Companies that offer both reasonable valuations and solid earnings growth have propelled the Reuters Select Growth At A Reasonable Price [GARP] stock screen to the top of the heap when compared to the gains made by other screens and key market benchmarks since the end of August. During this period, the Dow has climbed above 12,000 for the first time, the S&P 500 Index has advanced nearly 6 percent and the NASDAQ has climbed about 9 percent. The GARP screen, however, has gained more than 11 percent and construction company Eagle Materials, Inc. (NYSE:EXP) is among the standouts.
Out of the Reuters.com stock universe of nearly 8,900 stocks, 707 appeared on the Reuters Select stock screens recently. Of those stocks, only 17 appeared on the GARP screen. (Click here for an Excel sheet comparing these 17 companies.)
The GARP screen is designed to highlight companies that are both growing relatively quickly and trading at reasonable valuations. As such, we focused on various areas to reduce our list of stocks and hone in on Eagle Materials.
We started by focusing on quality criteria, specifically profit margins. We filtered for companies with operating profit margins that are wider than the industry averages over both the last five years and in the trailing 12-month [TTM] span. We also want companies that have improved over time, so we filtered for firms that have improved the magnitude of their relative superiority. This left us with a list of eight names.
Next, we looked at management effectiveness in using available capital to generate net income. We filtered for firms where return on investment [ROI] not only surpassed the industry average but also improved in the TTM span from the company's own five-year norm. The number of names fell to five, including Eagle Materials.
Another area that is ignored by the GARP screen is the balance sheet, so we also looked here. Since we want to identify solid companies, we required that a firm's total debt to equity ratio must be less than the industry average. As it turns out, all five of these companies had below-average relative-debt levels in the most recent quarter [MRQ].
We then turned to the stock market. Focusing on stock performance relative to the industry average over the last four weeks, we found that Eagle Materials came out on top with a gain of more than 12 percent, which was more than twice as fast as the industry average of about 5.7 percent. This also helped Eagle Materials land on the GARP screen, which requires that a stock either be above where it was four weeks ago or at least outperform the industry average over this time.
The GARP screen also looks at other growth characteristics. For example, the screen requires that the pace of improvement in a company's earnings per share [EPS] must be faster than the industry average and show some acceleration.
Given that Eagle Materials is involved in the construction arena, providing basic building materials such as gypsum paperboard and concrete, there may be reason for some concern given the slowing in the housing market. Analysts have penciled in EPS for fiscal year ending March 2008 of $3.55, which is slightly lower than the $3.83 they expect for fiscal year 2007. Yet, this does not seem to have hurt the company's growth potential: Analysts believe that the company can grow its EPS at an average annual rate of about 26.5 percent, faster than the 20 percent clip that is necessary to land on the GARP screen.
The GARP screen also takes into consideration analyst estimates to measure valuation. The screen looks at the P/E based on expected earnings relative to the long-term EPS growth rate or PEG ratio, and requires that this figure be less than 1.00.
Based on the consensus EPS estimates for fiscal 2007 and 2008, and the stock price of about $37.70, Eagle Materials is trading at forward P/E ratios of about 10 and 11, respectively. Dividing these ratios by the long-term EPS growth rate yields PEG ratios that are, indeed, well below unity, and solidify the company's presence on the GARP screen.
Disclosure: At the time of publication, Erik Dellith did not own shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.
Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.