Looking at profitability is a very important step in understanding a company, since it is —essentially — the reason behind a company’s existence, and a key component in deciding whether to invest in a company or sell out your stocks. In this article I will look at Dover Corporation (DOV)’s earnings, profit margins, profitability ratios and cash flow. In addition, I will evaluate which institutional investors bought the stock in the recent quarters.
As an industrial conglomerate, this company owns over 40 separate businesses, spread out through four major niche end markets: engineered systems (42%), energy (27%), communications technology (19%), and printing and identification (12%). With a strong focus on product innovation and customer relationships, Dover operates under a decentralized organizational structure, by acquiring smaller businesses in those industries and end markets it is most familiar with. And so far, this strategy has been successful, leading to strong profitability and efficient working capital management.
Although the company’s strong acquisition model leaves it exposed to integration risks, and the 50% of revenue derived from international markets make it somewhat vulnerable to currency risks, Dover is a strong contender for a solid long-term investment. Let’s see why.
First, I’m going to take a look at Dover’s earnings growth. For many stock investors, the most important thing is growth in earnings, since this is what fuels aggressive growth stocks. Therefore, it is of the utmost importance that investors have an idea of how long a company can sustain a certain level of earnings expansion. The company's valuation, and thus the stock price, is almost completely dependent on this fact.
The first question to ask is how well the stock is growing when compared to the same quarter last year. In this case, the company grew quarterly earnings at 17% compared to the same quarter in the previous year. I also like the fact that Dover generated more than 15% quarterly EPS growth, due to strong management execution and increased product adoption levels. Management sounded very optimistic in the last earnings call.
It’s interesting to see that consensus analysts recently upgraded their estimates for the current year, increasing their EPS projections by 4.76%, because it shows that sell-side analysts are confident in the company. The three-year annual average EPS growth rate gives us a perspective on how the company grew in the recent years. Dover generated 32.17% annualized average EPS growth in the past three years, which is considerably strong and in line with the quarterly results.
In addition to analyzing EPS growth, I focus on evaluating Dover's top line or revenue growth. The value of common stocks is, of course, closely tied to the sales power of the company. Therefore, an understanding of the company’s growth potential for both the near and long-term timeframes is required before making a sound investment decision.
The firm reported a 10% quarterly sales growth year over year, which I consider somewhat weak as companies should sport more than 15% quarterly revenue growth for these kinds of investments. When betting on a company, an investor wants to see sales grow or improve over time — and not just in the last reported quarter. Looking at the company’s financials in comparison to previous years will give participants a much better idea of how well a company is doing. Dover Corp. generated a three-year average annual sales growth rate of 6.97%, which is even weaker than the quarterly results.
Gross Profit Margin
The gross profit margin measures a company's manufacturing and distribution efficiency during the production process, in addition to telling an investor the percentage of revenue/sales left after subtracting the cost of the goods/services sold. A company that operates on a higher profit margin than its competitors is more efficient and investors tend to pay more for these businesses, as they should be able to make a decent profit as long as overhead costs are controlled.
In Dover’s case, gross margins over the past years have increased. The five-year low for the gross margin was reported at 36.3%, while the current margin of 38.4% is the five-year high point. Moreover, the TTM gross profit margin of 38.3% is above the five-year average of 37.8%, implying that management has been successful in making the manufacturing and distribution during the production process more efficient over the past five years.
Operating Margin = Operating Income / Total Sales
This metric measures the proportion of a company's revenue that is left over after paying for variable costs of production, such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt. If a company's margin is increasing, it is earning more per dollar of sales. Needless to say: The higher the margin, the better.
Over the past five years, the operating margin of this firm has been increasing. While in 2009 the company reported an operating margin of 10.2%, this margin reached 15.5% over the past 12 months. Also, the TTM operating margin of 15.5% is above the five-year average of 14.2%. This implies that there has been an increase in the percentage of the total sales left over after paying for variable costs of production compared to the five-year average.
Net Profit Margin = Net Income / Total Sales
This ratio of profitability measures how much out of every dollar of sales a company actually keeps in earnings. The profit margin is very useful when comparing companies in the same — or similar — industries. A higher profit margin indicates a more profitable company that has better control over its costs, compared to its competitors.
Over the past five years, Dover's net profit margin has been increasing in comparison to the five year average margin. The TTM net profit margin of 11.49% is above the five-year average of 9.75%, implying that there has been an increase in the percentage of earnings that the company is able to keep compared to the company's five-year average. The listed profitability margins show that the company is gaining strength, a requirement I seek when investing in a stock for the long-term.
ROA - Return on Assets = Net Income / Total Assets
ROA is an indicator of how profitable a company is relative to its total assets. It also gives us an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage and is sometimes referred to as "returns on investment."
The 2012 ROA of 9.43% is slightly above the five-year average of 8.10%. This implies that management has ameliorated its ability to use the company's assets to generate earnings over the past five years.
Free Cash Flow = Operating Cash Flow - Capital Expenditure
Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. It’s important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.
Dover generated a ratio of cash flow from operations/total sales of 10.51. The higher the percentage, the more cash will be available from sales.
Several institutional investors have been buying this company’s shares in the recent quarters. This is important because hedge funds use strict fundamental procedures before investing in a stock. I feel encouraged by the fact that Jim Simons (Trades, Portfolio) and Jeremy Grantham (Trades, Portfolio) bought the stock in the past months at an average price of $88.07 because it shows that hedge funds have confidence in the stock.
Currently, many analysts have a good outlook for Dover Corpration. Analysts at MSN money are predicting that the firm will retrieve EPS of $4.76 for fiscal 2013 and an EPS of $5.31 for fiscal 2014. Analysts at Bloomberg, on the other hand, estimate revenue to jump from 2013’s $7.92 billion to $8.28 billion for fiscal 2014. On Sept. 18, 2013, Global Hunter Securities gave the company a rating of "Buy" with a target price of $97.56, signifying significant upside potential from this point.
As the profitability analysis showed, Dover has been growing at a very solid and steady pace over the past few years, thanks to management’s diversification efforts. Although the company’s EPS rates will continue to fluctuate, due to the cyclical markets in which its businesses operate, I believe that the healthy balance sheet will be able to leverage most headwinds. Furthermore, the firm is currently trading at a 31% price discount relative to the industry average of 20.90x, making it a sound and cheap investment, with long-term profits.
Disclosure: Vanina Egea holds no position in any stocks mentioned.