REITs often attract a great deal of investors because of their strong cash flows and dividends, and those investors often overlook other parts of the business, choosing to analyze the company under a different set of criteria than companies in other sectors. This can create a problem in that it becomes difficult to compare a REIT to an industrial, which is fine if you use the typical top-down approach to stock selection; however, a top-down approach invites speculation in the fact that you are theorizing which sector will perform well going forward. Benjamin Graham taught that we should avoid speculation as much as possible, which is why it is critical to develop a system for analyzing companies that will allow them to be compared across industries. 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 investment opportunity. 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 AvalonBay Communities Inc. (AVB) fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): AvalonBay Communities, Inc. is a real estate investment trust (REIT) . It is engaged in developing, acquiring, owning and operating apartment communities in high barrier to entry markets of the United States. As of January 31, 2013, it owned a direct or indirect ownership interest in 178 operating apartment communities containing 52,427 apartment homes in nine states and the District of Columbia, of which 155 communities containing 45,056 apartment homes were consolidated for financial reporting purposes, two communities containing 674 apartment homes were held by joint ventures in which it holds an ownership interest, and 21 communities containing 6,697 apartment homes were owned by the Funds.The Company’s real estate investments consist of the segments include Established Communities, Other Stabilized Communities and Development/Redevelopment Communities.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 4/7
- 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 – PASS
- 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 = 3/5
- 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 – PASS
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – PASS
|Value Based on 3% Growth||$69.74|
|Value Based on 0% Growth||$40.88|
|Market Implied Growth Rate||13.16%|
|Net Current Asset Value (NCAV)||-$47.76|
Balance Sheet – September 2014
Earnings Per Share
Earnings Per Share – ModernGraham
AvalonBay Communities is not suitable for either the Defensive Investor or the Enterprising Investor. The Defensive Investor is concerned with the low current ratio, the the lack of sufficient earnings growth over the last ten years, and the high PEmg ratio. The Enterprising Investor is concerned with the high level of debt relative to the current assets. As a result, value investors following the ModernGraham approach 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 $3.05 in 2010 to an estimated $4.81 in 2014. This demonstrated level of growth does not support the market’s implied estimate of 13.16% earnings growth over the next 7-10 years. As a result, the ModernGraham valuation model returns an estimate of intrinsic value that is below the market 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 AvalonBay Communities Inc. (AVB)? 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 AvalonBay Communities Inc. (AVB) or 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. Logo taken from wikipedia; this article is not affiliated with the company in any manner.