Shares of home and security products company Fortune Brands Home and Security (NYSE:FBHS) have fallen about 16% this year, primarily due to concerns about the shares being overvalued. In contrast, shares of Beam (UNKNOWN:BEAM.DL), the company from which Fortune Brands was spun off, are up more than 72% year to date.
However, when you look at the bigger picture, it's a whole new ball game. Since its spinoff from Beam, shares of Fortune Brands have risen 228% to date, totally outperforming its parent company's modest 86% gain.
Luckily for investors, the sell-off in Fortune Brand shares has not been occasioned by weaknesses in the company, but rather due to the lofty valuation of its shares. The shares traded at a 12-month trailing P/E ratio of around 35 before the sell-off. The current forward P/E ratio of 17 times expected fiscal 2014 earnings is about half that, which is a lot more reasonable.
Meanwhile, Beam shares zoomed up on news that Japanese brewing and distillery company Suntory had agreed to buy the company for $13.62 billion, which represented a 25% premium to the share price back then. Following the massive gain, however, the expected 25% premium has more than been totally wiped out.
The spinoff of Fortune Brands was a sound idea, not just from an investor's perspective based on the healthy share gains, but also from a purely business perspective. Before the split, the combined entity lacked a clear focus on its numerous brand-name products, and the spinoff helped both companies to refocus more on their core businesses. This has been beneficial to both.
Why Fortune Brands is still a good investment
Fortune Brands Home and Security remains a very solid company with highly compelling fundamentals. The spinoff allowed the market to finally recognize the previously hidden value of its products, and investors bid up its share price.
Construction starts are still near historical lows, and predictions are that construction activity will increase by 9% in 2014, with growth extending to 2016. Demand for home construction products -- Fortune Brands' main docket -- is expected to grow by 10%-11% in the current year. This is likely to increase the demand for Fortune Brands' doors, windows, locks, cabinets, and other construction-related items.
Fortune Brand expects its full-year fiscal 2014 net sales to increase by 11%-13% to hit $4.7 billion, while this year's EPS is projected to grow about 23.5%, to $1.91-$2.01.
The company has been growing both its top and bottom lines in double digits since it became independent. At the current share price, the dividend yield for the year comes in at almost 5%.
Where are the shares going?
Given the huge share gains in the last two years, we can safely conclude that we are not likely to see similar gains this year. However, given the company's very strong earnings growth, the shares can still run.
The company also stocks some highly popular home construction brands (think of the ubiquitous Master Lock), and demand for its products is quite likely to remain high even when the broader industry experiences a slowdown.
Fortune Brands has been making highly strategic acquisitions, the most notable being WoodCrafters, which the company bought for $300 million, or a cheap 7.5 times EBITDA. WoodCrafters is a popular name in the vanity sink business, with annual sales of more than $200 million.
Fortune Brands was recently voted second by Fortune Magazine in the Home Equipment, Furnishings category as one the world's most admired companies for the third year running. Fortune noted that the company's key attributes, including financial soundness, optimal use of corporate assets, quality of products and services, and quality management, all made it a good long-term investment. Analysts at Credit Suisse have upgraded the company's shares to outperform, with a $50 price target, representing about 19% upside to the current share price.
Foolish bottom line
Although Fortune Brands' shares have been selling off this year, they are still a sound long-term investment based on the company's niche products and robust growth. Investors can use the sell-off to gain fresh entry points.
Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends Beam. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.