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 5 Most Undervalued Companies for the Enterprising Investor – November 2014. 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 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, that, through regulated public utility subsidiaries, is engaged primarily in the transmission, distribution and default supply of electricity and the distribution and supply of natural gas (Power Delivery): Potomac Electric Power Company (Pepco), Delmarva Power & Light Company (DPL) and Atlantic City Electric Company (ACE). As of December 31, 2012, the Company segments include Power Delivery, consisting of the operations of Pepco, DPL and ACE, engaged in the transmission, distribution and default supply of electricity and the distribution and supply of natural gas, Pepco Energy Services and Other Non-Regulated, consisting primarily of the operations of PCI. PHI Service Company, a subsidiary service company of PHI, provides a range of support services, including legal, accounting, treasury, tax, purchasing and information technology services, to PHI and its operating subsidiaries.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 3/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 – FAIL
- Earnings Stability – positive earnings per share for at least 10 straight years – FAIL
- Dividend Record – has paid a dividend for at least 10 straight years – PASS
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – FAIL
- Moderate PEmg ratio – PEmg is less than 20 – FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – PASS
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 1/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – FAIL
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – FAIL
- Earnings Stability – positive earnings per share for at least 5 years – FAIL
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – FAIL
|Value Based on 3% Growth||$8.41|
|Value Based on 0% Growth||$4.93|
|Market Implied Growth Rate||19.44%|
|Net Current Asset Value (NCAV)||-$37.96|
Balance Sheet – September 2014
Earnings Per Share
Earnings Per Share – ModernGraham
Pepco Holdings is not suitable for either the Defensive Investor or the Enterprising Investor. The Defensive Investor is concerned by the low current ratio, the insufficient level of earnings growth or stability over the last ten years, and the high PEmg and PB ratios. The Enterprising Investor is concerned by the level of debt relative to the current assets along with the lack of earnings growth over the last five years. As a result, value investors following the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities at this time. From a valuation side of things, the company appears to be overvalued after seeing its EPSmg (normalized earnings) drop from $0.94 in 2010 to only an estimated $0.58 for 2014. This level of demonstrated growth does not support the market’s implied estimate of 19.44% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham’s formula, to return 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.
Disclaimer: The author did not hold a position in Pepco Holdings Inc. (POM) or in any other company mentioned in this article at the time of publication and had no intention of changing that position within the next 72 hours. Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.