An Analysis Of Dover Corporation

Jan.31.12 | About: Dover Corp (DOV)

Dover Corporation (NYSE:DOV) owns and operates a global portfolio of manufacturing companies providing components and equipment, specialty systems and support services for a variety of applications in the industrial products, engineered systems, fluid management and electronic technologies markets. Dover is a dividend aristocrat that has raised its dividend for 56 consecutive years.

A 10-year summary of Sales, Earnings Before Interest and Tax [EBIT], Earnings per share [EPS], yearly high and low stock price, corresponding high and low P/E (calculated by dividing the high and low price by the EPS for the year), and average P/E (average of high and low P/E) is shown below.

Key 10-year data for Dover

Year

Sales (in Millions)

EBIT (in Millions)

EPS

High Price

Low Price

High P/E

Low P/E

Average P/E

2011

7950

1100

4.48

70

44

15.6

9.8

12.7

2010

6640

899.2

3.65

59

41

16.2

11.2

13.7

2009

5780

491.62

1.99

45

22

22.6

11.1

16.8

2008

7570

946.02

3.67

54

25

14.7

6.8

10.8

2007

7320

912.37

3.3

54

42

16.4

12.7

14.5

2006

6420

814.85

2.9

51

41

17.6

14.1

15.9

2005

5130

588.44

2.12

42

35

19.8

16.5

18.2

2004

4480

492.12

1.77

44

36

24.9

20.3

22.6

2003

4170

351.05

1.33

40

24

30.1

18.0

24.1

2002

4050

263.37

1.02

43

25

42.2

24.5

33.3

Click to enlarge

From these data, we can plot Sales, EBIT, and EPS versus Year, as shown in the chart below.

Sales (in Millions), EBIT (in Millions), and EPS versus Year for Dover, 2002-2011

As is evident from the chart above, except for a dip in 2009, DOV has demonstrated reasonably predictable sales and earnings over the past 10 years, allowing us to predict EPS in the near future, say in five years (i.e. Year 2016), using the linear regression equation for EPS = 0.3244 (2016) - 648.33 = 5.6604.

A conservative average P/E estimate for the stock can be obtained as follows:

Signature P/E: A well-established stock has a signature P/E, an average P/E it commands in the market based on its business. We calculate this by averaging the Average P/E over the past 10 years, excluding any outliers (data points that fall significantly beyond the other data points). The high P/E of 33.3 from Year 2002 is an outlier, so we average the Average P/Es from the other 9 years to arrive at a signature P/E of 16.6.

High P/E estimate: a conservative high P/E estimate can be calculated by averaging the five lowest High P/Es of the 10 High P/Es from the past 10 years. Averaging the 5 lowest High P/Es from the past 10 years gives 16.1.

Low P/E estimate: a conservative low P/E estimate can be calculated by averaging the five lowest Low P/Es of the 10 High P/Es from the past 10 years. Averaging the 5 lowest Low P/Es from the past 10 years gives 10.3.

Average P/E estimate: this takes the average of the High P/E estimate and the Low P/E estimate, as calculated above, to give a conservative estimate of an average P/E for the stock we can expect. Averaging 16.1 and 10.3 gives us 13.2.

Target Price

Multiplying our EPS projection for 5 years hence by the average P/E estimate gives us a projected average price for the stock: $5.6604 * 13.2 = $74.78, which represents an annual stock price return of 4.4% from the current price = $90. When we add in the 2.0% dividend yield, the total return expected is an annualized 6.4%, which means an investment in DOV today is expected to double in about 11-12 years.

Given a beta = 1.35 for DOV, a risk-free rate = 2% (using the yield on 10-year Treasury bond as a benchmark), and estimated risk premium of about 5% for the general stock market, we have a discount rate = 2% + 1.35*(5%) = 8.75%. Applying this discount rate of 8.75%, our projected price of $74.78 in 5 years translates to a target price = $49 in today's dollars, which is 22% below the current price of $63 for the stock, suggesting the stock is overvalued right now. For a good margin of safety, investors are well advised to buy only if the current price is at least 20% below the target price, which means a buy price of $39.

Market Expectation

What is the market's expectation of DOV's growth rate given its current market price = $90? Since stock price = dividend * (1 + growth rate) / (discount rate - growth rate), we have growth rate = ((stock price) * (discount rate) - dividend) / (stock price + dividend). Plugging in stock price = $63, dividend rate = $1.24, and discount rate = 8.75%, we get growth rate = 6.65%. This seems high, given that DOV has grown its revenue by 4.4%, its earnings by 7.3%, and its dividend by 11% annually over the past 5 years. The growth rate is limited by the sales growth rate (which is the slowest historic growth rate in this case), and is supposed to slow down a bit as a company matures, so an implied market expected growth rate of 6.65%, which is higher than the stock's historic sales growth rate, suggests that the stock is currently overvalued.

Current P/E Compared with Signature P/E

We should also determine how the stock's current P/E compares with its signature P/E, since established stocks tend to revert back to their respective signature P/Es over the long term. The current EPS = 4.46, giving us a current P/E = 14.1. This is about 85% of the stock's signature P/E of 16.6, which suggests the stock is slightly undervalued right now. To provide some margin for error, we should look to buy when the current P/E is 80% or less of the stock's signature P/E, which means a buy price around $59.

Dover's P/E Compared with Competitors' P/Es

It is helpful also to compare Dover's valuations with those of its peers/competitors in the diversified machinery industry. Current P/E and forward P/E are tabulated below for the company and its competitors.

Stock

Current P/E

Forward P/E

Dover (DOV)

14.82

11.63

Cooper Industries (CBE)

15.42

12.4

Ingersoll-Rand (NYSE:IR)

34.32

11.37

Weatherford International (NYSE:WFT)

48.4

10.93

Danaher (NYSE:DHR)

19.07

15.93

Mean

26.406

12.452

Median

19.07

11.63

Click to enlarge

Looking at current P/E, Dover is relatively undervalued compared to its peers; looking at forward P/E, though, it appears fairly valued compared to its peers. Cooper Industries appears undervalued as measured by current P/E, but overvalued as measured by forward P/E. Ingersoll-Rand and Weatherford International, by contrast, appear overvalued as measured by current P/E, but undervalued as measured by forward P/E. Danaher appears fairly valued as measured by current P/E, but overvalued as measured by forward P/E. Overall, Dover appears best valued among its peers in this comparative study.

Risk Index

Lastly, we calculate the Risk Index, calculated as (Current Price - Forecast Low Price)/ (Potential High Price - Forecast Low Price) to give an estimate of the risk: reward ratio. Risk index less than 20% is desired, which gives us +200% potential returns for every risk of 50% loss we assume.

The Forecast Low Price is calculated by multiplying the Low P/E estimate by the Forecast Low EPS, to give a conservative estimate of low price for the stock in 5 years, assuming zero EPS growth and low valuation. Forecast Low EPS is estimated by averaging the EPS over the past 5 years. For growth stocks with predictable earnings growth, EPS in 5 years should not be any lower than this conservative estimate. For DOV, the forecast low EPS is equal to 3.418, so the Forecast Low Price = 10.3 * 3.418 = $35.31.

The Potential High Price is calculated by multiplying the High P/E estimate by the projected EPS in 5 years, giving us a price target in 5 years should the stock command a high P/E. For DOV, this equals 16.1 * 5.6604 = $91.08.

Thus, the Risk Index = ($63 - $35.31) / ($91.08 - $35.31) = 50%. Since this is significantly greater than 20%, the stock has an unfavorable reward to risk ratio at the current price. A pullback to $46 would give a risk index less than 20%.

Conclusion

Dover Corporation, currently selling around $63, has a target price = $49, suggesting the stock is overvalued. Market expectations are high, and downside risk appears to outweigh upside potential at the current price. Nevertheless, at the current price, the stock is expected to return 8.8 percent a year, its current P/E of 14 is lower than its historic P/E of 16, and it appears best valued among its peers. Therefore, I rate the stock a HOLD at the current price. A pullback to $40 would provide conservative investors adequate margin of safety to buy as a long term investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: Use this information as a starting point for your own due diligence, before buying any stock. If you do buy, be sure to read any annual reports (10-K) and quarterly reports (10-Q) to ensure that the fundamentals remain good and the stock is on target to reach its projected price. After holding for five years, repeat the analysis detailed in the article to decide whether to continue to hold, add, or reduce your position.