Company Description: "Emerson Electric Company (EMR) designs, supplies, and delivers products, technology, and delivers engineering services and solutions in a range of industrial, commercial and consumer markets globally." Please see Company's 10-K for full details.
Emerson Electric is a dividend aristocrat that has raised its dividend for 55 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. Prices are adjusted for stock splits.
Key 10-year data for Emerson Electric
Year | Sales (in Billions) | EBIT (in Billions) | EPS | High Price | Low Price | High P/E | Low P/E | Average P/E |
2011 | 24.22 | 3.63 | 3.26 | 62.2 | 39.5 | 19.1 | 12.1 | 15.6 |
2010 | 21.04 | 2.88 | 2.6 | 58.4 | 41.5 | 22.5 | 16.0 | 19.2 |
2009 | 20.1 | 2.45 | 2.26 | 44.1 | 25.1 | 19.5 | 11.1 | 15.3 |
2008 | 23.75 | 3.65 | 3.1 | 58.2 | 30.6 | 18.8 | 9.9 | 14.3 |
2007 | 22.13 | 3.09 | 2.65 | 58.4 | 42.2 | 22.0 | 15.9 | 19.0 |
2006 | 19.73 | 2.67 | 2.23 | 44.5 | 38 | 20.0 | 17.0 | 18.5 |
2005 | 17.31 | 2.15 | 1.7 | 38.7 | 31.2 | 22.8 | 18.4 | 20.6 |
2004 | 15.62 | 1.85 | 1.49 | 35.1 | 28.6 | 23.6 | 19.2 | 21.4 |
2003 | 13.96 | 1.41 | 1.2 | 32.5 | 23.1 | 27.1 | 19.3 | 23.2 |
2002 | 13.75 | 1.59 | 1.28 | 32.6 | 22 | 25.5 | 17.2 | 21.3 |
From these data, we can plot Sales, EBIT, and EPS versus Year, as shown in the chart below.
Sales (in Billions), EBIT (in Billions), and EPS versus Year for Emerson Electric, 2002-2011
As evident from the chart above, EMR 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 = 0.2187 (2016) - 436.7 = 4.1992.
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). There are no significant outliers, so we average the Average P/Es from the past 10 years to arrive at a signature P/E of 18.8.
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 five lowest High P/Es from the past 10 years gives 19.9.
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 five lowest Low P/Es from the past 10 years gives 13.
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 19.9 and 13 gives us 16.43.
Target Price
Multiplying our EPS projection for five years hence by the average P/E estimate gives us a projected average price for the stock: $4.1992 * 16.43 = $69, which represents an annual stock price return of 7.3% from the current price = $52. When we add in the 3.1% dividend yield, the total return expected is an annualized 10.4%, which means an investment in EMR today is expected to double in seven years.
Given a beta = 1.23 for EMR, 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% + 1.23*(5%) = 8.15%. Applying this discount rate of 8.15%, our projected price of $69 in five years translates to a target price = $47 in today's dollars, which is 10% below the current price of $52 for the stock, suggesting the stock is slightly 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 $37.
Market Expectation
What is the market's expectation of EMR's growth rate given its current market price = $52? 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 = $52, dividend rate = $1.60, and discount rate = 8.15%, we get growth rate = 5%. This seems slightly high, given that EMR has grown its revenue by only 4 percent annually over the past five years, and growth is supposed to slow down as a company matures. A more realistic expectation of 4 percent annual growth rate would value the stock at $40.
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 = 3.26, giving us a current P/E = 16. This is about 85% of the stock's signature P/E of 18.8, 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 $49.
Emerson Electric's P/E Compared with Competitors' P/Es
It is helpful also to compare Emerson Electric's valuations with those of its competitors and peers in the industrial equipment industry. Normalized P/E, Current P/E and Forward P/E are tabulated below for the company and its competitors/peers. Normalized P/E is calculated using average earnings over the past 10 fiscal years. Current P/E uses earnings during the last fiscal year. Forward P/E uses projected earnings in the next year based on analysts' consensus.
Stock | Normalized P/E | Current P/E | Forward P/E |
Emerson Electric (NYSE:EMR) | 23.89 | 16.01 | 13.07 |
ABB (NYSE:ABB) | 36.07 | 19.43 | 13.23 |
General Electric (NYSE:GE) | 12.22 | 13.7 | 10.73 |
United Technologies (NYSE:UTX) | 21.44 | 14.61 | 12.01 |
Caterpillar (NYSE:CAT) | 28.48 | 14.94 | 9.93 |
Deere & Company (NYSE:DE) | 26.79 | 13.11 | 10.43 |
Illinois Tool Works (NYSE:ITW) | 20.99 | 13.46 | 13.26 |
Mean | 24.27 | 15.04 | 11.81 |
Median | 23.89 | 14.61 | 12.01 |
Compared with its peers, Emerson Electric appears fairly valued based on normalized P/E, but overvalued based on current and forward P/Es. ABB appears overvalued on all three measures. General Electric appears undervalued on all three measures. United Technologies appears undervalued based on normalized P/E, but fairly valued based on current and forward P/Es.
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 five years, assuming zero EPS growth and low valuation. Forecast Low EPS is estimated by averaging the EPS over the past five years. For growth stocks with predictable earnings growth, EPS in five years should not be any lower than this conservative estimate. For EMR, the forecast low EPS is equal to 2.774, so the Forecast Low Price = 13 * 2.774 = $36.05.
The Potential High Price is calculated by multiplying the High P/E estimate by the projected EPS in five years, giving us a price target in five years should the stock command a high P/E. For EMR, this equals 19.9 * 4.1992 = $83.45.
Thus, the Risk Index = ($52 - $36.05) / ($83.45 - $36.05) = 34%. Since this exceeds 20%, the stock has an unfavorable reward to risk ratio at the current price. A pullback to $45 would give a risk index less than 20%.
Conclusion
Emerson Electric Company, currently selling around $52, has a target price = $47, suggesting the stock is slightly overvalued. Market expectations are high, the stock appears overvalued compared with its peers, and downside risk appears to outweigh upside potential at the current price. Nevertheless, at the current price, the stock is expected to return 10.4 percent a year, and its current P/E of 16 is lower than its historic P/E of 18.8. Overall, the stock appears fairly valued. Therefore, I rate the stock a HOLD at the current price. A pullback to around $40 would provide conservative investors adequate margin of safety to buy as a long-term investment.
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.