Brighter Outlook Makes McGraw-Hill a Buy

by Dan Burrows | October 12, 2012 6:15 am

There’s nothing quite like a brighter, clearer future to make a seemingly pricey stock suddenly look a lot more like a buy.

McGraw-Hill (NYSE:MHP[1]) is just such a stock.

The company is getting very close to finally splitting into two companies, according to media reports. At the same time, Wall Street’s expectations for earnings and share-price gains have risen, too.

That has MHP looking like a much better short-term bet than it did just a month ago.

MHP, through McGraw-Hill Financial, owns Standard & Poor’s, the second-largest credit-rating agency after Moody’s (NYSE:MCO[2]). S&P also is a huge provider of financial data, and maintains indices like the S&P 500 and Dow Jones Industrial Average. That’s where the growth is.

But MHP has another big business, McGraw-Hill Education, the world’s largest textbook publishers, and that’s a tougher row to hoe — which is why MHP intends to spin off or sell the division by year’s end. Separating the slower-growth book publishing business from the faster growth data division is a move that’s been long anticipated — and applauded — by Wall Street.

When we looked at MHP a little more than a month ago, we liked it as a long-term, core, equity income holding[3], but not so much on a tactical basis.

Over the long haul, we love dependable dividend payers — and MHP, with a payout history stretching back to 1937, earns a place on InvestorPlace’s list of Dependable Dividend Stocks[4]. Furthemore — and more important — MHP has a long history of hiking its dividend, which is key to any long-term dividend investor.

Indeed, despite the seemingly paltry current yield of 1.8%, MHP has raised its dividend at a compound annual rate of 9.6% since 1974, according to Zacks Investment Research. Hold onto MHP long enough, and the yield on your original cost basis will become very generous.

But shares looked too pricey back when we last reviewed it. The stock was trading at significant premiums to its own five-year average by forward earnings, for one. Also troubling was that MHP was bumping up against analysts’ average and median price targets, making a downgrade based on valuation a very real possibility.

MHP is up more than 5% since then to notch a 52-week high Thursday, helped by reports that the company could fetch $3 billion for the education business[5], with both private equity and strategic players in the mix.

And yet shares look more attractive despite the latest gains, thanks to greater expectations on the part of the Street.

The stock still trades at a premium to its five-year average by forward earnings, but only by 10% these days, according to data from Thomson Reuters Stock Reports. No, that doesn’t make it look like a screaming bargain, but the valuation is by no means stretched, either.

Furthermore, Wall Street has lifted its price target on MHP to $64. Add in the yield on the dividend, and you get an implied upside of more than 16% in the next 12 months or so. That rates a buy call right there.

Indeed, Barclays initiated coverage of MHP at overweight (buy, essentially) on Tuesday.

With the education unit divorce on track for year-end and stronger growth prospects ahead, MHP, which already looked promising on a long-term basis, suddenly looks compelling in the shorter run, too.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

  1. MHP:
  2. MCO:
  3. long-term, core, equity income holding:
  4. Dependable Dividend Stocks:
  5. $3 billion for the education business:

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