While there are a number of valuation methodologies, I prefer to keep it simple. If the company has a good balance sheet, stable or improving revenue and margins, and generates real cash, then a reasonable way to evaluate fair value is to review forward earnings as a function of the historical price-earnings ratio, otherwise known as the PE ratio.
Over the past ten years, Halliburton’s “normalized” PE ratio has been about 17. This means over the period, Mr. Market has placed an average multiple on the stock of seventeen times trailing twelve month earnings. Sometimes it’s higher and sometimes its lower, but the middle ground centers around the normalized figure.
Now then, Halliburton management provides investors with their best assessment of the business and forward earnings “guidance” for the year; updating or commenting upon it each quarter. At the end of the last quarter, I took their guidance and now forecast about 2013 EPS of $3.20. A consensus of 36 Wall Street analysts expect the EPS to be $3.15. We’re close.
Placing a 17 times multiple on those earnings says the fair value of the stock may be about $54 a share. That’s a 20% upside from the stock’s price last night.
While it may take a stock months or even years to reach “fair value,” I believe that over time the price and earnings will harmonize; thereby “reverting to the mean.” If the stock and storyline remain viable, then patient investors can wait.
In other words, if the stock appears beneath fair value today, it may afford the investor an opportunity to buy shares at a discount now, and sell them at a profit: when they approach fair value.
Other investment considerations
All these facts and figures are just part of performing a sound fundamental stock analysis. There’s actually a lot more to it. In addition to other metrics, there’s a key element that is not found in any of the math. It’s the current storyline and ownership thesis.
The current storyline is the news and events around the company that could help or hurt the enterprise.
Here’s a few Halliburton storylines for consideration:
1). Halliburton management has stated that growing international revenues and margins are priorities. The company has been succeeding in this area: over the past year, of all the major energy service companies, Halliburton has demonstrated better international growth than its peers. Revenue increased by 8% year-over-year.
2). The corporate directors recently authorized the company to buy back $5 billion of its shares. This amounts to about 12% of the current shares outstanding. Typically, a company buys back its shares to offset dilution or express confidence in its future prospects.
3). The quarterly cash dividend was increased from $0.09 to $0.125 – a 39% boost. Rarely do directors raise the dividend without expecting the business to support it via future cash generation.
4). On the other hand, Halliburton management was less sanguine about the near-term prospects for settlements related to the BP-Macondo incident. Previously, the company set aside a $1.3 billion reserve to settle litigation associated with the tragedy. Here’s a quote from CFO Mark McCollum upon the second quarter conference call confirming the corporate view:
5). Throughout this quarter, we have continued to pursue in our (inaudible) settlement to resolve a substantial portion of the private claims pending in the Macondo multi-district litigation. However, discussions among the parties to the proposed settlement have recently slowed while BP challenges certain provisions of their previous settlement with the plaintiffs’ Steering Committee including a current appeal in the Fifth Circuit Court.
Finally, why should we invest in this company going forward? What is promising enough about its future for us to consider placing our hard-earned cash down? This is the ownership thesis.
