despite its 1856 origins, the famous Burberry Check is still trendy, and that bodes well for the prospects of further earnings growth.
Engineering support services
Babcock's services are in demand, and that shows in its strong record of earnings growth. With the release of its half-year results Nov. 6, the engineering support services provider revealed further good progress with a set of desirable growth figures and a reduction in debt. The order book is up and now stands at 12.5 billion pounds, offering the prospect of decent forward-earnings visibility. Around 36% of revenue comes from support services, 35% from marine and technology, 20% from defense and security, and 9% from international operations. If the recent upbeat results are any indicator, further earnings growth seems likely.
Further ideas for capital gains
Those five shares have been among 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, 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 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.
