REITs often attract a great deal of investors because of their strong cash flows and dividends, and those investors often overlook other parts of the business, choosing to analyze the company under a different set of criteria than companies in other sectors. This can create a problem in that it becomes difficult to compare a REIT to an industrial, which is fine if you use the typical top-down approach to stock selection; however, a top-down approach invites speculation in the fact that you are theorizing which sector will perform well going forward. Benjamin Graham taught that we should avoid speculation as much as possible, which is why it is critical to develop a system for analyzing companies that will allow them to be compared across industries. This is best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another investment opportunity. By using the ModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. What follows is a specific look at how HCP Inc. (HCP) fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): HCP, Inc. (HCP) is a real estate investment trust (REIT). The Company invests primarily in real estate serving the healthcare industry in the United States. HCP acquires, develops, leases, manages and disposes of healthcare real estate and provides financing to healthcare providers. The Company’s portfolio consists of investments in the five healthcare segments: senior housing, life science, medical office, post-acute/skilled nursing and hospital. The Company makes investments within its healthcare segments using the five investment products: properties under lease, debt investments, developments and redevelopments, investment management and RIDEA, which represents investments in senior housing operations. In October 2012, Emeritus Corp announced that HCP closed the acquisition of 127 of the 133 senior housing communities. In February 2014, Kindred Healthcare Inc’s subsidiaries completed the acquisition of real estate associated with two nursing centers which it leases from HCP.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 5/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 – FAIL
- Earnings Stability – positive earnings per share for at least 10 straight years – PASS
- Dividend Record – has paid a dividend for at least 10 straight years – PASS
- 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 – FAIL
- Moderate PEmg ratio – PEmg is less than 20 – PASS
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – PASS
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – FAIL
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – FAIL
- Earnings Stability – positive earnings per share for at least 5 years – PASS
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – PASS
|Value Based on 3% Growth||$31.66|
|Value Based on 0% Growth||$18.56|
|Market Implied Growth Rate||5.49%|
|Net Current Asset Value (NCAV)||-$19.38|
Balance Sheet – 6/30/2014
Earnings Per Share
Earnings Per Share – ModernGraham
HCP Inc. does not qualify for either the Defensive Investor or the Enterprising Investor at this time. The Defensive Investor has concerns with the current ratio as well as the level of earnings growth over the last ten years. The Enterprising Investor is concerned with the level of debt relative to the current assets. As a result, value investors following the ModernGraham approach, based on Benjamin Graham’s methods, should explore other opportunities at this time. As for a valuation, the company appears undervalued after growing its EPSmg (normalized earnings) from $1.34 in 2010 to an estimated $2.18 for 2014. This level of demonstrated growth is greater than the market’s implied estimate of 5.49% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value above the market price.
Be sure to check out ModernGraham’s previous valuations of HCP for greater perspective!
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. What do you think? What value would you put on HCP Inc. (HCP)? Where do you see the company going in the future? Is there a company you like better? Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.
Disclaimer: The author did not hold a long position in HCP Inc. (HCP) or any other company mentioned in the article at the time of publication and had no intention of changing that position within the next 72 hours. Logo taken from wikipedia or the company website for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.