Monday, December 17, 2012

Taking another look at Eaton Corporation

Eaton, ETN, has had a nice run in price since I bought it in July.  I identified ETN in a screen I ran on FAST Graphs shortly after subscribing to the service.   At the time, ETN looked to be priced about 35% under fair value.  I didn't do too much additional diligence, and purchased shares on July 5, 2012.

I purchased additional shares on July 6, July 12, and August 13, and received a dividend which was reinvested on October 19.  My weighted average cost for ETN now sits at $39.95.  ETN trading today at a price of $53.93.  This is a gain, including dividends reinvested, of 34.98%.

My initial premise was that the stock was under fair value by 35%, and now I've gained 35%.  Is it time to sell the position?  Let's take a look at the current valuation vs. earnings.

Here an historical look at earnings and price movement for the past 15 years:

Based on this graph, the price still needs to rise to about $61/share to reach "fair value" based on the average PE given over this 15 year period.

However, most stocks have suffered from "PE Compression" since the great recession of 2008, so I like to do a six year graph to get a more up to date picture.  Here is is for Eaton:

If you look at the blue PE line, you see the average PE for ETN has come down from the 15 year average of 14.9, to a six average of 13.9.  "Fair" value based on this ratio is $57.37.  Thus, today, ETN is trading below fair value, but only by $3.44 or 6%.  Moving to technical analysis (gasp), here is a YTD price chart:

From this you can see that July was a pretty good time to buy, and today may be a decent time to sell.  I'll expand the graph to three years:

This has me wondering about the PE ratios at each of these tops, so I'll go back to FAST Graphs, and check each below:

So, I went back over the black price line, and pulled the prices at each peak and valley, which FAST Graph gives you easily, but then divided by earning listed for that year.  Unfortunately, I can't figure out quarterly earnings for each of these points, and haven't found a source for these.  My PE numbers listed seem incorrect in absolute terms.  Correct directionally for this comparison, but incorrect nevertheless.  If the blue line represents PE=13.9, how can a point above the orange line have a PE of 13.8?  I'll have to ask Chuck.  Anyway, from this chart I conclude that ETN may be reaching fair value, and may be due for a dip after a nice run up from my buy point this summer.

Therefore, I'm placing a 4% trailing stop loss on the shares, which will guarantee me a sell price of at least $51.73 based on today's prices.  Let's hope it keeps climbing before execution.

Best Chump

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