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, Harley Davidson, is currently significantly undervalued based on the ModernGraham valuation model.
Results of Recent Valuation
Please be sure to reviewÂ ModernGraham’s latest valuation of Harley DavidsonÂ in detail, but here is also a summary:
Harley-DavidsonÂ is suitableÂ for the Enterprising Investor but not the Defensive Investor. Â The Defensive Investor has concerns with the company’s low current ratio, insufficient earnings growth over the last ten years, and high PEmg and PB ratios. Â The Enterprising Investor’s only initial concern is the level of debt relative to the net current assets. Â As a result, Enterprising 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 From a valuation side of things, the company appears to be undervalued after growing its EPSmg (normalized earnings) from $1.77 in 2010 to an estimated $3.09 for 2014. Â This low level of demonstrated growth does not supportÂ the market’s implied estimate of 7.07% earnings growth and leads the ModernGraham valuation model, which is based on Benjamin Graham’s formula, to return an estimate of intrinsic value that is belowÂ the current price.
Price trend compared to the market
The following two charts show two very different trends. Â The first shows the price history over the last five years, and it is clear that Harley Davidson has outperformed the market very significantly. Â This demonstrates that Mr. Market is currently favoring the company over most others, but, of course, investors cannot predict if that will continue. Â The second chart shows the price history over the last five years, and interestingly during that time overall, the market has not been so favorable to the company. Â In fact, the company trails over the time period significantly behind the market as a whole. 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 toÂ be bringing the company back into line with the rest of the market.
Earnings Per Share
The next chart shows Harley Davidson’s earnings per share over the last 30Â 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 be closing in on the same level of earnings it saw before the recession. Â It’s important to consider earnings data that is normalized to smooth some effects of the business cycle, and Harley DavidsonÂ has grown its EPSmg (normalized earnings) from $1.77 in 2010 to an estimated $3.09 for 2014. Â This confirms the strong growth shown in the chart.
Price to Book
This metric can sometimes be helpful in determining whether the market will find more room for the price to rise quickly. Â If the price to book ratio is well below where it has been historically, the market is more willing to bring the price up as it is psychologically seen as cheap. Â If it is not low, the market may wait for a higher book value before increasing the price. Â For Harley Davidson, the price to book is higher than its been over the last five years, but still quite a bit below its peak levels before the recession. Â As a result, it is possible the market will be comfortable continuing to rise.
Dividend payments should be a critical part of any intelligent investment analysis, and an analysis of dividends takes two forms: growth in the actual dividend payment, and observation of the dividend yield. Â There is no better way to ensure a return on investment than through dividend income. Â For Harley Davidson, the first chart in this section demonstrates the company has historically raised its dividends very regularly, with the exception of the recent recession. Â It should be noted that as the company’s earnings have recovered from the recession, so too have the dividend payments. Â The second chart shows the yield over the last five years, and shows that the yield has been pretty steady at around 1 – 1.4%. Â Theoretically, if the dividend continues to rise, and the market continues to seek to keep the yield in that range, then the price will rise to meet that level of yield.
Harley DavidsonÂ should appeal to Enterprising Investors but not Defensive Investors. Â The comparison to market condition andÂ the quantitative analysis both show the company to be significantly undervalued. Â With this company, the demonstrated 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 In the Intelligent Investor’s view, the company is simply trading for less than its worth based on its demonstrated growth in earnings, and the market will eventually bring the value and the price together.
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 Harley Davidson (HOG) 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.