This past week, I bought shares in the biggest security service company in the world, G4S. Although this behemoth has faced a beleaguered past 12 month, the current share price looks really attractive. At the current share price, I expect G4S to be a really good long term buy and provide returns in excess of 13% a year.
When investing in companies, one of the most important factors that will determine the return you get is the price you initially pay. Apart from solid growth companies like Visa and Starbucks or elite companies like Unilever and Coca Cola, I would argue that you should not buy a stock if it has a P/E ratio in excess of the 15, which is the markets long term average. (If you prefer the cyclically adjusted P/E ratio, the number jumps to about 20).
At current, G4S has a P/E ratio of 12 which makes it very attractive in the current overvalued market environment. A P/E of 12 means that the price of G4S stock is currently 12 times more than its earnings.
Talking of earnings, the company remains profitable. This may be a shock to many considering the many difficulties the company has faced over the past couple of years. When a company faces problem after problem yet still remains profitable and keeps winning contracts , you know that you have a very good business model. G4S has contract retention rates of over 90% which shows that the company has little problem winning new contracts even after all the scandals. This is a very good company.
The current earnings per share is 0.15p and the current dividend is 0.10p giving a very healthy dividend yield of 5%.
One of the ways I like to value a company is to do a discounted cash flow analysis. For anyone serious about investing, learning about discounted cash flow is imperative to being successful as you need to know how to discount future cash flows to their present value in order to determine a fair price to pay for the stock. Below is an excerpt of the DCF analysis I used on G4S.
Discounted Cash Flow Analysis:
- The discount rate, or required rate of return, is estimated by calculating the Cost of Equity.Discount rate = Cost of Equity = Risk Free Rate + (Levered Beta * Equity Risk Premium)
Discount rate = 8.38% = 1.92% + (0.8 * 8.08%)
- The Levered Beta is the Unlevered Beta adjusted for financial leverage. It is limited to 0.8 to 2.0 (practical range for a stable firm).
Levered Beta = Unlevered beta (1 + (1- tax rate) (Debt/Equity))
0.658 = 0.407 (1 + (1- 21%) (78.01%))
Levered Beta used in calculation = 0.8
- The risk free rate of 1.92% is from the 10 year government bond rate in United Kingdom.
- Equity Risk Premium = Market Return Premium (10%) – Risk Free Rate (1.92%) = 8.08%)
Terminal Value = FCF2020 × (1 + g) ÷ (Discount Rate – g)
Terminal Value = £381 × (1 + 1.9%) ÷ (8.38% – 1.9%)
Terminal value based on the Perpetuity Method where growth (g) = 1.9%: £6,009
Present value of terminal value: £4,018
Equity Value (Total value) = Present value of next 5 years cash flows + terminal value
Value = Total value / Shares Outstanding (£5,186 / 1,546)
Value per share:£3.35
Current discount (share price of £1.889): 44%
By applying Discounted Cash Flow Analysis, it shows that the fair value of G4S stock is £3.35 and this is 44% more than the current share price of £1.88. But please note that many estimates are used in a DCF value analysis so you should not use any of my figures for your stock purchases. If you have an interest in buying G4S or any other stock listed on this figures, please do your own research. After all, it is your money.
My purchase of G4S – Increasing my Dividend Income
G4S looks like a very good stock to me at the moment. G4S being held in large amounts by two of the best value investment funds in the world, Woodford Funds and Tweedy Browne, gives me added assurity that I have picked a long term winner with this stock.
I was able to buy 580 shares in G4S for just under £1,100. The anticipated dividend a year from this purchase would be £55 and I would expect this to grow over time.
Based on the numbers I have run, the stock should provide returns of 13% over the next 7 years. This all due to the low entry price of £1.88. Most of the bad news, including the high levels of debt, have already been priced in to the stock and I expect there to be minimal downside from here. Apart from being beaten up by the market, what has led to the stock price falling further than what you would rationally expect is the demotion of the company from the FTSE 100 into the less popular FTSE 250 index. This has the opposite effect of front running, as the big index providers have been forces to sell the stock as it no more warrants a place in the FTSE 100. This is one of the great disadvantages of index funds but that argument is for a different day.