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Using the Value Line Page: Finding Growth Companies – May 27, 2011
Value Line research reports aren’t made for just one type of investor. The reports are intended to aid any type of investor, from those seeking stable dividend income to those seeking roaring earnings growth. However, at first glance, the information contained in these reports can be daunting. It isn’t. In fact, Value Line analysts spend a great deal of time digesting the information provided by companies, such as balance sheets, earnings statements, and statements of cash flows, so our customers don’t have to drown in the sea of information companies legally must make available.
It is impossible to explain how every type of investor could use a Value Line report in one article, however taking one perspective, growth, and one company report, Caterpillar (CAT – free Value Line report on Caterpillar), can provide a useful example.
There are any number of ways that one might chance upon Caterpillar as an investment candidate. These include reading something in a newspaper or hearing about it from some other news source, but many subscribers use Value Line’s online and offline tools to winnow down the list of candidates to just a handful. The most obvious option is to use the online screening tool, which allows subscribers to search multiple companies using several variables. However, the Index section of the weekly Value Line Investment Survey also includes a multitude of pre-set screens that can provide a similar jumping off point. (Note that these screens are also available as pre-set options online.)
One of the most frequently used screens, both online and in print, are those that make use of the Timeliness Ranking System. The Rankings box at the top left of every Value Line research report is where each individual company’s Rank can be found. The Rank is derived via a computer program using as inputs, among other things, long-term price and earnings history, recent price and earnings momentum, and earnings surprises. All data are known and actual.
Ranks range from 1 to 5 using a modified bell curve. Stocks ranked 1 (Highest; 100 stocks) and 2 (Above Average; 300 stocks) are expected to outpace the year-ahead market. Those ranked 4 (Below Average; 300 stocks) and 5 (Lowest; 100 stocks) are expected to underperform most stocks over the next 12 months. Stocks ranked 3 (Average; the remainder) are expected to perform in line with the market in the year ahead. For a growth-oriented investor, then, starting with a list of stocks having a Timeliness Rank of 1 or 2 would provide a solid foundation from which to build. Caterpillar currently has a Timeliness Rank of 2 (Above Average).
That said, there are other metrics that could lead to a list of investment candidates, including past earnings growth and projected earnings increases. These figures can be found in the Annual Rates box for individual companies, can be screened online, and are used as the basis of several preset screens. Interestingly, if one were using historical figures, Caterpillar might not pass muster, as its annualized trailing 10-year earnings growth rate is 8.5%. This is a decent number to achieve over that long a time horizon, but not something that would meet a growth investor’s needs. However, the company’s earnings growth rate doubles when looking at the trailing five-year figure of 17%; a far more enticing number. Where Caterpillar really shines, however, is in the projected annualized growth rate of 23% over the next three to five years. This is definitely a number a growth investor would find interesting.
Growth investors, however, shouldn’t only look at earnings when considering an investment. Often a company’s stellar earnings growth prospects have already been noted by the market, leading to a lofty share price. To figure this out, a review of a company’s Price to Earnings ratio is of great importance. A collection of P/E ratios can be found in the Top Label section of each report, which runs across, as one might expect from the name, the top of the page. Here one will find the current P/E, which in Caterpillar’s case is 15.2, and the Relative P/E, 0.94, prominently displayed. Taken alone, the current P/E provides very little information other than falling back on very static guides, such as a P/E of 20 is expensive and a P/E of 10 is likely undervalued. It is the relative P/E that provides more meaningful guidance—a number above 1.00 indicates a stock trading at a higher multiple than the market and a number below 1.00 indicates the opposite. In this instance, Caterpillar is trading at a slight discount to the market.
At first glance, that would seem a very hopeful sign when added to the high Timeliness Rank and impressive earnings growth projections. However, it is enlightening to also view this current figure in a historical light. For that, one can look at the historical portion of the Statistical Array at the Average Annual P/E Ratio line. This review shows that, historically speaking, Caterpillar shares have traded with a relative P/E as low as 0.61 and a high as elevated as 1.96. Over 50% of the time, it has traded below a relative P/E of 1.00—and often well below. So, while the shares are currently at a slight discount to the market, they are not cheap compared to the stock’s own history. Neither are Caterpillar shares expensive historically, however, so this measure shouldn’t be viewed positively or negatively.
Another interesting aspect to consider for a growth investor, particularly in a case such as Caterpillar’s where valuation seems at least reasonable, is where the stock price might head from current levels. Value Line analysts create earnings projections over the three- to five-year time period which drive both the Annual Rates projections and the price projections found in the Projections box. On this score, Value Line analyst James Jan Sullivan has a target price range of $125 to $185 on the shares.
Value Line does not provide specific price targets because it believes such exacting figures are unreliable. As such, earnings are forecasts and then multiplied by a projected P/E multiple. This provides a specific price figure around which a range is built based on a stocks’ Safety rank. The range, the percentage gain, and annualized total return potential (which includes projected dividend payments) are shown in the Projections box. A visual representation is displayed with dotted lines to the right of the Graph.
Examining the $125 to $185 range provides a less than exciting share price gain of 20% on the low end and a more impressive 80% at the high end. Taking dividends into account results in an annualized share price gain of about 7% on the low end and 17% on the high end. This range provides something of a mixed answer to a growth investor. A clarifying point, and one that is worth noting, is the projected P/E ratio used in the calculation of this range, which can be found in the Statistical Array. This number, 12, is in line with the lower range of the company’s history, making it a somewhat conservative projection. This, in turn, suggests that the projected price range and annualized total returns might also be conservative.
Interestingly, the Analyst Comment appears to support this hypothesis, as Sullivan notes that his projections, per Value Line convention, do not include potential merger benefits from Caterpillar’s uncompleted acquisitions of MWM and Bucyrus. So there may, in fact, be some upside potential that is not yet reflected in Value Line’s numbers.
In the end, Caterpillar may not be the fastest growing, growth company out there, but it should interest investors with a growth bent. That is particularly so for those seeking to balance out a portfolio filled with small-cap names.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.