Streetwise for Sunday August 10, 2008

Streetwise for Sunday August 10, 2008

 

 

Streetwise

 

Lauren Rudd

 

Sunday, August 10, 2008

 

 

Wall Street Is Not Las Vegas

 

 

You often hear the comment that Wall Street is Las Vegas dressed in pin stripped suits. Needless to say, I adamantly disagree with that statement. While speculating is certainly high risk, and could therefore be viewed as sophisticated gambling, investing is not gambling. Ironically, right now Las Vegas would rather portray itself as an investment Mecca rather than a gambling emporium.

 

Several casino developers are folding their cards as the mortgage markets deal them a losing hand. The building boom that turned much of the Las Vegas Strip into a construction zone is disappearing with a sleight of hand equivalent to the one that initiated the expansion.

 

Unfortunately, many of you have been tempted to fold your investment hands, a desire tempered only by the recent rally on Wall Street. Before you take such a step, remember that the market’s performance over the past 40 years clearly indicates that fluctuations occur and occasionally become dramatic. Nonetheless, there is also an undeniable upward trend. Furthermore, you invest in individual stocks, not the market.

 

However, a decline in the value of any asset inflicts pain. And just as you would seek medical help to remedy pain, there is an effective salve for an ailing portfolio...and that is time. As Warren Buffett has said repeatedly, "In the short run, the market is a voting machine and sometimes people vote unintelligently. However, in the long run, it is a weighing machine and the weight of business and how it does determine its value."

 

Therefore, investing is simply a straightforward task of finding under priced companies with winning records of accomplishment whose product lines you understand. Procter & Gamble (PG) is an excellent example. Everyone understands toothpaste and laundry detergent.

 

In terms of accomplishment, P&G recently reported fourth quarter revenues of $21.27 billion, a 10 percent increase over the same period a year ago. For the year, revenues increased 9 percent to $83.5 billion. Organic sales, which exclude the impacts of acquisitions, divestitures and foreign exchange, were up 5 percent, for both the quarter and the year.

 

Breaking down the increase in quarterly sales, higher volume contributed 3 percent, while price increases contributed 3 percent and foreign exchange 4 percent. The company’s gross profit rose 7 percent, with sales, general and administrative expenses (SG&A) growing only 3 percent.

 

P&G was impacted by rising commodity and energy costs, which it mitigated with price increases, cost savings and economies of scale. The company’s operating margin improved by 50-basis points for the quarter and 30-basis points for the fiscal year.

 

Earnings in the fourth quarter increased 33 percent to $3.02 billion. For the year, earnings increased 17 percent to $12.1 billion. Net earnings per share increased 37 percent for the quarter to $0.92. A tax benefit of 12 cents per share left an adjusted EPS number of 80 cents per share. For the year, earnings rose 20 percent to $3.64 per share.

 

Operating cash flow was $15.8 billion for the year and free cash flow was $12.8 billion. Capital spending came in at 3.6 percent of net sales, well below the company’s 4.0 percent annual target.

 

The recent price of $67.77 has the stock trading at 19.88 times trailing 12 month earnings. When I last wrote about the company a year ago, the share price was $63.48, producing a one-year capital gain of 6.8 percent. The intrinsic value of the shares, using a discounted earnings model, is $99 per share, while a more conservative free cash flow to the firm model produces an intrinsic value of $100 per share.

 

My earnings estimate for 2009 is $3.88 per share with a 12 month target price on the shares of $75, for a capital gain of 10.7 percent. There is also a current 2.44 percent dividend yield.