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 – May 2015. 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 L3 Communications Holdings Inc. (LLL) fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): L-3 Communications Holdings, Inc. (L-3 Holdings) operates through its wholly owned operating subsidiary L-3 Communications Corporation (L-3 Communications). L-3 is a prime contractor in intelligence, surveillance and reconnaissance (ISR) systems, aircraft sustainment (including modifications, logistics and maintenance), simulation and training, night vision and image intensification equipment, enterprise and mission information technology (IT) solutions, and cyber operations. L-3 also provides a range of communication and electronic systems and products used on military and commercial platforms. It operates in four segments: Electronic Systems, Aerospace Systems, Communication Systems and National Security Solutions (NSS). Its customers include the United States Department of Defense and its prime contractors, the United States Government intelligence agencies, the United States Department of Homeland Security, foreign Governments, and domestic and international commercial customers.
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 – PASS
- 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 – FAIL
|Value Based on 3% Growth||$111.84|
|Value Based on 0% Growth||$65.56|
|Market Implied Growth Rate||3.50%|
|Net Current Asset Value (NCAV)||-$45.85|
Balance Sheet – March 2015
Earnings Per Share
Earnings Per Share – ModernGraham
L3 Communications is not suitable for either the Defensive Investor or the Enterprising Investor. The Defensive Investor is concerned with the low current ratio and the insufficient earnings or growth over the last ten years. The Enterprising Investor is concerned with the level of debt relative to the net current assets and the lack of earnings growth over the last five years. As a result, value investors following the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities. As for a valuation, the company appears to be overvalued after seeing its EPSmg (normalized earnings) drop from $8.14 in 2011 to only an estimated $7.71 for 2015. This level of demonstrated earnings growth does not support the market’s implied estimate of 3.5% annual earnings growth over the next 7-10 years. As a result, the ModernGraham valuation model, based on Benjamin Graham’s formula, returns an estimate of intrinsic value well below the price.
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 L3 Communications (LLL)? 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 any 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.