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RVB's Market Musings

What began here as an avenue to interact and learn has far exceeded those goals.

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Tuesday, May 24, 2005

Q&A - Church and Dwight (CHD)

A co-worker talked about potentially "going long" CHD (buying shares of Church and Dwight stock). (I will continually use this lingo so that everyone who reads my blog gets used to it).

So, I thought that I would give a brief description of some of the things I would look at. Since I am primarily a "growth" minded investor (see growth stock, I would pay more attention to the company's annual revenue growth, and quarterly earnings per share (EPS) growth. I would also look to make sure that there is a somewhat linear relationship between the two - meaning that if the top line (revenue growth aka total sales) is increasing at a significantly different rate than earnings per share, I would be skeptical of the companies longer-term prospects. Here's why:
Imagine XYZ company growing sales at 25% - let's say our hypothetical company sold $1 billion of widgets two years ago, and $1.25 billion last year - I like 25% because for a "growth stock", it's a good ballpark figure for a bare minimum of revenue growth. Anyhow, imagine if the company is growing earnings per share at a much higher rate, say 100%. So let's say last year they earned $1 per share and this year the co. earned $2 per share. The question is, how is the company doubling their overall earnings, without increasing sales as much? What's the company doing? The simple answer is that productivity is basically responsible for the 100% EPS growth. The thing about productivity is that it typically is not sustainable forever. Remember, "growth" means that we like to see EPS continually increasing and accelerating. If the company increased EPS 100% last year, I'd like to see MORE than 100% this year! But, for the company to continue to grow at a 100% EPS growth rate the company has to either start increasing sales while maintaining the same level of productivity, OR increase the productivity even more! That would be tough to do, although many companies are able to do it.

Back to Church and Dwight. CHD is in the "soap and cleanings" industry group in the Investor's Business Daily. For example, one of the flagship products the company has is the "Arm and Hammer" line of products. The stock is the leader in its group. Fundamentally the stock is sound in some regards, however, last december's EPS checked in at 17 cents versus 24 cents the year before. June saw a similar decrease. Year over year, revenue was up last year 36% compared to the year before, but EPS was up only 6%. Some investigation would be necessary to see if there was a reason for such a discrepancy (like a one-time charge or something like that). This doesn't automatically raise a flag, but some further investigation may be necessary. The first quarter reported this year showed a 42% revenue increase and 20% EPS increase over last year. That's good news. The dividend decrease is NOT good news, however. Notice that last year's dividend paid was only 17 cents, versus 21 cents the year before. For a look at the numbers, the Nasdaq is a good reference (EPS/Revenue Table) The stock chopped wildly on the earnings announcement on May 10th (Chart)

Technically (looking at the charts), the stock is basing, though the longer term trend is definitely up. Since the stock isn't doing much now, one could wait for the stock to break the base, and decide then. For example, if the stock traded above the high of 37.50, one could argue that the stock has made up its mind to move higher (it has broken out, and be bought at, say, 37.60. Then, if it is a "fakeout", one could sell it if it fell back near the $35 or $36 range - depending on your investing style. This is probably what I would do, because the company's industry group is not really in favor right now, despite the fact that the stock is considered the leader in its group.

This is a start. Remember, I'm not recommending to buy or sell CHD, just showing how I might start to look at the company. More questions could be asked, or less, depending on your style.


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