The ModernGraham approach to investing has multiple layers to it. Regular readers will be familiar with the first two steps; the first is to determine if the company is suitable for the Defensive Investor or the Enterprising Investor, and the second is to compare the price to the intrinsic value through quantitative analysis. The next step in the analysis is to review the company’s management and other qualitative factors to determine how the company may compare to other companies that pass the first two steps. In this Company of the Week series, we will delve into more detail about a specific company that performed well in the first two areas. This week, the company chosen, Capital One Financial, is one of the most undervalued out of all 250+ companies in the ModernGraham database and was recently featured as one of April’s 5 Undervalued Companies for the Enterprising Investor.
Results of Recent Valuation
Feel free to review ModernGraham’s latest valuation of Capital One Financial in detail, or read this summary:
Capital One Financial is a great company for Enterprising Investors to look at in more detail, but it does not quite qualify for the Defensive Investor because it has not shown sufficient growth in its earnings over the ten year historical period. That said, the company passes all of the requirements of the Enterprising Investor. As a result, Enterprising Investors following the ModernGraham approach based on Benjamin Graham’s methods should feel very comfortable proceeding with further research into the company and comparing it to competitors through a review of ModernGraham’s valuation of JP Morgan Chase (JPM) and ModernGraham’s valuation of Wells Fargo Inc. (WFC). From a valuation side of things, the company appears to be significantly undervalued after growing its EPSmg (normalized earnings) from $3.14 in 2009 to $6.56 for 2013. This solid level of demonstrated growth surpasses the market’s implied estimate of 1.46% earnings growth and leads the ModernGraham valuation model to return an estimate of intrinsic value that is well above the market price.
Price trend compared to the market
In the following chart, it is clear that over the last ten years Capital One has underperformed the market. This is largely due to the financial crisis dropping the prices of financial companies significantly. While Intelligent Investors will know that price trends are not determinative of value or opportunity, they can be helpful in comparing Mr. Market’s behavior toward the company with the valuation. It is easy to see that Mr. Market may have overreacted in some respects by bringing down Capital One Despite the company’s performance during the crisis. Now, despite the company outperforming the market over the last five years, it does appear to still have upside, as explained in the summary above.
Earnings Per Share
The next chart is a bit interesting, as it shows the company’s earnings history over the last ten years. Clearly, the company took a hit during the crisis. However, the company has recovered well since then, and has certainly returned to the level of earnings seen before the crisis. The Intelligent Investor’s concern, however, may be that the company has not shown strong enough growth over the full ten year period. This is the case for those following the Defensive Investor requirements of the ModernGraham approach, and this company is definitely not suitable for that investor type, but the Enterprising Investor may be satisfied as the company has grown its earnings over the five year period and appears to have the potential to grow further at a rate above what the market is implying.
Dividend Rate & Yield
Dividends are a very important part of any analysis into a company, as they not only indicate management’s willingness to return value to shareholders, but they also indicate an opportunity for the Intelligent Investor to gain a return on the investment outside of capital appreciation. In the next chart, we see that Capital One has consistently paid a dividend, and recently raised it significantly. However, the dividend growth history is not as strong as an Intelligent Investor would like to see, but the main requirement of dividend payments is met. After all, even though the company has not grown the dividend in a consistent manner, it has proven willing to return value to the shareholders.
Price to Book
This final chart demonstrates the potential value by showing the company’s price to book ratio over the last 20 years. As you can see, the company is still trading at a comparatively low Price to Book ratio. This alone is not a strong indicator of value, but used in conjunction with intrinsic value estimates and detailed analysis, it can help show again that the market may be undervaluing the company. At the very least, the market is not treating it the way it did in the past.
To me, Capital One appears to be a very intriguing opportunity for value investors. The company qualifies for Enterprising Investors, and the quantitative analysis using one of Benjamin Graham’s formulas indicates the company is significantly undervalued. However, there are some concerns with the earnings growth and dividend growth that may shy away some investors. I think any decision about investing in Capital One may turn out to be a gut call based on the individual’s responses to the Management Tenet questions listed below. The company passes the initial tests, and has some great qualities but I need to know a little bit more before committing. I’d be very interested to hear readers views regarding any qualitative analysis regarding the company.
Warren Buffett has promoted looking at some key management tenets, and I’d like to leave it up to readers to discuss how Intel fulfills (or fails to fulfill) these qualities. Please discuss the following in the comments below:
- Is the business simple and understandable?
- Does the business have a consistent operating history?
- Does the company have favorable long-term prospects?
- Is management rational?
- Is management candid with shareholders?
Disclosure: The author did not hold a position in Capital One Financial (COF) 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.