Johnson Controls: Leader of the Pack (Vroom Vroom)

Harley Davidson (HOG), Coach (COH), Herman Miller (MLHR), Johnson Controls (JCI). . . the tie that binds these companies together is that their fortunes often rise or fall with the economy. As data last Wednesday showed, economic growth in the United States is humming along, having grown at a surprisingly fast 3.5 percent clip in the final months of 2006. The numbers suggest favorable momentum for the first part of 2007 - and for companies that rely on economic health. Of the names that made it onto the Reuters Select stock screens, auto and truck parts company Johnson Controls, Inc. (JCI) was ahead of the pack.

Strength in personal spending helped drive the fourth-quarter expansion. Indeed, personal consumption expenditures climbed throughout 2006. It started off on a strong note, advancing at a seasonally adjusted annualized rate [SAAR] of 4.8 percent in the first quarter, according to government figures. The pace of growth then slowed to 2.6 percent in the second quarter. But, it picked up in the third and fourth quarters, growing 4.4 percent in the final three months of last year. Given the on-going strength in personal consumption expenditures, we wanted to zero in on companies that have been growing relatively quickly.

We started with the 399 companies in the consumer cyclical sector and then filtered for those names that appeared on at least one of the Reuters Select stock screens. This shortened our list to 26. (Click here for an Excel sheet comparing these companies.)

To narrow the list further, we filtered for companies that posted revenue and earnings-per-share [EPS] growth rates above the averages for their respective industries in the trailing 12-month [TTM] period. This left us with 14 names.

It isn't enough that the growth rates are faster than the industry benchmarks, we also want some measure of quality. For this, we examined measures of management effectiveness and we filtered for companies that have generated superior return on equity [ROE] in the TTM span. We also want companies that have been doing well over a longer period of time, so we extended our search for better-than-average ROE numbers to the last five years. This resulted in six companies.

Often, companies that are growing faster than their peers command premium valuations, and we want stocks that have reasonable price tags. Filtering for companies that are trading at price to earnings [P/E] and P/Sales ratios that are south of their industry averages left us with two companies.

These below-average valuation metrics also helped Johnson Controls land on the Relative Value stock screen. The screen is designed to highlight companies that are reasonably priced on the basis of key metrics. For instance, it requires that a company's P/E and P/Sales ratios are no more than 10 percent above the industry averages. Given our stricter criteria here, it is not surprising to also find Johnson Controls on the Relative Value screen.

The P/E and P/Sales ratios above are based on TTM EPS and revenue. It is also important to take into consideration valuation based on expectations of future performance. Specifically, we look at the PEG ratio, which is the forward P/E - P/E ratio based on analyst estimates for future EPS - divided by the average analyst estimate for long-term EPS growth rate. While conservative value-oriented investors generally prefer to focus on companies with PEG ratios below 1.00, numbers a bit north of this threshold are still reasonable. We filtered for the stock that had PEG readings, based on EPS for this year and next, below 2.00. This is where Johnson Controls stood out. This is also where Johnson Controls satisfied the final valuation requirement of the Relative Value screen. Much like our search criteria, the screen hones in on companies with PEG readings below 2.00.

According to a recent Reuters poll, analysts following Johnson Controls expect the company to register EPS of $6.03 in fiscal year ending September 2007. They believe EPS will hit $7.01 in fiscal 2008. Given its current stock price of about $91.40, Johnson Controls is priced at forward P/E ratios of about 15.16 and 13.04, respectively. Dividing these ratios by the analyst mean estimate for the rate of future EPS growth of 13.5 percent, we see that Johnson Controls has PEG ratios of 1.12 and 0.97, respectively.

Disclosure: At the time of publication, Erik Dellith did not directly 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.