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, Ralph Lauren, is currently significantly undervalued based on the ModernGraham valuation model.
Results of Recent Valuation
Please be sure to review ModernGraham’s latest valuation of Ralph Lauren in detail, but here is also a summary:
Ralph Lauren is suitable for Enterprising Investors, having passed all of the investor type’s requirements, but the company is not suitable for Defensive Investors. The Defensive Investor is concerned with the high price-to-earnings and price-to-book ratios. As a result, Enterprising Investors following the ModernGraham approach based on Benjamin Graham’s methods should feel comfortable proceeding with further research into the company and comparing it to other opportunities through a review of ModernGraham’s valuation of VF Corp (VFC) and ModernGraham’s valuation of Coach Inc. (COH). As for a valuation, the company appears significantly undervalued after growing its EPSmg (normalized earnings) from $4.13 in 2010 to $7.45 for 2014. This high level of demonstrated growth outpaces the market’s implied estimate of 6.03% and leads the ModernGraham valuation model, which is based on a Benjamin Graham formula, to return an estimate of intrinsic value well above the market price.
Price trend compared to the market
Ralph Lauren is a little bit different from recent companies selected for the Company of the Week honor, because the market has been very favorable to Ralph Lauren over the last five years. As you can see by the following chart, the company has shown a very large return above what the market has achieved during the same time period. However, in more recent times, the market has not been as favorable. Over the last year, Ralph Lauren is down 12.2% while the S&P 500 is up more than 18%. Intelligent Investors know that the price trend has nothing to do with value, but this portion of an analysis can be useful in trying to understand Mr. Market’s movements.
Earnings Per Share
The next chart shows Ralph Lauren’s earnings per share over the last 10 years. Clearly, the company has demonstrated a very strong upward trajectory in its earnings over the time period. Even the great recession could not completely derail this company’s growth and only appears as a pothole on the road to higher earnings. It’s important to consider earnings data that is normalized to smooth some effects of the business cycle, and Ralph Lauren has grown its EPSmg (normalized earnings) from $4.13 in 2010 to an estimated $7.45 for 2014. This confirms the strong growth shown in the chart.
Price to Book
In another confirmation that Ralph Lauren would seem to be an excellent value at this point in time, the price to book ratio is well below where it has been seen in the last couple of years. It is important to note that over the last ten years, the book value today may be a little higher than average, but it is clear that it is low compared to more recent history. As a result, it is possible we could see Mr. Market turn around and start pricing the company higher.
Dividend payments should be a critical part of any intelligent investment analysis. There is no better way to ensure a return on investment than through dividend income. Ralph Lauren does not pay out a significantly high dividend, but the company has paid more attention to its dividend rate in recent years, and it can be expected that the trend will continue given the strong earnings levels. The yield is now the highest it has been for the company over the last ten years, so it is attractive in that regard, but again it is still less than some other companies we’ve reviewed for this column.
Ralph Lauren should appeal to Enterprising Investors but not Defensive Investors. In addition, the quantitative analysis shows the company to be significantly undervalued. With this company, the demonstrated steady earnings growth is very intriguing. It is likely that Mr. Market is now speculating and assuming that the growth is going to slow down soon; However, as has been seen time and time again, large companies often have the resources to weather the ebbs and flows of business competition and that may be the case with Ralph Lauren as well.
Warren Buffett has promoted looking at some key management tenets, and I’d like to leave it up to readers to discuss how JP Morgan 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 held a long position in Coach Inc. (COH) but did not hold a position in 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.