The Best of Last Week – Stagecoach

Stagecoach released its interim report last week and was the highest-ranked stock on my shortlist to do so.  The question is, at a price of around 250p, what do the shares of this company have to offer the average investor?

The first thing to note is that in the past the company has provided a stable base of earnings.  This stable earnings power comes primarily from the industry in which they operate.

By providing public transport on their fleet of buses and trains the company’s earnings are generated from many millions of frequent and often non-discretionary cash payments.  Even during recessions, people have to travel.  The same is true of their competitors, including FirstGroup and Go-Ahead.

The average earnings of the past decade are around 13.5p per share, which means the current price is around 19 times that level (also known as the Graham and Dodd PE or PE10).

There is, however, more to being a good company than simply generating stable earnings and Stagecoach has done more by growing at over 11% a year for many years.  Although growth is not a prerequisite for a sound investment it is certainly better to own a growing company than one which cannot even keep pace with inflation, let alone a company which is in decline.

Historic growth is desirable, but it is only proof that the company has grown in the past and does not necessarily mean that the growth will continue into the future.

There is research which suggests that a long-term ‘modal’ shift towards non-car transport is occurring, which of course includes buses and trains.  If that is correct then Stagecoach and similar companies may have a relatively successful time over the next decade or more.

However, it is probably best not to get too excited about the potential for a more prosperous future, but instead to simply say that the industry is likely to remain largely unchanged in the years ahead, with the possibility of some further growth.

It is one thing to be a good, stable and growing company, but it is quite another for the company’s shares to be a good investment.

At the current price, the PE10 ratio is close to 20, which Ben Graham sometimes cited as a reasonable ceiling.  Also, the yield is about 3%, which is not much different than the FTSE 100, which is a far safer investment.  In Stagecoach’s favour is its higher growth rate, closer to 10% rather than the wider market’s 5-7% growth rate (or perhaps less in the years ahead).

In the shorter term there doesn’t seem to be any particular ‘catalyst’ which might cause Mr Market to re-rate the share price upwards, nor would I expect him to do so given that the shares appear to be fairly valued at the moment.

For me, Stagecoach is exactly the sort of company I like to invest in.  It has a long history of stability, dividend payments and growth.  However, at 250p the potential future rewards are not enough to make me a buyer.

To give a clear advantage over other stocks, bonds or even the market index, the price would have to drop to something below 200p.  At that price, I’d certainly be interested in a closer look.

Verdict: Good company, mediocre price.  If the shares were sub-200p I’d be interested.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

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