Over the past year, shares of Minneapolis-based packaged food company General Mills (NYSE:GIS) have traded hands anywhere between about $59 and about $73. As I write this, the going rate is around $60, quite close to the 52-week low. Indeed, shares are down about 15% in just the last eight months. And with this information alone, some investors might now be interested.
Personally, I'm reminded that just because a much better or worse deal was previously offered, this does not necessarily influence the current value proposition. As an example, a stock like Wells Fargo (NYSE:WFC) got down to $8 or so per share during the last recession. In the months and years that followed, it would hit $18, $28, $38, and so on, all the way to today's $58. Naturally, you would have preferred to purchase shares at $8, but this doesn't mean that solid opportunities weren't being offered along the way at $18 or $38 (or even today).
The idea is that just because a great deal was once offered, this doesn't mean that a higher price is now a bad deal. It's not mutually exclusive.
The interesting part to me is that this works the other way as well. Just because an investment has declined in price does necessarily mean it's a now good deal. Let's see what I mean by using General Mills as an example.
The company recently reported third-quarter fiscal year 2017 results, reiterating its full-year outlook:
Constant-currency adjusted diluted EPS is expected to increase 5 to 7 percent from the base of $2.92 earned in fiscal 2016. The company estimates currency translation will have an immaterial impact on full-year fiscal 2017 adjusted diluted EPS.
For our purposes, let's use $3.10 in underlying earnings power as our starting point (quite close to what analysts are anticipating as well). Intermediate-term growth expectations for the business are around 6% per year. Let's use 5% to stay somewhat cautious.
Just to give you a reference point, in the past decade, General Mills grew revenues by 3.6% annually, total company-wide earnings by 5.1% per year and earnings per share by 7.3% per annum. In the past five years, the rate of increases has slowed to 2.2%, 1.6%, and 3.3%, per year respectively.
So depending on how you look at it, current expectations are a bit lower than what was achieved in the past decade, but a decent amount higher than what has been accomplished as of late. Moreover, the dividend payout ratio, net profit margin, and total earnings and sales are now higher - creating a higher "investment bar" from which to grow.
If General Mills were to grow earnings by 5% annually (starting with $3.10 this year), you would anticipate the firm generating $3.95 or so after five years. The future share price is going to depend on the future valuation, which naturally is not yet known. However, coming up with a baseline can be useful. A "typical" valuation over the years for General Mills has been around 16 to 18 times earnings (within a range of around 12 to around 25).
At 17 times earnings and future profitability of $3.95 per share, you'd be looking at a share price of about $67. With a current price near $60, this highlights the idea that just because the share price has declined materially, this does not automatically that a great deal is now being offered.
Of course, we have to add in the dividend as well. General Mills' last quarterly dividend was $0.48. Given that the company is currently paying out about 60% of earnings. you might anticipate the payout to more or less grow in line with earnings.
Should the dividend grow by 5% annually as well, you'd be looking at collecting $11 or so in cash dividends. Added to the share price anticipation, this equals a total value of about $78. As compared to the near $60 starting price, this would represent a total return of roughly 5.4% per annum — reasonable, but not exactly compelling.
Now two notes should be made. For one thing, the returns at a much lower price are better. As an example, using the same assumptions from above, a share price of around $73 would have meant the expectation of just 1.4% annualized gains. So the much lower share price (absent much lower business expectations) is more compelling in that sense. It's just not a guaranteed way to find a great investment.
The second item of note is that this is a single scenario. If I had to come up with a baseline for General Mills, I might use the above as a starting point, but it by no means is all encompassing. Here's a table with a lot more coverage:
The above table shows potential earnings growth rates on the left-hand side and potential ending valuations on the top row. So as an example, our scenario above of 5% annual growth and an ending P/E ratio of 17 is highlighted in the green box. Each cross-section shows you what the potential return would be with every circumstance. Note that for simplicity dividends are anticipated to grow in line with earnings.
A single starting baseline is nice (and essential, in my view) but looking at something like the scenario table above can be a lot more powerful. It allows you to quickly test your own investment thesis.
For instance, suppose you believe my assumptions above are too conservative. Instead of 5% growth and 17 times earnings, you think 7% growth and 19 times is more realistic. (Personally, I like to stay conservative, but the idea is to come up with an independent baseline.) You can see these assumptions lead to the anticipation of around 9% annualized gains.
This makes the very important point that a security can perform much better than you imagine. Areas where my starting baseline would prove too conservative are highlighted in yellow. On the other side, any growth rate under 5% with a future multiple below 18 or so is probably not going to look interesting. You can see those potential results in the unshaded areas.
In short, General Mills has proven to be an excellent business, pumping out billions in profits with iconic brands. And the share price has declined materially as of late. Yet these two factors do not necessarily mean the security is now an interesting investment. There are other factors, like going from a very high valuation to "just" a high one, or starting from an elevated base, that could make future returns harder to formulate. So what do you think? Is General Mills now compelling near its 52-week low?
Disclosure: I am/we are long WFC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.