Honeywell profits have not grown in recent years
Stocks have vastly underperformed the US stock market
Invest in product lines that should increase profits in the future
Wall Street consensus rating is bullish
Implied market outlook is bullish
Honeywell (NASDAQ:) shares have fallen 7.8% in the last 12 months, compared to +12.3% for the US stock market as a whole.
The poor performance reflects low expectations for earnings growth in the coming years. Honeywell is in a period of transition. The technology and manufacturing giant is investing in lines of business with strong projected growth and potentially higher margins (including quantum computing, battery technology, green fuels and carbon capture), but EPS growth is currently low. The question is whether it is worth investing now.
Honeywell 12 month price history.
HON is currently trading at $194.44, 17% below the 12-month high closing price of $234.18 on August 11.
The three-year total return, at 8.72% per annum, is less than half of the total return for the same period. However, over 10 and 15 year periods, equities have delivered a total return in line with the US equity market.
Final total returns of HON vs. Industrial Group, Stock Market Index.
An examination of historical quarterly earnings explains why Charlotte, North Carolina-based mega-cap stocks have underperformed. Although it has met or slightly exceeded expectations over an extended period, there is no growth. Note that EPS for the fourth quarter of 2019 of $2.06, $2.07 in the fourth quarter of 2020 and $2.09 in the fourth quarter of 2021 are almost identical.
Historical quarterly EPS and estimated future HON.
With a current dividend yield of 2% and 3-year and 5-year dividend growth rates of 5.8% and 7.4%, respectively, the Gordon Growth Model supports an expected total return in the 8-9% range. annual %. The consensus outlook for EPS growth over the next three to five years is 9.65% per year.
These figures are consistent with a stable company that is increasing the dividend at a conservative pace relative to projected earnings growth. The big question is whether Honeywell can deliver this expected level of growth.
On |October 18, 2021 I assigned a bull/buy rating. Since then, the stock has returned a total of -10.9% compared to +2% for the S&P 500.
The company filed the reports for the third quarter of 2021 and the fourth quarter of 2021 in this period, very slightly exceeding EPS expectations in both.
My bullish assessment in October 2021 was motivated by expectations that Honeywell would be able to break out of its earnings doldrums. The consensus of Wall Street analysts was bullish, with a 12-month price target near $240, about 8.7% above the share price at the time. The options market also indicated a modestly bullish view. These positive outlooks supported my buy rating. However, expected earnings growth is not yet evident, so the stock has fallen relative to the broader market.
Although most readers will be familiar with the consensus of Wall Street analysts, many will not have encountered perspectives calculated from option prices. A brief explanation will explain the approach. The price of a stock option reflects the market’s consensus estimate of the probability that the stock price will rise above (call) or fall below (put) a specified level (strike prices). of the option) between the current time and the expiration time of the option. By analyzing the prices of call and put options over a range of strike prices all with the same expiration date, it is possible to calculate a likely price outlook that reconciles the option prices. This is called the implied view of the market and represents the consensus view of option buyers and sellers. For readers who want to delve into the implied market outlook beyond the information in the link above, I recommend this excellent free monograph from the CFA Institute.
With almost six months since my last analysis, I have updated the implied market outlook to early 2023 and compared it to the current Wall Street consensus outlook, as in my previous analysis.
Wall Street Consensus Outlook for HON
E-Trade calculates the Wall Street Consensus Outlook for HON by aggregating the views of 15 ranked analysts who have released ratings and price targets in the last 90 days. The consensus valuation is bullish and the 12-month consensus price target is 16.1% above the current share price.
Analyst consensus rating and 12-month price target.
Investing.com’s estimate of Wall Street consensus combines price targets and valuations from 28 analysts and is bullish with a 12-month price target of 12.7% above the current share price.
Analyst consensus rating and 12-month price target.
Although the price targets are lower than in October, the expected revaluation is greater due to the drop in the price in this period. With a median expected appreciation of 14.4% and a dividend yield of 2%, the consensus outlook for expected total return is 16.6% over the next 12 months.
Implied Market Outlook for HON
I have calculated the implied market outlook for HON for the 9.5 month period now through January 20, 2023, using option prices expiring on this date. I chose this specific expiration date to provide a perspective until the end of 2022, and the January expiration date was the closest to the end of the year.
The standard presentation of implied market outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.
Source: Author’s calculations from E-Trade option prices
The market-implied outlook for HON over the next 9.5 months is generally symmetrical, with comparable odds of positive and negative returns of the same magnitude, but the maximum odds are tilted in favor of positive returns. The maximum probability corresponds to a price return of +4% during this period. The expected volatility calculated from this perspective is 25% (annualized).
To facilitate direct comparison of the probabilities of positive and negative returns, I have rotated the negative returns side of the distribution about the vertical axis (see chart below).
Source: Author’s calculations using E-Trade option prices
This view shows that the probabilities of positive returns are systematically greater than the probabilities of negative returns of the same magnitude, across a wide range of most likely outcomes (the solid blue line is above the dashed red line by three-quarters of the way). chart above). This is a modestly bullish outlook for HON.
Although Honeywell has failed to grow profits in recent years, the company is investing in higher-margin businesses that are expected to boost profits.
Wall Street’s consensus outlook is bullish, with a 12-month consensus price target corresponding to a 16.6% total return. As a general rule of thumb, for a buy rating, I want to see a 12-month expected return that is at least half the expected annualized volatility.
Taking the Wall Street consensus at face value, the 16.6% return is more than half of the 25% volatility anticipated in the implied market outlook. The implied market outlook for HON through early 2023 is modestly bullish, so I maintain my bullish rating on HON.