by Dan Burrows | September 6, 2012 1:24 pm
The McGraw-Hill Cos. (NYSE:MHP) isn’t exactly a household name, but you’re almost certainly aware of its products and brands.
Most notably, MHP, through McGraw-Hill Financial, owns Standard & Poor’s, the famous (or infamous, depending on your point of view) credit-rating agency, financial-data provider and maintainer of the S&P 500 Index, the most commonly used benchmark for U.S. equity performance.
MHP’s other business, McGraw-Hill Education, is one of the world’s biggest textbook publishers, meaning you and your kids have been lugging around the company’s products for years.
MHP intends to spin-off or sell the education division by year-end, separating the slower-growth book publishing business from the faster growth data division. It’s a move that’s been long anticipated — and applauded — by Wall Street.
Meanwhile, a string of better-than-expected quarterly earnings and scuttlebutt that private equity interests could offer as much as $3 billion for the education business have helped propel MHP to yet another 52-week high. Indeed, MHP is up more than 16% year-to-date and, more impressively, has jumped almost 25% since hitting a year-to-date low in late June.
So, should you follow the herd and get in on MHP now? To help decide, let’s look at the pros and cons:
Dividends. MHP has an outstanding history of dependable, rising payouts. Indeed, it’s been paying dividends since 1937, earning it a place on InvestorPlace’s list of Dependable Dividend Stocks. True, the current yield of 2% seems paltry compared to what else is out there, but the five-year average stands at a respectable 2.6%. Furthermore, this is a company that hikes payouts — a key criteria for any long-term equity income holding. According to Zack’s Investment Research, MHP has raised its dividend at a compound annual rate of 9.6% since 1974.
Defense. MHP is something of a port in a storm when markets are rocky, with attractively low volatility. With a beta of 0.8, it can be thought of as 20% less volatile than the S&P 500. Yes, that also makes it kind of boring. It tends to lag when the broader market is taking off, but it also holds up better when everything is selling off.
Quality. Return on equity (ROE) measures the amount of profit a company generates with the hard-earned cash investors have plowed into it. As such, ROE is often used as a shorthand for quality. With a return on equity of more than 35%, MHP looks like a high-quality stock — management is generating ample returns with the cash shareholders invested.
Valuation. The idea, of course, is to buy low, and with shares notching new 52-week highs, MHP’s valuation is no longer cheap. By both forward and trailing earnings, MHP now trades at significant premiums to its own five-year averages, according to data from Thomson Reuters Stock Reports. True, it’s possible that MHP’s earnings will grow into the valuation — especially after the sale or spin-off — but at current levels, the data hardly say this stock is a screaming bargain.
Downgrades? Analysts’ median price target on MHP currently stands at $55.50. At north of $52, the stock is getting awfully close to that level. Yes, it’s possible some analysts will update their discounted cash flow analyses and raise their price targets. But it’s more likely that some analysts will have to downgrade MHP on valuation. There’s nothing wrong with that. The stock has come very far, very fast, and analysts live by their spreadsheets. But a downgrade or two will whack the stock, at least in the short term.
Execution Risk. The clock is ticking on the sale or spin-off of the education business, and both have attendant risks. A spin-off is more advantageous from a tax perspective, but then investors will have to decide if they want to hold onto their stakes in the slow-growth textbook business. A lucrative sale of the business to a consortium of private-equity players sounds good — but it would have to be far-and-above the spin-off value of $2.5 billion to make up for the tax hit.
We’re huge fans of dependable dividend payers here at InvestorPlace, and MHP’s history of rising payouts makes it a core holding for an equity income portfolio.
But not at this price. Buy MHP, by all means, but wait for a pullback before you do.
As of the writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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