TheÂ ModernGraham approachÂ to investing has multiple layers to it. Â 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 theÂ intrinsic value through quantitative analysis. Â 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. Â 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. Â This week, the company chosen, CF Industries, is currently significantly undervalued based on the ModernGraham valuation model.
Results of Recent Valuation
Please be sure to reviewÂ ModernGraham’s latest valuation of CF IndustriesÂ in detail, but here is also a summary:
CF Industries is a very intriguing company for both Defensive Investors and Enterprising Investors. Â The Defensive Investor’s only concern is the lack of earnings stability over the last ten years, while the Enterprising Investor’s only issue is with the level of debt relative to the net current assets. Â As a result, value investorsÂ 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. Â Looking at the company from a valuation angle shows the company to be significantly undervalued after growing its EPSmg (normalized earnings) from $7.11 in 2010 to an estimated $21.47 for 2014. Â This strong level of demonstrated growth greatly exceeds the market’s implied estimate of 1.23% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value well above the price.
Price trend compared to the market
CF IndustrialsÂ is a little bit different from recent companies selected for the Company of the Week honor, because the market has been very favorable to the companyÂ over the last five years. Â 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. Â 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. Â As it appears, the market seems to be continuing an upward trend overall for the company.
Earnings Per Share
The next chart shows CF Industrial’s earnings per share over the last 10Â years. Â Clearly, the company has demonstrated a very strong upward trajectory in its earnings over the time period. Â The only large bump in the road came during the great recession, but the company has since recovered to now earn nearly three times the amount it earned at its peak before the recession. Â It’s important to consider earnings data that is normalized to smooth some effects of the business cycle, and CF IndustrialsÂ has grown its EPSmg (normalized earnings) from $7.11 in 2010 to an estimated $21.47 for 2014. Â This confirms the strong growth shown in the chart.
Price to Book
Normally, companies chosen for this series demonstrate a price to book ratio considerably lower than shown in the prior years; however, withÂ CF Industrials, the price to book ratio has been rather steady over the last five years, though it is considerably lower than was shown just prior to the recession.
Dividend payments should be a critical part of any intelligent investment analysis. Â There is no better way to ensure a return on investment than through dividend income. Â CF IndustrialsÂ 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. Â 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.
CF IndustrialsÂ should appeal to both Defensive Investors and Enterprising Investors. Â In addition, the quantitative analysis shows the company to be significantly undervalued. Â With this company, the demonstrated steady earnings growth is very intriguing. Â It is likely that Mr. Market is now speculating and assuming that the growth is going to slow down soon; Â 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 CF IndustrialsÂ 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. Â 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:Â Â The author did not hold a position in CF Industrials Â (CF) orÂ 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.