When one looks to buy a stock that they hope will increase in value, there are two important things that one usually checks. Growing revenues and growing earnings per share. Growing revenues are important, but it also helps if you can translate that growth to the bottom line. Some companies can improve margins, while others are buying back stock to boost earnings per share numbers.
One of the most interesting emerging markets growth stocks to analyze is Ambev (ABV). The company is expanding into new markets, executing cost optimization measures and its management is optimistic on future growth, according to the company´s last earnings transcript.
Why I like Ambev? because AmBev is a leader in the Latin American beverage market. While the overall trend of worldwide beer consumption is not rising, the dynamics for continued volume and pricing growth in Brazil's beer industry and other emerging economies are attractive. Brazilian beer consumption has still room to grow, fueled by high per capita consumption and increased regional levels consumption. According to leading research firm Plato, Brazil has a 5 year beer consumption CAGR of 5.7% and China 7% while the US is growing at a negative 0.5% and Europe's rate is flat. I am always looking for compelling growth opportunities. ABV is 17% YTD and several institutional investors have been buying the stock in the recent quarters (see paragraph below). I have been following the stock since 2011 because it combines pricing power and strong management. Those are two important items I look for in growth stocks.
Which are the most important items when analyzing Ambev?. I tend to focus on analyzing current and projected earnings/revenue growth. In addition, it is essential to keep track on the company´s margins, debt/equity ratios and ROE. I detail my key analysis on growth stocks here.
Evaluating Ambev EPS and sales growth
The first step is analyzing Ambev earnings growth. I am looking for companies that are able to grow both quarterly and annual earnings more than 15% a year. That growth could come either from new product introductions or a solid strategy of expansion into new markets.
The company generated 38% EPS growth last quarter compared to the same quarter in the past year. I like the fact that ABV generated more than 15% quarterly EPS growth. This shows that the business is growing organically and the company´s products generate solid demand. In fact, management sounded optimistic in the last earnings call.
It is important to highlight that analysts just upgraded its estimates for the current year, increasing projected EPS at 1%.
In addition, Ambev generated 3 year average annual EPS growth of 22%. The company generated strong growth in the past 3 years that was above my 15% threshold growth level.
A key step in analyzing Ambev is studying how sales grew in the recent quarters or years. Why this is important? Revenue growth can not be masked with accounting tricks or via cost cutting strategies. This metric tells you in simple terms how demanded a company´s products or services are. The company reported 15% quarterly revenue growth y/y. Ambev generated strong revenue growth last quarter, in fact, management sound optimistic in the call, explaining analysts the plan to keep expanding into emerging economies. Ambev generated 11% 3 year annual sales growth rate.
I do not like the fact that Ambev generated less than 15% annual sales growth in the past 3 year.
Management execution analysis
In addition to understanding ABV past EPS and sales growth it is essential to focus on analyzing ROE. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
ABV Return on Equity is 34%. Ambev has a strong ROE. This is important because this ratio is often said to be the ultimate ratio or the "mother of all ratios" that can be obtained from a company's financial statement. I think that ABV management is executing very well.
In addition, Ambev has a very low Debt/Equity of 0.7. This is a very strong financial ratio and I like companies with low ratios. The debt-to-equity ratio is a measure of the relationship between the capital contributed by creditors and the capital contributed by shareholders.
The company has a return on assets (ROA) of 19%. This is important to analyze because this ratio shows how profitable a company's assets are in generating revenue.
Several institutional investors have been buying ABV in recent quarters. This is important because hedge funds use strict fundamental procedures before investing in a stock.
Prominent investors Ken Fisher and John Keeley bought the stock in the past quarter at an average price of $38. As detailed in my blog, I like to see what hedge funds buy or sell in recent quarters.
Valuation is the last final step in any fundamental research analysis. Why? You buy financial assets for the cash flows you expect to gain. The price of a stock cannot be justified by assuming there will be other investors around who will pay a higher price in the future. This is the equivalent of playing an expensive game of musical chairs. As a prudent investor, you need to value the investment you are considering before buying it. Let's see how Ambev is valued against the market and its industry.
Ambev is trading at 24x trailing P/E in comparison to its industry average P/E of 32x and SP&500 P/E of 15x.
Ambev trades at a premium to the general market. I think that investors have high expectations on ABV projected EPS for 2013.
The company also trades at a lower P/E than the industry average multiple. The market probably placed lower expectations in ABV than the rest of the industry. As several hedge fund managers explained, it is essential to find if those expectations are exaggerated or real.
It is essential to evaluate ABV 5 year average P/E ratio in order to get a complete perspective. The company has a 5 year avg. P/E of 22x, trading at a higher P/E than its 5 year average. I consider this as a bullish signal.
Ambev also trades at a P/BV of 10x and a P/S of 4x. While I consider this multiples important, I think that the Price/Earnings is the most important one to analyze.
Ambev is a company that reported strong EPS and sales growth in the past quarter. In addition I consider positive that the company has a strong balance sheet (very low debt/equity ratio). It is important to invest in shareholder oriented management teams that execute very well. In the case of ABV this can be evidenced in its high ROE and ROA measures. Lastly, the stock is trading at fair valuations considering that it is not overvalued in relation to its industry and the stock trades at multiples very similar to the past 5 year averages. I recommend the stock for the conservative, long oriented investor.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.