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 10 Most Undervalued Companies for the Defensive Investor – November 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 stock analysis showing a specific look at how Pepco Holdings Inc (POM) fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): Pepco Holdings, Inc. (PHI) is a holding company, through its utility subsidiaries, engaged in the transmission, distribution and default supply of electricity, and, to a lesser extent, the distribution and supply of natural gas. The Company’s subsidiaries include Potomac Electric Power Company (Pepco), Delmarva Power & Light Company (DPL) and Atlantic City Electric Company (ACE). Pepco is engaged in the transmission, distribution and default supply of electricity. DPL is involved in the transmission, distribution and default supply of electricity, and distribution and supply of natural gas. ACE is engaged in the transmission, distribution and default supply of electricity. The Company’s utility subsidiaries own and operate a network of wires, substations and other equipment that are classified as transmission facilities, distribution facilities or common facilities.
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Downloadable PDF version of this valuation:
Stage 1: Is this company suitable for the Defensive Investor or the Enterprising Investor?
|Defensive Investor; must pass 6 out of the following 7 tests.|
|1. Adequate Size of the Enterprise||Market Cap > $2Bil||$6,665,027,358||Pass|
|2. Sufficiently Strong Financial Condition||Current Ratio > 2||0.66||Fail|
|3. Earnings Stability||Positive EPS for 10 years prior||Fail|
|4. Dividend Record||Dividend Payments for 10 years prior||Pass|
|5. Earnings Growth||Increase of 33% in EPS in past 10 years using 3 year averages at beginning and end||-75.95%||Fail|
|6. Moderate PEmg Ratio||PEmg < 20||40.14||Fail|
|7. Moderate Price to Assets||PB Ratio < 2.5 OR PB*PEmg < 50||1.53||Pass|
|Enterprising Investor; must pass 4 out of the following 5 tests, or be suitable for the Defensive Investor.|
|1. Sufficiently Strong Financial Condition||Current Ratio > 1.5||0.66||Fail|
|2. Sufficiently Strong Financial Condition||Debt to NCA < 1.1||-6.34||Fail|
|3. Earnings Stability||Positive EPS for 5 years prior||Fail|
|4. Dividend Record||Currently Pays Dividend||Pass|
|5. Earnings Growth||EPSmg greater than 5 years ago||Fail|
Stage 2: Determination of Intrinsic Value
|MG Growth Estimate||-4.25%|
|MG Value based on 3% Growth||$9.45|
|MG Value based on 0% Growth||$5.54|
|Market Implied Growth Rate||15.82%|
|% of Intrinsic Value||N/A|
Pepco Holdings Inc does not qualify for either the Enterprising Investor or the more conservative Defensive Investor. The Defensive Investor is concerned by the low current ratio, the insufficient earnings growth or stability over the last ten years, and the high PEmg ratio. The Enterprising Investor has concerns with the level of debt in relation to the current assets as well as the insufficient earnings stability or growth over the last five years. As a result, all value investors following the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities at this time or proceed with a cautious speculative attitude.
As for a valuation, the company appears to be overvalued after seeing its EPSmg (normalized earnings) decline from $0.94 in 2011 to an estimated $0.65 for 2015. This level of demonstrated earnings growth does not support the market’s implied estimate of 15.82% 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 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 Pepco Holdings Inc (POM)? 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.
Stage 3: Information for Further Research
|Net Current Asset Value (NCAV)||-$41.98|
|Number of Consecutive Years of Dividend Growth||0|
|ModernGraham tagged articles||Morningstar|
|Google Finance||MSN Money|
|Yahoo Finance||Seeking Alpha|
Most Recent Balance Sheet Figures
|Balance Sheet Information||Sep15|
|Total Current Assets||$1,546,000,000|
|Total Current Liabilities||$2,340,000,000|
|Shares Outstanding (Diluted Average)||254,000,000|
Earnings Per Share History
|Next Fiscal Year Estimate||$0.98|
Earnings Per Share – ModernGraham History
|Next Fiscal Year Estimate||$0.65|
Other ModernGraham posts about the company
|32 Companies in the Spotlight This Week – 12/6/14|
|Pepco Holdings Inc. Annual Valuation – 2014 $POM|
Other ModernGraham posts about related companies
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. See my current holdings here. This article is not investment advice; any reader should speak to a registered investment adviser prior to making any investment decisions. ModernGraham is not affiliated with the company in any manner. Please be sure to review our detailed disclaimer.