Emerson Electric (EMR) - Sensible to Buy Now ?

Emerson is a extremely well run Enterprise.  There really isn't much more to say than that. Emerson is run by no nonsense operating managers. They live and breath the latest Kaizen success.  They work hard for their money. 

The following two tables describe Emerson well. The tables are from Emerson's latest 10-Q. The first table shows a company that has  had steady earnings growth during the recent boom years.  The second table shows key ratios.   The key ratios also describe a prudently run Industrial Enterprise. 

What is Sensible Price for Emerson ?

Emerson is nearly a perfect case study of a  Value Stock. It produces a steady dividend. It is an Enterprise with predictable results. It's growth prospects are limited over the long term. 

Although there are occasions when Mr. Market decides Emerson is a growth company, Owners should consider Emerson a mature enterprise.  The short term ups and downs of Mr. Market's emtions should not concern an Owner. Therefore, one can price Emerson purely on the basis of   When and How much will this Enterprise pay me back ?

Emerson's dividend should drive Owners' price expectation.  Emerson's payout ratio is at a prudent 64%. Owner's can expect this ratio to increase in the next few quarters as Emerson's earnings are impacted by the Depression. However, it is unlikely that Emerson will need to cut its dividend, given the conservative capitalization structure.  

Therefore, Owners can apply the Gordon Growth Model to the expected dividend stream. Owners can then arrive at a sensible price to pay for Emerson.  

The annual dividend rate is a given at $1.32 per share.  

Owners next need to determine if they believe Emerson will increase its dividend at the 8.9% CAGR rate of the last 5 years forever or if they believe Emerson will be able to increase its dividend rate at roughly double the pace of global GDP growth (ie 2.8%).  

Finally, Owners need to determine what they believe to be an appropriate Equity Rate of Return.  Gudovac believes it is reasonable that different Owners might have different Equity Rates of Return.  This stance would horrify most financial professionals who believe Equity Rate of Returns can be calculated out to a 5 decimal places.  

Gudovac believes financial models are simply not that precise.  The implications of this lack of precision are manifest in the following chart.  

The blue line is the price of Emerson at various equity return rates using the 8.9% dividend growth rate. Gudovac does not believe a 8.9% dividend growth rate is possible to sustain forever. However, he shows this in the chart to illuminate how reasonable people might reach widely differing conculsions. The red line is the price at same equity return rates but substituting a 2.8% dividend growth rate.  The range of possible prices is rather wide. Suffice to say - Emerson's Price is highly sensitive to changes in the rate of Equity Return demanded by Owners. 

What's an Owner to do ? Gudovac recommends that Owner's think deeply about their own required returns of Employed Capital. 

Mr. Market believes Emerson is worth $34. This suggests Mr. Market requires a equity return of 6 5/8% at a perpetual dividend growth rate of 2.8% for Emerson.   

6 5/8% is certainly more than US Treasuries are paying.  

The question Owners need to ask themselves - does 6 5/8% adequately compensate one for the risks of owning equity in Emerson ? 

Gudovac's own belief is that a 6 5/8% return is sensible for Emerson.  

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