Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. 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 company or by reviewing the 5 Most Undervalued Companies for the Defensive Investor – November 2014. 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 Baker Hughes Inc. (BHI) fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): Baker Hughes Incorporated (Baker Hughes) is engaged in the oilfield services industry. Baker Hughes is a supplier of oilfield services, products, technology and systems to the worldwide oil and natural gas industry. The Company may conduct its operations through subsidiaries, affiliates, ventures and alliances. It operates in more than 80 countries worldwide. The Company operates in five segments. Four of these segments represent its oilfield operations and their geographic organization: North America (U.S. Land, Gulf of Mexico and Canada), Latin America, Europe/Africa/Russia Caspian and Middle East/Asia Pacific. Its Industrial Services and Other segment includes downstream chemicals, process and pipeline services, and the reservoir development services group. In April 2014, the Company acquired Perfomix, Inc. In September 2014, Baker Hughes Inc acquires Weatherford’s Pipeline and Specialty Services Business.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 6/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 – PASS
- 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 = 4/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – PASS
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – PASS
- 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 – FAIL
|Value Based on 3% Growth||$46.63|
|Value Based on 0% Growth||$27.34|
|Market Implied Growth Rate||5.50%|
|Net Current Asset Value (NCAV)||$2.86|
Balance Sheet – September 2014
Earnings Per Share
Earnings Per Share – ModernGraham
Baker Hughes Inc. passes the requirements of both the Defensive Investor and the Enterprising Investor at the initial stage of the analysis. The Defensive Investor’s only concern is the lack of sufficient earnings growth over the last ten years while the Enterprising Investor has concerns with the level of earnings growth over the last five years. As a result, value investors following the ModernGraham approach based on Benjamin Graham’s methods should feel comfortable proceeding with further research into the company. As for a valuation, the company appears to be overvalued after seeing its EPSmg (normalized earnings) fail to grow at all from $3.22 in 2010 to 2014. This level of demonstrated growth does not support the market’s implied estimate of 5.50% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value below the price.
Be sure to check out previous ModernGraham valuations of Baker Hughes Inc. (BHI) 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 Baker Hughes Inc. (BHI)? 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 position in Baker Hughes Inc. (BHI) or in any other company mentioned in this article at the time of publication and had no intention of changing that position within the next 72 hours. Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.