Ceradyne (CRDN): Growth Company of the Year 2006

Ceradyne (CRDN) is this year’s winner of the NAIC/Better Investing “prestigious” [snark] award for the Growth Company of the Year. The brief article was in the December 2006 issue of Better Investing magazine.

The company makes high-tech ceramic products, primarily for the defense industry (ceramic armor) and for industrial applications. CRDN is a small cap stock that ranked #10 on the Forbes list of the 200 best small companies for 2006. Last year, it ranked #8 and has been on the list for four consecutive years.

CRDN was nominated by Richard Chauncey of Rochester, N.Y., who also nominated last year’s winner, Cognizant Technology Solutions [see my September 5 post below, "Two Small Company Stocks: Cognizant Technology Solutions and Jack Henry and Associates"]. Richard sure knows how to pick growth stocks.

The award is based on the company’s historical record of revenue and EPS growth, and the quality of the SSG which is qiven the most weight. CRDN’s Pre-Tax Profit Margin, the SSG’s main quality indicator, is trending up for the past 5 years and averages 15.4% which is substantially better than its industry average of 5.82% according to Reuters.com. The company’s PTPM for 2005 was 20.6%. even better than its 5 year average.

CRDN’s Return on Equity, the second quality indicator on the SSG, is also trending up and averages 14.4% for the past 5 years, almost identical to its industry average. The company’s ROE for 2005 was 20.6%, also better than its 5 year average.

Ceradyne’s historical growth also has been impressive. Over the last 10 years, Sales and EPS growth have averaged 32.2% and 38.1% per year; over the past 5 years, due to our several wars, both have increased to 72.4% and 94.3% per year.

The contest is based solely on a company’s historical performance and, even though a SSG is required, the stock does not have to be a SSG Buy. That is, the SSG does not have to satisfy the reasonable price criteria of a 3.0 Upside/Downside Ratio and a 15% Total Return. “This article is for educational purposes only.”

Sooooo, let’s see what we can learn:

- While the company’s historical EPS for the last 10 and 5 years averaged 38.1% and 94.3%, Richard decided to “err on the conservative side” (his words) in his projected growth estimates for the next 5 years.

He said: “My growth projections of revenues (15 percent) and earnings (17.5 percent) are quite conservative compared with historical levels over the past few years, but I’m doubtful growth in sales and earnings will remain at current levels….For CRDN, a higher estimate of growth rates may be appropriate based on its past performance and current momentum, but I will err on the conservative side for this study.”

However, most long-term analyst estimates are currently projecting less than Richard’s 17.5%. Most are estimating 15.0%: First Call (2 analysts), Zacks (2), and S&P. Reuters (3 analysts) is projecting 16.67% and 2.36% Standard Deviation. Value Line’s estimate at 28.00% seems way out of line and is the only one estimating more than Richard.

So, his 17.5% EPS estimate is actually liberal compared to the 15.0% estimate by First Call, Zacks, and S&P, and the 16.67% by Reuters. Conservative might be the Reuters estimate less one Standard Deviation or 16.67 – 2.36 = 14.31%.

- Richard chose 27.8 as his Projected High PE for the next 5 years which he said was based on averaging the average High PE for the past 5 years (33.3) and the average PE for the past 5 years (22.3). Not only is this comparable to averaging apples and avocados, but there were two other High PEs that were more conservative: 2005 only (25.0) as the trend has been downward for the last three years and Alt-M (24.2) which is usually the most conservative option and is based on eliminating the highest 5 out of the last 10 PEs and averaging the remainder. Again, Richard did not err on the conservative side.

- When I use Richard’s 17.5% Projected EPS and his 27.8 Projected High PE, my SSG software calculates a Forecast High Price of $202.40. However, Value Line is estimating a High Price in the next 3-5 years of $75-110 (on 9-15 when CRDN’s price was $43.53 while its current price on 11-20 was $53.22). That means Richard exceeded VL by $92.40 per share or by a whopping 84%. That’s surely not erring on the conservative side!!

- armin

Addendum: CRDN was the Stock to Study in the February 2007 issue of Better Investing magazine. The article discusses several promising non-defense products which the company is developing: a titanium ceramic used in the making of aluminum that could be a billion-dollar market for CRDN; ceramic crucibles for melting silicon in the manufacture of photovoltic solar cells, a market that’s growing 35% per year; and a process to more economically get at oil trapped in shale, a decision by CRDN to go forward is expected in 2009.