I recently submitted an article on three stocks that I consider being undervalued: 3 Stock Considerations
Before that article was posted, I made a buy of each of those companies. Those buys can be seen on my website (which can be found on my profile page).
Since the article was published, one of the companies went down 7.16%. I saw this as an opportunity to add more shares of that company.
I added more shares to my portfolio with the purchase of W. W. Grainger Inc (NYSE: GWW).
7 Shares @ $170.95 on 7/14/2017
My up to date portfolio can be found on my website as well.
Source: Grainger Investor Site
Grainger is a primarily business-to-business distributor of products used to maintain, repair and operate facilities. Approximately three million businesses and institutions worldwide rely on Grainger for products such as safety gloves, ladders, motors and janitorial supplies, along with services like inventory management and technical support. These customers represent a broad collection of industries including healthcare, manufacturing, government, and hospitality. They place orders online, over the phone and at local branches. Approximately 5,000 key manufacturers supply Grainger with 1.6 million products stocked in Grainger’s distribution centers and branches.
- Source (W W Grainger Investor Relation)
Let's talk about how GWW has been doing the past 10 years and where they are now. Revenue grew at a Compound Annual Growth Rate (CAGR) of 5.21% from 6.4 billion in 2007 to 10.137 billion in 2016. This year, revenue is expected to be around 10.38 billion. Analysts foresee 10.27 billion being in the low end. Analysts expect 2018 to be around 10.88 billion.
Net Income increased from 420 million in 2007 to 606 million in 2016 which gives us a CAGR of 4.16%. The past two years GWW has been on a downward trend from their high of 802 million net income in 2014; however, so far this year the Trailing Twelve Months (TTM) is at 594 million. GWW looks to surpass their high in 2014 of 802 million.
Earnings Per Share (EPS) on the other hand had a much better CAGR of 7.99% compared to revenue and net income. In 2007, GWW EPS was $4.94 and in 2016 it was $9.87. Analysts expect 2017 EPS to be around $10.37 and 2018 to be $11.17 EPS.
Now let's talk about my favorite part of investing and that's dividend. GWW has been increasing dividend for 46 consecutive years. WOW!! They have been growing dividend for longer than I have been alive. That is amazing.
They have a 5-year dividend growth rate of 13.9% and a current dividend yield of 2.98%. GWW most recent dividend raise was 4.92%. The analyst's group CFRA is expecting a 3-year projected EPS of 8. This leads me to believe that the future dividend growth rate will be in the mid to high single digit rate.
GWW currently has a dividend payout ratio of 50%. This meets my criteria of less than 70% payout ratio. This gives GWW plenty room to grow its dividend at the rate I mention.
With any investment, there are risks and uncertainty. GWW is currently facing what a lot of people are calling the "Amazon Effect". Which is basically Amazon (NASDAQ:AMZN) takes market shares from companies like GWW.
However, GWW saw eCommerce business grow 23% vs same time last year. Another way they are combating against the "Amazon Effect" is by adjusting lists prices to large customers and by introducing new web prices to ~450k SKUs as mentioned below.
Source: Q1 2017 Earnings Presentation
Some of the keynotes from the above picture are "Stronger than anticipated volume responses..." and "Prior to web pricing, volume was declining at double digits and is now up in the mid-single digits..."
This looks promising and you can see the positive changes in the analyst's 2017 and 2018 EPS expectation.
So we know the history and where GWW currently sits. We know the risks and how they are trying to overcome it. So how much is GWW worth?
The normal PE for 10 years sits at 19.9 as you see in the below picture from FastGraphs. GWW is now at 17.58 with a forward PE of 16.4 based on 2017 EPS. The 5-year PE average is 21.5. This metric is a great indicator that GWW is indeed undervalued when looking at normal PE.
This is a picture from fastgraphs.com. Whenever the black line is under the orange line, it is considered to be undervalued. GWW is a high-quality company with 46 years of dividend increases, so GWW tends to always go for premium prices. Therefore, I look at the PE Line (Blue Line) when looking a high-quality company like GWW. This shows us that GWW is undervalued when looking at the Normal PE Line.
If you look at the earnings (Orange Line), we see that GWW is the fair price level.
As Mr. Warren Buffet said, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
This chart is one of my favorite from FastGraphs because it shows the Normal PE where a company averages. As you see here, I like to pick a PE with the lowest multiple because it kind of gives me the worst case scenario. The normal PE here is at 18.5. GWW is currently at 17.58. Based on this, if GWW were to hit that normal PE of 18.5, we will get a total Rate of Return of 14.56% by year end. That's really good in my opinion.
Another great indicator to find if a company is undervalued is looking at the dividend yield history. The 5-year dividend yield average is 1.8%. GWW is currently at 2.98%.
As you see in this chart, this is the highest it has been in the last 10 years.
Source: SIMPLY WALL ST
So how much should you pay for this stock?
My assumption of the DDM model is 7% growth rate seeing how CFRA is giving GWW an 8% growth rate for the next 3 years. I like to be a little bit conservative. I also used a 10% discount rate.
My DDM Analysis: $174.05
S&P Capital Fair Price: $173.30
Yahoo Analyst Price Target: $182.91
Fair Value from SIMPLY WALL ST: $166
Source: SIMPLY WALL ST
Averaging out the four fair price estimates gives us a fair value of $174.07. GWW is currently at $171.89. This means that GWW is 1.2% undervalued.
It is not a great discount but like Mr. Buffet said himself "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
I currently have 13 shares of GWW and do not plan to add more unless it drops significantly. With the 13 shares and the company paying a dividend of $1.28 a share, this will increase my annual dividend income by $66.56. My forward annual dividend income is now at $3,894.00.
I think GWW will be a great addition to any dividend growth portfolio. They have an amazing dividend history and the value GWW brings to shareholders.
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Disclosure: I am/we are long GWW.
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.