The key feature of their model incorporates a star rating. They look at five important metrics and give a star for certain attributes in the company. According to the post, the following earn a star:
- Fair Value: I look at five measures of fair value: 1.) Avg. High Yield Price, 2.) 20-Year DCF Price, 3.) Avg. P/E Price, 4.) Graham Number and 5.) NPV MMA Price. Of the first four, the highest and lowest fair values are excluded and the remaining two calculations are averaged to calculate the Mid-2 price. Then I compare it with the NPV MMA Price and use the lower of the two.
- Free Cash Flow Payout: A Star is awarded if the Free Cash Flow Payout is less than 60% and there were no negative free cash flows during the last 10 years.
- Debt To Total Capital: Having less debt provides a company more financial flexibility. A Star is awarded if the Debt To Total Capital is less than 45%.
- NPV MMA Diff: The value calculated is the net present value (NPV) of the difference between the dividend earnings of this investment and the interest income from the MMA over 20 years. A Star is added for amounts in excess of the target amount.
- Key Metrics: “Dividend Growth Rate”, “Years of Div. Growth”, “Rolling 4-yr Div. > 15%” and “Years to >MMA” are considered Key Metrics. A Star is awarded if 2 of the 4 Key Metrics are true.
This method caught my attention because of its similarity in style to what we do here at ModernGraham. We require companies to pass a number of tests to qualify as suitable to the Defensive or Enterprising Investors. Here are the tests that we require:
Defensive Investor – must pass at least 6 of the following 7 tests:
- Adequate Size of Enterprise – market capitalization of at least $2 billion
- Sufficiently Strong Financial Condition – current ratio greater than 2
- Earnings Stability – positive earnings per share for at least 10 straight years
- Dividend Record – has paid a dividend for at least 10 straight years
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period
- Moderate PEmg ratio – PEmg is less than 20
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50
Enterprising Investor – must pass at least 4 of the following 5 tests:
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1
- Earnings Stability – positive earnings per share for at least 5 years
- Dividend Record – currently pays a dividend
- Earnings growth – EPSmg greater than 5 years ago
While the two methods are similar, we do have one main difference. We focus a lot of our criteria on balance sheet issues; Dividends Value tends to base more on dividend payout and cash flow. However, after a little bit of comparison, it seems that we come to the same conclusion.
I looked at all 12 of the companies Dividends Value wrote about today, and the result is that 8 of the 12 would be suitable for the defensive investor. 4 of the 12 would be suitable for the enterprising investor. Also, 9 of the 12 are considered undervalued based on our intrinsic value formula. The other 3 are fairly valued (only because of our margin of safety, though – none are actually priced higher than the intrinsic value).
Here are the detailed results:
- Automatic Data Processing (ADP) – Fairly Valued & Enterprising
- AFLAC Incorporated (AFL) – Undervalued & Defensive
- Chubb Corp (CB) – Undervalued & Defensive
- Dover Corp (DOV) – Undervalued & Defensive
- Emerson Electric Company (EMR) – Undervalued & Defensive
- Johnson & Johnson (JNJ) – Undervalued & Defensive
- McDonald’s Corp (MCD) – Undervalued & Enterprising
- Nucor Corp (NUE) – Fairly Valued & Defensive
- Paychex (PAYX) – Undervalued & Enterprising
- Proctor & Gamble (PG) – Undervalued & Defensive
- Sysco Corp (SYY) – Fairly Valued & Enterprising
- United Technologies Corp (UTX) – Undervalued & Defensive
Thanks to Dividends Value for the great work today. It was fun to find a model that obtains such similar results to ours!