The Motley Fool

Can Stella-Jones Inc. Go Higher After Popping 5% in a Day?

In the past few weeks, I’ve written multiple articles about Stella-Jones Inc. (TSX:SJ) indicating that it was priced at a decent valuation. On Monday the stock popped 5%. Is more upside coming?

First, here’s an overview of the business for you to determine if it’s a company you’d like to own.

The business

Stella-Jones has a leading position in producing and selling pressure-treated wood products and related services in North America. Last year almost 80% of its sales were railway ties and utility poles. Its main clients are railway companies, electrical utilities, and telecoms, which provide necessary infrastructure for the economy and stable business for Stella-Jones. One of Stella-Jones’s growth areas is residential lumber, which contributed 27% of its total sales in the second quarter.

Why did its share price pop 5%?

Stella-Jones didn’t release any material news that could have caused the pop. However, the consensus analyst opines and fundamental data indicates that the stock is priced at a decent value.

For example, on Monday Desjardins upgraded Stella-Jones from a “hold” to a “buy.”

Across seven analysts, Thomson Reuters rates Stella-Jones as a “buy” and has a mean 12-month price target of $54.80 per share. This indicates the shares are still discounted by 16% despite of Monday’s 5% pop. More importantly, Reuters rates Stella-Jones to have strong earnings and fundamental with a history of low volatility.

Some analysts even believe Stella-Jones will grow at an average rate of 25% per year in the near term. That’s not farfetched given that even in 2008 during the last recession, in which many companies posted negative earnings, Stella-Jones still managed to grow its earnings per share by 10%.

At $46 Stella-Jones trades at about 18.3 times its estimated 2016 earnings, which puts the stock in a fair to discounted valuation depending on if you use a more conservative growth rate in the teens or the 25% growth rate mentioned earlier.

Great performance

In the past five years, Stella-Jones has appreciated 400%, which greatly outperforms the market, which returned over 20% in that period.

In the past year, Stella-Jones has matched market returns in terms of price appreciation. Both Stella-Jones and the market have returned 5% in capital appreciation. However, the market beat Stella-Jones in the other returns component: the dividend. As a result, the market’s total returns were about 8%, while Stella-Jones’s were below 6%.

However, as mentioned in the previous section, Stella-Jones’s sideways action in the past year brought the shares to decent valuations, which is an opportunity to buy for a long-term investment.

Stella-Jones has had a track record of successful acquisitions. In the last five years it has posted a return on equity (ROE) of 16-18% every year. And in the past 10 years its ROE was between 14% and 24%.

The ROE calculates how many dollars of profit a company generates with each dollar of shareholders’ equity. The fact that Stella-Jones has consistently maintained a high ROE in the past decade indicates it’s an excellent capital allocator.

Stella-Jones has paid a growing dividend for 11 years. Although it yields less than 1% today, in the past five years the company managed to grow its dividend per share at a compound annual growth rate of 27.5%, which is a rare achievement.

Currently, Stella-Jones maintains a low payout ratio of about 16%. However, the company is likely to keep its payout ratio low if it continues to find excellent acquisition opportunities to grow the business.

Conclusion

At $46, Stella-Jones trades in a fair to moderately undervalued territory. So, the shares are likely to be higher a year from now barring macro events such as a recession coming into play.

However, given Stella-Jones’s quality and stability, it should really be a company to buy at decent valuations and hold for a very long time.

If you’re looking for above-average returns with most returns coming from capital appreciation, Stella-Jones is a great option for long-term investors. And it will be an even stronger buy on any dips.

5 Canadian Growth Stocks Under $5

We are giving away a FREE copy of our "5 Small-Cap Canadian Growth Stocks Under $5" report. These are 5 Canadian stocks that we think are screaming buys today.

Get Your Free Report Today

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kay Ng owns shares of STELLA JONES INC.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss an important event.

Iain Butler and the Stock Advisor Canada team only publish their new “buy alerts” twice a month, and only to an exclusively small group.

This is your chance to get in early on what could prove to be very special investment advice.

Enter your email address below to get started now, and join the other thousands of Canadians who have already signed up for their chance to get the market-beating advice from Stock Advisor Canada.