5 Most Overvalued Dow Components – January 2015

5 Worst Dow Components (3)There are so many great companies in the market today, but there are also many overvalued companies. By using the ModernGraham Valuation Model, I’ve selected the five most overvalued Dow Components reviewed by ModernGraham according to the ModernGraham approach. 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.  Only speculators should pursue companies not suitable for either the Defensive Investor or the Enterprising Investor.

Merck & Company (MRK)

logo_MerckMerck & Company does not qualify for either the Defensive Investor or the Enterprising Investor.  The Defensive Investor is concerned by the low current ratio, lack of earnings growth over the last ten years along with the high PEmg and PB ratios.  The Enterprising Investor is similarly concerned by the lack of earnings growth over the last five years along with the high level of debt relative to the net 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 seeing its EPSmg (normalized earnings) drop from $2.66 in 2010 to only an estimated $2.23 for 2014.  This demonstrated lack of growth clearly does not support the market’s implied estimate of 9.01% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value well below the price.  (See the full valuation)

Verizon Communications Inc. (VZ)

500px-Verizon_logo.svgVerizon Communications is not suitable for either the Defensive Investor or the Enterprising Investor.  For the Defensive Investor, the company has not shown sufficient earnings growth over the ten year historical period, and is trading at too high PEmg and PB ratios.  For the Enterprising Investor, the company has too much debt relative to its current assets and has not grown its EPSmg (normalized earnings) over the five year historical period.  As a result, value investors seeking to follow the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities.  From a valuation perspective, the company does not fare well, after seeing EPSmg fall from $1.84 in 2009 to $1.79 in 2013.  This demonstrated lack of earnings growth does not support the market’s implied growth rate estimate of 8.95%, and the ModernGraham valuation model returns an intrinsic value estimate that is significantly below the market price.  (See the full valuation)

Goldman Sachs (GS)

145px-Goldman_Sachs.svgGoldman Sachs does not perform well in the initial stages of the ModernGraham analysis, having not met the requirements of either the Defensive Investor or the Enterprising Investor. Specifically, the Defensive Investor is turned away by the lack of earnings growth over the last ten years and the Enterprising Investor is similarly concerned by the lack of growth over the last five years. As a result, any value investor following the ModernGraham approach based on Benjamin Graham’s teachings should explore other opportunities at this time or proceed with extreme caution when continuing to review this company.

To determine an estimate of the intrinsic value, one must consider the company’s earnings. Goldman Sachs has seen its EPSmg (normalized earnings) drop from $15.80 in 2010 to an estimated $4.00 for 2014. This drop in earnings is approximately a loss of 2.28% each year. Even assuming the company’s drop in earnings will be lessened in the future, a conservative growth estimate may be around a loss of 1.7% annually, which clearly does not support the market’s implied forecast of 2.58% earnings growth over the next 7-10 years. As a result, the ModernGraham valuation model returns an estimate of intrinsic value below the price, supporting a conclusion that the company is overvalued.  (See the full valuation on Seeking Alpha)

AT&T Inc. (T)

ATTAfter looking over the company’s fundamentals, AT&T qualifies for the Defensive Investor as the only concern at this time is the low current ratio. The Enterprising Investor has many other concerns but is willing to overlook them as it passes the more conservative Defensive Investor requirements. As a result, all value investors should feel very comfortable proceeding to the next part of the analysis, which is a determination of the company’s intrinsic value.

Estimating the intrinsic value requires examining the company’s earnings history. AT&T has seen its EPSmg (normalized earnings) drop from $2.48 in 2010 to only an estimated $2.31 for 2014. This demonstrated drop in earnings does not support the market’s implied estimate of 3.3% earnings growth. In recent years, the company has actually seen an average annual drop in earnings of around 1.4%. Clearly, there would have to see a significant change in its level of growth in order to meet the market’s estimated growth level. As a result, the ModernGraham valuation model returns an estimate of intrinsic value below the market price at this time, and the company appears to be overvalued by the market.  (See the full valuation on Seeking Alpha)

General Electric Company (GE)

438px-General_Electric_logo.svg

After looking over the company’s fundamentals, General Electric qualifies for both the Enterprising Investor and the even more conservative Defensive Investor. Both investor types should be concerned with the lack of earnings growth, but those concerns are not great enough on their own to turn away investors before considering the intrinsic value. As a result, all value investors should feel comfortable proceeding to the next part of the analysis, which is a determination of the company’s intrinsic value.

Estimating the intrinsic value requires examining the company’s earnings history. General Electric has seen its EPSmg (normalized earnings) stay relatively flat from $1.39 in 2010 to only an estimated $1.38 for 2014. This demonstrated level of earnings growth does not support the market’s implied estimate of 5.2% earnings growth. This is particularly true because the company has not actually grown its earnings at all over the last few years, so there would need to be a significant change in the company’s earnings in order to justify the market’s current long-term estimates. As a result, our valuation model returns an estimate of intrinsic value below the market price at this time, and the company appears to be overvalued by the market.  (See the full valuation on Seeking Alpha)


What do you think?  Are these companies a good value for Defensive 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.  Company logos were taken from Wikipedia; ModernGraham has no affiliation with any of the companies mentioned.


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