Streetwise
Lauren Rudd
Sunday, September 15, 2013
Look To Vince Lombardi For Direction
Vince Lombardi’s famous “Number One” soliloquy epitomizes the
way you should look at your investment portfolio. Lombardi said, “There is no
room for second place. There is only one place in my game, and that's first
place. ...There is a second place bowl game, but it is a game for losers played
by losers.”
These words are pertinent to what your investment strategy
should be; a selection of only the best investment candidates with judicious
attention being paid to profitability and intrinsic value.
Keep in mind that I am directing my comments at investing and
not trading, a polite word for speculation. A speculator is similar in many ways
to a Las Vegas gambler; they both want to profit by successfully picking the
correct outcome of a random event. And as in every game of chance there will be
winners and losers. Yet, speculation, including flash trading, the ultimate form
of speculation, has value; it brings liquidity to the markets.
Whereas an investor minimizes his or her risk through
diligent research and the utilization of a reasonable time horizon. The time
factor is critical because trying to forecast short-term economic trends and
their effect on Wall Street is like trying to herd cats, a great idea but one
with little probability of success. Being patient will not only alleviate minor
share price fluctuations, but it also enables you to benefit from a continual
compounding of earnings.
A good example of a company that has rewarded investor
patience with a trailing 12-month 38 percent increase in share price is the
Eaton Corporation (ETN).
When I wrote about the Company a year ago, my earnings target
for 2012 was $4.35 per share, with a $4.75 estimate for fiscal 2013 and a
12-month targeted share price of $55 for a capital gain of 13.4 percent. There
was also an indicated dividend of 3.2 percent.
So how did the Company do? Earnings for the year came in at
3.94 per share, somewhat lighter than my estimate. At the same time the share
price recently closed at $68.00, a 40 percent capital gain over the share price
a year ago of $48.52.
Looking at the Company’s most recent earnings release, Eaton
chalked up record sales and operating earnings during its second quarter, driven
by the acquisition of Cooper Industries. Sales in the second quarter were $5.6
billion, 38 percent above the same period in 2012.
Second quarter operating earnings, excluding charges of $39
million to integrate recent acquisitions, were $519 million. This represented an
increase of 32 percent over 2012.
Operating earnings per share, which exclude charges of $0.05
per share to integrate recent acquisitions, were $1.09 for the second quarter of
2013, a decrease of 5 percent from the second quarter of 2012. However, the
number does reflect the shares issued as part of the acquisition of Cooper
Industries and the purchase price accounting charges resulting from the
transaction.
Since 2000, Eaton has been shaped by more than 50
acquisitions and 10 joint ventures. This strategy has produced impressive
results, with acquisitions consistently delivering above their cost of capital,
and has made us a better-balanced company in terms of geography, end markets,
and the business cycle.
From 2011 to 2015, Company guidance calls for sales growth of
12 to 14 percent, 20 percent earnings growth and 15 percent return on invested
capital (ROIC). Eaton also anticipates generating 9 percent free cash flow as a
percent of sales by 2015.
The intrinsic value of the shares, using a discounted
earnings model with an earnings growth rate of 15 percent applied to earnings of
$1.4 billion and a discount rate of 12 percent, yields an intrinsic value of $83
per share. The more conservative free cash flow to the firm model produces an
intrinsic value of $98 per share. The shares recently closed at $65.63.
My earnings target for 2013 is $4.30 per share, with a $4.75 estimate for fiscal
2014 and a 12-month share price target of $76 for a capital gain of 12 percent.
There is also an indicated dividend of 2.60 percent.