5 Speculative and Overvalued Companies to Avoid – December 2014

The market is filled with companies with a lot of hype which are touted as great investments, but Benjamin Graham taught that intelligent investors must look past the hype and avoid speculating about a company’s future.  By using the ModernGraham Valuation Model, I’ve selected five of the most overvalued companies reviewed by ModernGraham. Each company has been determined to not be suitable for either the Defensive Investor or the Enterprising Investor according to the ModernGraham approach. This is a sample of one screen that is included in ModernGraham Stocks & Screens, which is available for premium subscribers and is a great resource for selecting better opportunities.  Defensive Investors are defined as investors who are not able or willing to do substantial research into individual investments, and therefore need to select only the companies that present the least amount of risk. Enterprising Investors, on the other hand, are able to do substantial research and can select companies that present a moderate (though still low) amount of risk. Each company suitable for the Defensive Investor is also suitable for Enterprising Investors.

General Dynamics Corporation (GD)

After reviewing the data, it is clear that conservative value investors may wish to seek other opportunities. The Defensive Investor has numerous concerns, including the low current ratio, the lack of earnings stability or growth, and high PEmg and PB ratios while the Enterprising Investor has concerns with the low current ratio, as well as the lack of earnings growth or stability over the last five years. As a result, both investor types would find the company to be too risky to proceed. That said, any investors willing to speculate about the future of the company may go ahead with the next step of the analysis, which is a determination of the company’s intrinsic value.

When calculating an estimate of intrinsic value, it is important to consider the historical earnings results along with the market’s implied estimate for future growth. Here, the company has seen its EPSmg (normalized earnings) drop from $6.13 in 2010 to only an estimated $5.52 for 2014. This lack of demonstrated growth is in stark contrast to the market’s implied estimate of 8.93%. There would have to be a shift in the company’s growth in order to be worth the current market pricing. As a result, the company appears to be significantly overvalued at the present time.  (See the full valuation on Seeking Alpha)

Prudential Financial (PRU)

Prudential does not perform well in the initial stages of the analysis, as it is not suitable for either the Enterprising Investor or the Defensive Investor. The Defensive Investor is concerned with the insufficient earnings growth or stability over the last ten years along with the high PEmg ratio. The Enterprising Investor is concerned with the lack of earnings growth or stability over the last five years. Any value investor following the ModernGraham approach based on Benjamin Graham’s teachings should be very cautious proceeding to the next part of the analysis, which is a determination of the company’s intrinsic value.

To determine an estimate of the intrinsic value, one must consider the company’s earnings. Here, the company has seen its EPSmg (normalized earnings) drop from $4.75 in 2010 to only an estimated $4.19 for 2014. This drop in earnings does not support the market’s implied forecast of 5.87% earnings growth over the next 7-10 years. The company would have to see a significant change in growth in order to be valued at the market’s current price. As a result, the ModernGraham valuation model returns an estimate of intrinsic value well below the price, supporting a clear conclusion that the company is significantly overvalued.  (See the full valuation on Seeking Alpha)

Entergy Corporation (ETR)

Entergy is not suitable for either the Defensive Investor or the Enterprising Investor.  The Defensive Investor is concerned by the low current ratio and the insufficient level of earnings growth over the last ten years.  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 $6.24 in 2010 to only an estimated $5.36 for 2014.  This level of demonstrated growth does not support the market’s implied estimate of 3.58% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value below the price.  (See the full valuation)

Air Products & Chemicals Inc. (APD)

Air Products & Chemicals does not qualify for either the Defensive Investor or the Enterprising Investor. The Defensive Investor is concerned with the low current ratio, and high PEmg and PB ratios. The Enterprising Investor takes issue with the level of debt relative to the current assets. As a result, any purchase of the company is made with a speculative nature behind it. That said, any speculator interested in pursuing the company should still proceed to the next part of the analysis, which is a determination of the company’s intrinsic value.

With regard to that intrinsic value, the company has grown its EPSmg (normalized earnings) from $4.03 in 2010 to only an estimated $4.94 for 2014. This level of demonstrated growth does not support the market’s implied estimate for earnings growth of 10.13% over the next 7-10 years. In fact, actual growth has been closer to 4.51% in recent years. The ModernGraham valuation model therefore returns an estimate of intrinsic value below the current price, indicating the company is overvalued at the present time.  (See the full valuation on Seeking Alpha)

Cabot Oil & Gas Corporation (COG)

Cabot Oil and Gas Corporation does not qualify 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 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.  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 growing its EPSmg (normalized earnings) from $0.35 in 2010 to only an estimated $0.59 for 2014.  This level of demonstrated growth does not support the market’s implied estimate of 23.66% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value below the price.  (See the full valuation)

What do you think?  Are these companies a bad opportunity for Intelligent Investors?  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 any company mentioned in this article at the time of publication and had no intention of changing those holdings within the next 72 hours.  Logos are taken from either the company page or Wikipedia for purposes of identifying the company only; ModernGraham has no affiliation with the companies.