Andrew Kuhn April 13, 2020

What is a Fair Price to Pay For Omnicom (OMC)?

Someone Geoff  this email ( to ask your own question: just send me an email ) :

My question is a simple one.

“What do you think is a fair price to pay for Omnicom?”

Answer: Omnicom (OMC) Could be Worth Anywhere Between 1 to 1.5 Times Sales – so, About $70 to $100 a Share – But: You Probably Want At Least a 35% Margin of Safety, So Try Not To Pay More than $45 a Share for Omnicom

This is a simple question. But, it’s tougher to answer than it appears. I see 3 big factors to consider:

1) What is the organic growth (or decay) in Omnicom’s business likely to be?

2) How much will stock buybacks drive growth in earnings per share that’s higher than organic growth?

3) How bad and how long will an ad recession be?

Because Omnicom uses so much of its free cash flow to buyback stock, there’s an element of circular logic to valuing the stock. Bizarrely, the cheaper the stock gets today – the more valuable it should be in the future. Assume Omnicom uses 50% of its EPS to buyback stock. I’ll also assume there is 1% share dilution normally before buybacks. This means that the formula that tells us how much Omnicom’s EPS will grow BEYOND its organic growth is:

(0.5 * Earnings Yield) – 1% = Inorganic EPS growth caused by stock buybacks

Let’s run this number for the following P/E ratios:

P/E = 4

P/E = 6

P/E = 8

P/E = 10

P/E = 12

P/E = 14

P/E = 16

P/E = 4 (this would be like 50% cheaper than today’s price) makes the formula…

(0.5 * 25%) – 1% = 11.5% CAGR in EPS

P/E = 6 gives us…

(0.5 * 17%) – 1% = 7.5% CAGR in EPS and so on. The “and so ons” work out as follows..

P/E 4 => 11.50%

P/E 6 => 7.50%

P/E 8 => 5.25%

P/E 10 => 4.00%

P.E 12 => 3.17%

P/E 14 => 2.57%

P/E 16 => 2.13%

Now, if we assume organic growth is equal to 0% – which may or may not be an accurate assumption – then, we can keep the fair value formula pretty simple. In theory, Omnicom should be worth its stream of dividends. EPS can be ignored as a direct thing. Instead we just assume that 50% of EPS is paid out in dividends and 50% is used to do buybacks. Again, I assume 1% is just constant share dilution in the form of stock grants to employees.

That means only two things matter. One is the buyback rate. I’ve shown that above. It ranges from a little over 2% to something like 11-12% a year depending on whether the stock trades as low as a P/E of 4 or as high as a P/E of 16. The dividend yield – if we assume a 50% dividend payout – is really easy to calculate. We just take “earnings yield times 0.5 equals dividend yield”. So, it’s as simple as:

P/E 16 => 3.13% dividend yield

P/E 14 => 3.57%

P/E 12 => 4.17%

P/E 10 => 5.00%

P/E 8 => 6.25%

P/E 6 => 8.33%

P/E 4 => 12.50%

We can simplify things further by adding together the dividend yield and the dividend growth rate. Here, the dividend growth rate is the same as the amount of the market cap being bought back each year. So, we simply add together the two numbers we’ve calculated for each P/E. That gives us…

P/E 16: 3.13% + 2.13% =5.26%

P/E 14: 3.57% + 2.57% = 6.14%

P/E 12: 4.17% + 3.17% = 7.34%

P/E 10: 5.00% + 4.00% = 9.00%

P/E 8: 6.25% + 5.25% = 11.50%

P/E 6: 8.33% + 7.50% = 15.83%

P/E 4: 12.50% + 11.50% = 24.00%

The next step would be to compare the expected return in Omnicom at various prices (shown above) to the return you can expect in stocks. I’d expect the S&P 500 to return something more than 6% but less than 10%. An estimate of 6-9% returns in the S&P 500 over the next 10, 15, 20 years, etc. sounds fine. At times, the S&P 500 has done more like 10% a year. But, the market is more expensive now than usual. It’s unlikely to do better than 9% a year. So, that would equate to a P/E of 10 on Omnicom. In other words, we know Omnicom should have a fair value – if it neither grows nor shrinks in organic terms – of more than a P/E of 10. However, it should also have a fair value of less than a P/E of 14 (that’s the 6% expected return). So, a probable intrinsic value range of like 10 to 14 times after-tax earnings seems right.

We’re not done yet though. Ad stocks are cyclical. So, it’s important NOT to use this year’s earnings. Instead, you need to use a Price/Sales ratio and then adjust for the normal operating margin. It’s probably wisest to buy Omnicom when its operating margin is low and sell when the operating margin is high. So, we actually need to take our 10-14 P/E range and convert it into a more helpful P/S range. Let’s do that now.

Omnicom’s 20-year average operating margin is 13%. The current tax rate in the U.S. is 21%. In Europe (and elsewhere) it might average 25% or higher. I’ll assume 25% overall for Omnicom. That’s 13% * (1-0.25) = 9.75%. Omnicom’s after-tax earnings should – over a full cycle – be equal to about one-tenth of its reported sales. That makes things easy. A “normal” P/E of 10 is the same as a P/S ratio of 1. While a normal P/E of 14 is the same as a P/S ratio of 1.4. So, Omnicom should be priced to match the market when it trades at between 1 and 1.4 sales.

Omnicom did $15 billion in sales last year. The company has 217 million shares outstanding. So, sales per share are $15 billion / 217 million = $69.12. It’s about $70 per share in sales.

That means the stock’s intrinsic value – if it neither grows nor shrinks organically – should be somewhere between…

Minimum: $70 * 1 = $70

Maximum: $70 * 1.4 = $98

Basically, Omnicom’s “fair value” should be somewhere in the $70 to $100 a share range.

This isn’t that different than other estimates I’ve used before. In a 2015 report on Omnicom, I gave an appraisal value of $95. I’ve often said – on the podcast – that buying Omnicom at $65 a share or less should work out. Those two things seem pretty consistent with a $70 to $100 a share intrinsic value estimate for Omnicom.

Sort of.

One thing you’ll notice is that my $95 a share appraisal in 2015 isn’t consistent with having $100 as the top of the range now. Why is that?

In 2015, I over-appraised Omnicom. The reason for this is simple. I assumed organic growth at ad agencies would be higher than it was from 2015-2020. If ad agencies see organic declines – which they will in a recession – my current appraisal of $70 to $100 a share could also be too high. The reason for this is that I’m assuming Omnicom will not – over a full cycle – experience organic sales declines.

I don’t know if that’s accurate or not. Some things have changed in the ad business. So, it’ll take more than simple arithmetic I can do to answer this problem. It’ll require actual business analysis and analysis of the industry.

To be fair, I have not – in this current appraisal – assumed it’s possible for Omnicom to grow at the rate of inflation. So, an assumption of 0% nominal organic growth at Omnicom is actually projecting REAL revenue declines. It means I’m predicting ad agencies will only hold their organic sales at current nominal levels. They’ll shrink in real terms. They’ll shrink relative to GDP. And they’ll lose market share in the overall ad industry.

This might be too harsh an estimate.

If it is – Omnicom could grow organically by as much as 3% a year. That would shift the intrinsic value range from 1 to 1.4 times sales ($70 to $100 a share) to more like 1.6 to 2 times sales ($112 to $140 a share). I’m not comfortable making that assumption. Maybe as recently as 5 years ago – and certainly as long ago as 11 years ago – I would’ve said that Omnicom was probably worth no less than 1.5 times sales – and it was a bargain at 1 times sales or less.

I’d amend that now.

I’d say Omnicom is probably worth anywhere from 1 times sales to 1.5 times sales.

Sales are roughly $70 a share. So, 1 to 1.5 times sales give you an appraisal range of $70 to $105. In round terms, I think a range of $70 to $100 is about right. I can live with that range. If someone said they wanted to buy Omnicom below $70 a share – I wouldn’t object. If they felt they should consider selling the stock once it got over $100 a share – I also wouldn’t object.

As I write this, Omnicom is trading at $50 a share.

So, the price-to-appraisal value is 0.5 to 0.7. Put another way – the “margin of safety” in Omnicom stock is about 30% to 50%. Just as a rule of thumb, I think it’s a good idea to buy stocks when there’s at least a 35% margin of safety relative to the low end of your appraisal range. So, I wouldn’t necessarily say you should gobble up Omnicom stock till it hits a price of $45 a share. It’s close to that now.

If we try to put what I just said into some sort of practical advice, it’d be to buy Omnicom at $45 a share or less and sell Omnicom at $105 a share or more. The range from $45 to $105 is the “zone of indifference” as I like to call it. I think the stock would be an acceptable investment going forward if held at prices between $45 and $105 a share. However, there may sometimes be better stocks you can find. So, it’d make sense to me to switch from cash to Omnicom when OMC is below $45 a share. It’d also make sense to switch from Omnicom stock back into cash when OMC is over $105 a share. Between $45 and $105 – you should only switch out of Omnicom if you have a better stock to buy. Likewise, it may be fine to pass up on Omnicom at between $45 and $105 a share if you are already 100% invested in stocks you like. These appraisal value ranges are really most useful for making decisions about switching out of cash and into a stock or switching out of a stock and into cash. Appraisal values can’t really tell you to switch out of one stock and into another. For that, you’d need to do appraisals of each of the two stocks and compare the relative undervaluation of each.

Also, these appraisals will move in the future at the same rate as Omnicom’s sales per share. So, I’d raise the per share appraisals as sales per share rose and I’d lower the appraisal as sales per share shrank.

That last point is debatable. I’m not sure you should lower your appraisal of the stock to account for the amount of sales decline during an ad recession. I’m aware of lots of historical precedents for using “peak” earnings and sales and so on when valuing a resilient business. So, it’s possible that a 15% decline in sales during an ad recession shouldn’t really result in you lowering your buy price from $45 a share to $38 a share. The more conservative thing to do is to adjust your appraisal down with a sales decline. And I’m more comfortable advocating that than saying you should always stick to using the peak in revenue divided by today’s shares outstanding.

So, my answer to your question would be that Omnicom is worth between 1 and 1.5 times sales. Today, that would work out to be about $70 to $105 a share.

I think a fair price to pay for Omnicom is $70 to $105 a share. Given that, I would only be totally confident buying the stock at $45 a share or less.