Amgen Inc. (AMGN) has shown very strong earnings growth over the last several years, which when combined with the company’s healthy dividend yield should immediately intrigue many investors. In fact, multiple analysts have recently given positive sentiment towards the company. For example, Seeking Alpha contributor DoctoRX recently wrote that the company’s strong history creates an expectation that its new drugs will do well despite the risk. Roadmap2Retire shares that view, believing that the company will see continued earnings growth into the future. These articles focus on great qualitative considerations that must be taken into account when making investment decisions.
However, Benjamin Graham, the father of value investing, taught that investors must take emotion out of the equation, as the most important aspect to consider is whether the company is trading at a discount relative to its intrinsic value. It is through a thorough fundamental analysis that the investor is able to make a determination about a potential investment’s merits. Here’s a look at how the company fares in the ModernGraham valuation model.
The model is inspired by the teachings of Benjamin Graham and considers numerous metrics intended to help the investor reduce risk levels. The first part of the analysis is to determine whether the company is suitable for the very conservative Defensive Investor or the less conservative Enterprising Investor, who is willing to spend a greater amount of time conducting further research.
In addition, Graham strongly suggested that investors avoid speculation to remove the subjective elements of emotion. This is best achieved by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another. By using the ModernGraham method, one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries.
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Defensive Investor – Must pass at least 6 of the following 7 tests: Score = 4/7
- 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 – FAIL
- Earnings Growth – Earnings per share has increased by at least 1/3rd over the last 10 years, using 3-year averages at the beginning and end of the period – PASS
- Moderate PEmg (price over normalized earnings) ratio – PEmg is less than 20 – FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – FAIL
Enterprising Investor – Must pass at least 4 of the following 5 tests or be suitable for a Defensive Investor: Score = 5/5
- 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 – PASS
|Value Based on 3% Growth||$104.35|
|Value Based on 0% Growth||$61.17|
|Market Implied Growth Rate||6.79%|
|Net Current Asset Value (NCAV)||-$9.59|
Balance Sheet – March 2015
Earnings Per Share
Earnings Per Share – ModernGraham
Amgen is very attractive when compared to some of its competitors. For example, ModernGraham valuations of both Eli Lilly (LLY) and Merck (MRK) indicate both of those companies are not suitable for either the Defensive Investor or the Enterprising Investor, and both are considerably overvalued at the present time.
Amgen performs well in the ModernGraham model and is suitable for Enterprising Investors. The Defensive Investor is concerned with the low current ratio, along with the poor PEmg and PB ratios, while the Enterprising Investor has no initial concerns. As a result, all Enterprising Investors should feel very comfortable proceeding to the next part of the analysis, which is a determination of the company’s intrinsic value.
When it comes to valuation, it is critical to consider the company’s earnings history. In this case, the company has grown its EPSmg (normalized earnings) from $4.22 in 2011 to an estimated $7.20 for 2015. This is a strong level of growth and is well above the market’s implied estimate of 6.79% annual earnings growth over the next 7-10 years.
Here, actual growth in EPSmg over the last several years has averaged nearly 14.1% annually, so the market is expecting a very significant drop in earnings growth. The ModernGraham valuation model reduces the historical growth to a more conservative figure, assuming that some slowdown will occur, but still estimates a growth figure much higher than the market’s implied rate. Therefore, the model returns an estimate of intrinsic value well above the current price, indicating the company is significantly undervalued at the present time.
Enterprising Investors should take this information regarding the company’s valuation and proceed with further research into whether the company would be suitable for individual portfolios, as it has passed a ModernGraham review.
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.