FERG Shares Fall -3.0% Today -- Is This an Opportunity or Value Trap?

Industrial Distribution company Ferguson is taking Wall Street by surprise today, falling to $151.56 and marking a -3.0% change compared to the S&P 500, which moved -1.0%.

FERG currently sits within range of its analyst target price of $154.97, which implies that its price may remain stable for the near future.

Ferguson plc distributes plumbing and heating products in the United States and Canada. The company belongs to the industrials sector, which generally includes cyclical companies -- with the exception of conglomerates whose business may span several industries. Cyclical companies experience higher sales during periods of economic expanision, and worsening outlooks during recessions.

Ferguson's trailing 12 month P/E ratio is 16.8, based on its trailing EPS of $9.0. The company has a forward P/E ratio of 16.5 according to its forward EPS of $9.2 -- which is an estimate of what its earnings will look like in the next quarter. As of the first quarter of 2023, the average Price to Earnings (P/E) ratio for US industrials companies is 20.49, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (EPS), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.

One limitation P/E ratios is that they don't tell us to what extent future growth expectations are priced into Ferguson market valuation. For example, a company with a low P/E ratio may not actually be a good value if it has little growth potential. On the other hand, it's possible for companies with high P/E ratios to be fairly valued in terms of their growth expectations.

Dividing Ferguson's P/E ratio by its projected 5 year earnings growth rate gives us its Price to Earnings Growth (PEG) ratio of -3.25. Since it's negative, either the company's current P/E ratio or its growth rate is negative -- neither of which is a good sign.

To understand a company's long term business prospects, we must consider its gross profit margins, which is the ratio of its gross profits to its revenues. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost. After looking at its annual reports, we obtained the following information on FERG's margins:

Date Reported Revenue ($ k) Cost of Revenue ($ k) Gross Margins (%) YoY Growth (%)
2022-07-31 28,566,000 19,810,000 30.65 0.1
2021-07-31 22,792,000 15,812,000 30.62 4.04
2020-07-31 21,819,000 15,398,000 29.43 0.31
2019-07-31 22,010,000 15,552,000 29.34 n/a
  • Average gross margin: 30.0 %
  • Average gross margin growth rate: 1.1 %
  • Coefficient of variability (higher numbers indicating more instability): 2.4 %

Ferguson's gross margins indicate that its underlying business is viable, and that the stock is potentially worthy for investment -- as opposed to speculative -- purposes.

To deepen our understanding of the company's finances, we should study the effect of its depreciation and capital expenditures on the company's bottom line. We can see the effect of these additional factors in Ferguson's free cash flow, which was $859.0 Million as of its most recent annual report. This represents the amount of money that is available for reinvesting in the business, or for paying out to investors in the form of a dividend. With its strong cash flows, FERG is in a position to do either -- which can encourage more investors to place their capital in the company. Over the last four years, the company's free cash flow has been growing at a rate of -0.4% and has on average been $1.15 Billion.

Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts). Ferguson's P/B ratio is 6.57 -- in other words, the market value of the company exceeds its book value by a factor of more than 6, so the company's assets may be overvalued compared to the average P/B ratio of the Industrials sector, which stands at 3.78 as of the first quarter of 2023.

Since it has an average P/E ratio, an elevated P/B ratio, and consistent free cash flow with a flat trend, Ferguson is likely overvalued at today's prices. The company has strong growth indicators because of an above average PEG ratio and average operating margins with a positive growth rate. We hope you enjoyed this overview of FERG's fundamentals. Be sure to check the numbers for yourself, especially focusing on their trends over the last few years.

The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.