In big market corrections, good stocks often get unfairly punished for the market’s change of mood. These volatile conditions can provide good buying opportunities for smart investors.
In today’s article, I’m going to take a look at three companies with stable earnings forecasts but falling share prices. Are they bargain buys, or are these firms’ falling share prices a sign that current forecasts are too optimistic?
Shire
Shares in pharmaceutical firm Shire (LSE: SHP) have fallen by 24% so far this year. That’s a big drop, given that the FTSE 100 has only fallen by 10% over the same period. Is trouble brewing at Shire?
Not necessarily. Shire published its full-year results on Thursday. The firm’s earnings were slightly higher than expected, at $3.89 per share, versus forecasts for $3.83 per share. Looking ahead, Flemming Ornskov, Shire’s chief executive, said that he expected “double-digit” sales growth and a 7%-to-10% increase in earnings per share this year.
Current analyst forecasts suggest that Shire’s earnings will rise by 12% to $4.29 this year. This puts the shares on a forecast P/E of 12.
This may look cheap for a growth stock, but Shire is in the middle of acquiring Baxalta for $32bn. This deal is expected to increase Shire’s net debt from $2bn to about $25bn. A lower market cap makes sense given such a dramatic rise in debt.
Another factor is that investors are keen to see whether any of Shire’s other new products will reduce the firm’s dependence on its flagship Vyvanse ADHD treatment.
Overall, I’d say Shire’s share price looks about right.
Airlines are falling
British Airways owner International Consolidated Airlines Group (LSE: IAG) is down by 22% so far in 2016. The firm’s shares now trade on a 2016 forecast P/E of just 6.1 and offer a prospective yield of nearly 4%.
It’s a similar story at easyJet (LSE: EZJ). The budget carrier’s share price has fallen by 15% so far this year, and its shares now trade on a 2016 forecast P/E of less than 10.
These falling share prices don’t seem to be caused by a lack of growth. Passenger numbers were up in January. easyJet’s earnings per share are expected to rise by 8% this year, while last year’s Aer Lingus acquisition is expected to help drive IAG’s earnings per share up by 41%.
Fuel costs shouldn’t be a problem either. Lower oil prices should gradually help to reduce both airlines’ costs and enable them to lock-in cheaper fuel for the next 12-to-18-months.
So what’s the problem?
There are two possibilities. One is that the airline sell-off is providing us with a great buying opportunity. The second possibility is that after six years of strong growth, airline earnings are getting close to their cyclical peak.
After all, IAG’s post-tax profits have risen by 680% since 2010, thanks partly to a string of big acquisitions. easyJet’s profits have risen by 350% over a similar period. Ryanair is expected to report profits 325% higher for this year than in 2010.
Although analysts’ forecasts remain firm for these airlines, this big sell-off suggests to me that the market could be starting to lose confidence in airlines’ earnings growth.
Can all of these airlines really continue to grow at current rates? I’m not sure.
