Streetwise

Lauren Rudd

Sunday, March 25, 2012

Don't Be a Muppet

With all due respect to the original Muppets, it seems that Greg Smith, formerly of Goldman Sachs, has given new meaning to the word and made it a defacto part of Wall Street lexicon. Although many may have admired Smith’s unvarnished soliloquy on the culture at Goldman Sachs, did Smith really accomplish anything? Will Goldman repent and vow to remove any reference to Muppets from its corporate lexis? Probably not; rather the firm will likely continue with business as usual.

Do not let the antics and attitudes of those on Wall Street act as an impediment to your ongoing investment strategy. The Street has never been mistaken for a rose garden, despite a possible analogy between the thorns on a rose bush and the callous attitude of the Street towards its customers. At the same time, it is also all too easy to become mesmerized by those who sermonize.

Instead, direct your efforts towards locating investment opportunities that enhance your wealth and immunize your portfolio against transient market activity. For example, you might want to consider the Dover Corporation (DOV), an industrial manufacturing company.

When I last wrote about the Company a year ago, my earnings forecast for FY 2011 was $4.28 per share, and $4.78 for FY 2012, representing an earnings growth rate of about 12 percent. My 12-month target price on the shares was $72. In addition, there was an indicated 1.70 percent dividend yield. So how did the Company perform in 2011?

Revenue for the year ended December 31 was $7.95 billion, an increase of 20 percent over the prior year reflecting organic growth of 11 percent, while 7 percent of the increase came from acquisitions and 2 percent from foreign exchange.

Earnings from continuing operations for the year were $4.48 per share, representing a 23 percent increase in earnings. If you exclude tax benefits of $0.22 per share, earnings were $4.26 per share, a 26 percent increase over the prior year.

It is evident from the figures above that Dover’s overall earnings from operations well exceeded my projection. Even if you exclude tax benefits, the earnings number was very close to my estimate. So why has the share price, recently at $64.21, not followed suit? One reason could be the Street’s perceived weakness within the solar and semiconductor businesses.

However the Energy division overall had an operating margin in 2011 of 23.7 percent, down 0.60 percent from 2010, but still 6.7 percent higher than Dover's overall margin. It also happens to be the Company’s second largest revenue generator, chalking up revenues of $1.9 billion in 2011, a 46 percent gain year-over-year.

Operating earnings at the energy division were also healthy, increasing 42.5 percent to $450.6 million and surpassing Engineered Systems as Dover’s most profitable division. Those two segments combined generate two-thirds of Dover's operating profits.

Long-term debt accounts for 31 percent of corporate capital and cash flows are strong and consistently growing, providing excellent flexibility in the capital structure for investments and acquisitions. Return on shareholders' equity is a respectable 16 percent. This is a very stable, well-managed company generating nearly $800 million in free cash flow.

In its forward looking guidance, management said it expects full year 2012 revenue growth of 7 to 10 percent. Broken down, expected organic revenue growth is 4 to 7 percent, with 3 percent from acquisitions. Full-year earnings from continuing operations are projected at $4.70 to $5.00 per share.

A discounted earnings model yields an intrinsic value of $107 per share utilizing a 15 percent discount rate and a 13 percent growth rate, while the more conservative free cash flow to the firm model suggests an intrinsic value of $122 per share, using a 12.28 percent growth rate. The shares recently traded at $64.21.