World Fuel Services Corporation (NYSE:INT) has a long history of earnings growth of more than 15% per annum. Since the 2008 recession that reduced its share price significantly by historical standards, the company's stock price has been steadily on the rise. Indeed, much of the company's run-up from a low of just under $7 per share to its current $47-plus share price can be attributed to a reversion to the mean, back to historically normal valuations.
Additionally, part of World Fuel Service Corporation's momentum can be attributed to its popularity as a mid-cap growth stock, a classic example of which can be found in a recent Barron's article covering the co-managers of the FBR Focus Fund. This article examines whether World Fuel Service Corporation should be considered as an attractive mid-cap growth opportunity.
Growth stocks are defined as companies with high rates of change of earnings growth of 15%-20% or more. Growth stocks offer the potential for share prices to rise in lockstep with their profit growth in the long run. Therefore, the PEG ratio formula (price equals growth rate) tends to be the most appropriate formula used to value growth stocks. However, due to the exponential nature of compounding large numbers, PEG ratio forecasts are capped at 40%.
Due to the higher valuation typically awarded to fast growth, growth stocks offer the potential for greater capital appreciation. On the other hand, they also come at higher risk. First of all, they tend to command much higher than average P/E ratios, and second, it is difficult to sustain very high levels of growth. Consequently, forecasting future earnings growth is more important with high growth stocks than with any other class of stock. Also, the average growth stock will typically plow all of its profits back into the company to fund future growth, instead of paying out dividends.
World Fuel Services Corporation: Large-cap growth at a price
Company description from its website: "Headquartered in Miami, Florida, World Fuel Services is a leading global fuel logistics company, principally engaged in the marketing, sale and distribution of aviation, marine and land fuel products and related services on a worldwide basis. World Fuel Services sells fuel and delivers services to its clients at more than 6,000 locations in 200 countries and territories worldwide.
The company's global team of market makers provides deep domain expertise in all aspects of aviation, marine and land fuel management. Aviation customers include commercial airlines, cargo carriers, private aircraft and fixed base operators (FBO's), as well as the United States and foreign governments. World Fuel Services' marine customers include international container and tanker fleets, cruise lines and time-charter operators, as well as the United States and foreign governments. Land customers include petroleum distributors, retail petroleum operators, and industrial, commercial and government accounts."
Earnings determine market price
The following earnings and price correlated F.A.S.T. Graphs™ clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.
World Fuel Services Corporation: Historical Earnings, Price, Dividends and Normal PE Since 1998
Click to enlarge
Performance Table: World Fuel Services Corporation
The two keys to long-term performance
Years of research and experience have taught us that there are two critically important keys to achieving above-average, long-term shareholder returns at reasonably controlled levels of risk. The first key is earnings growth, or what we like to call the rate of change of earnings growth. The faster a company can grow its business (i.e. earnings), the larger the income stream it can produce with which to reward shareholders. This is because of the power of compounding, which Albert Einstein was alleged to have called "the most powerful force on earth." Ultimately, both capital appreciation and dividend income will be a function of a company's ability to grow its profits.
The second key is valuation. When a company can be purchased at its intrinsic value based on earnings and cash flow generation, the shareholders' rate of return or long-term capital appreciation will inevitably correlate to and/or equal its earnings growth rate. Overvaluation will lower that rate of return and conversely, undervaluation will increase it. Consequently, paying strict attention to the valuation you pay to buy a stock is a critical component of both greater return and taking lower risk to achieve it. Because, ironically, when you overpay for even the best business, you simultaneously lower your return potential, while increasing your risk of achieving the lower return.
The associated performance results with the earnings and price correlated graph, validates the above discussion regarding the two keys to long-term performance. Notice the impact that valuation (black line above or below orange earnings justified valuation line) has on the following performance results.
The following graph plots the historically normal P/E ratio (the dark blue line) correlated with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as normal as it has been since 1998.
A further indication of valuation can be seen by examining a company's current price to sales ratio relative to its historical price to sales ratio. The current price to sales ratio for World Fuel Services Corporation is 0.11 which is historically low.
Looking to the future
Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:
1. The rate of change (growth rate) of the company's earnings.
2. The price or valuation you pay to buy those earnings.
Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.
Therefore, it logically follows that measuring performance without simultaneously measuring valuation is a job half done. World Fuel Services Corporation is clearly an industry-leading superior business, which based on consensus estimates from leading analysts, appears to be capable of growing earnings at an above-average rate for the foreseeable future. At its current price, which is attractively aligned with its True Worth™ valuation, World Fuel Services Corporation represents an opportunity for growth at a reasonable price. The important factor is that World Fuel Services Corporation, with its strong balance sheet and potential for future earnings growth, has real assets and cash flow underpinning its stock price. This solid economic foundation offers shareholders the potential for both a strong margin of safety and an opportunity for outsized future returns.
The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.
The consensus of six leading analysts reporting to Capital IQ forecast World Fuel Services Corporation's long-term earnings growth at 9.3%. World Fuel Services Corporation has long-term debt at 2% of capital. World Fuel Services Corporation is currently trading at a P/E of 17, which is the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, World Fuel Services Corporation's True Worth™ valuation would be $70.20 at the end of 2017, which would be a 7.5% annual rate of return from the current price.
Earnings yield estimates
Discounted future cash flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stake holders over time. Therefore, because earnings determine market price in the long run, we expect the future earnings of a company to justify the price we pay.
Since all investments potentially compete with all other investments, it is useful to compare investing in any perspective company to that of a comparable investment in low-risk Treasury bonds. Comparing an investment in World Fuel Services Corporation to an equal investment in 10-year Treasury bonds, illustrates that World Fuel Services Corporation's expected earnings would be 4.6 times that of the 10-Year T-Bond Interest (see EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.
Summary and conclusion
This report presented essential "fundamentals at a glance" illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although, just a quick glance can tell readers a lot about the company, it's imperative that they conduct their own due diligence in order to validate whether the consensus estimates seem reasonable.
In the case of World Fuel Services Corporation, it should be noted that consensus estimates are significantly lower than the company's recent historical earnings growth rates. Consequently, the reader should at least consider the possibility that consensus is offering a pessimistic view of the company's future prospects. Regardless, even if you calculated earnings growth at the 16.8% rate that the company has achieved over the past five years, World Fuel Services Corporation appears fully valued; however, not necessarily overvalued at today's levels, based on earnings justified valuation. Therefore, we would rate this stock a long-term hold, and might recommend adding to positions on dips.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.