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Industrial giant Franklin Electric Co., Inc. (NASDAQ: FELE) isn’t exactly a household name, but it has managed to rack up some impressive dividend numbers. For example, it has increased its dividend each year for 26 consecutive years, and the annualized growth rate over the past decade is around 6%, roughly twice the historical rate of inflation growth. It’s payout ratio, meanwhile, is a super-safe 25% or so. Before you jump at the stock, though, you should step back and consider some additional information.
A big turn
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Industrials like Franklin Electric, which makes systems and components for moving water and fuel, were hit hard by the 2007 to 2009 recession. However, the group started to move higher in 2016, with Franklin’s stock price up more than 70% since the start of that year.
There’s a pretty good reason for that price advance. The company’s revenue rose nearly 3% in 2016 after falling a steep 12% in 2015, hinting at material change in fortune. The company didn’t disappoint in 2017: Revenue rose 18%. Revenue has been higher year over year in each of the last four quarters, as well, so the momentum hasn’t stopped. Although earnings haven’t been quite as robust as revenue, they are much improved since the recent low in 2014 and have been higher year over year in five of the last six quarters.
Basically, it looks like the worst is over for Franklin Electric. And so long as demand holds up reasonably well, the future should be pretty bright. On that score, management reaffirmed its guidance for 2018 earnings of between $2.27 and $2.37 a share after announcing second-quarter results — despite weaker-than-expected performance in Asia and Brazil. Notably, that earnings guidance is improved from the $2.16 to $2.28 that management was projecting at the start of 2018. So, while not every segment is doing well, the overall business is still humming along.
But is it a buy?
The problem here isn’t the underlying business; it’s valuation. To paraphrase Benjamin Graham, the man who helped train Warren Buffett and who is often called the father of financial analysis, price is what you pay, and value is what you get. In other words, even good companies can be bad investments if you pay too much for them. And Franklin looks expensive today on most valuation metrics.
For example, the company’s price to earnings ratio is currently around 26 compared to a five-year average of roughly 24. That compares to around 18 for the broader industrials group, using Vanguard Industrials Index Fund ETF (NYSEMKT: VIS) as a proxy. Franklin Electric is expensive compared to its own history and to peers on this metric.
Franklin appears expensive when looking at historical price-to-book and price to cash flow trends, too. In both instances, it is trading higher than its five-year mean average. The only exception here is that its current P/B value of 3.05 is a little less pricey than the broader industrial average of 4.0, but this alone doesn’t change the fact that investors have pushed the stock above its own recent valuation levels.
That said, the one metric that doesn’t suggest overvaluation compared to historical levels is price to sales. Franklin’s P/S ratio is around 1.75 versus a five-year average of 1.8. Unlike other metrics, P/S looks only at a company’s top line, which tends to be more consistent over time. In fact, the company’s gross margin and profit margin both declined in 2017 and continue to fall based on trailing 12-month numbers. If the company can improve its margins other valuation metrics might start to look better, but weakness in Asia and Brazil are likely to make that difficult over the near term. Meanwhile, the broader industrial group’s P/S ratio is roughly 1.7 and the difference between Franklin’s five-year average and its current P/S ratio is pretty small. So, it’s hard to suggest that the P/S ratio is pointing out an investment opportunity.
Not the right time
Although there are some mixed messages in the valuation metrics, when you put it all together, Franklin doesn’t look cheap. At best you might consider it fairly priced (if you look at the P/S ratio), but that’s only if it can get margins back in line with historical trends. Essentially, it looks like investors have fully priced in the good news taking shape at Franklin. So, despite a solid dividend history, Franklin isn’t a stock that value-conscious investors should be rushing to buy today.
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