5 Most Overvalued Dow Components – February 2015

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.

AT&T Inc. (T)

AT&T Inc. is not suitable for the Enterprising Investor or for the Defensive Investor.  The Defensive Investor is concerned by the low current ratio and the insufficient earnings stability over the last ten years.  The Enterprising Investor is concerned by the level of debt relative to the current assets and 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 $2.48 in 2010 to $1.86 for 2014.  This level of demonstrated growth does not support the market’s implied estimate of 5.04% 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)

Merck & Company (MRK)

Merck & 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)

Verizon 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)

Proctor & Gamble (PG)

Procter & Gamble does not qualify for either the Defensive Investor or the Enterprising Investor. The Defensive Investor is concerned with the low current ratio, insufficient earnings growth over the last ten years, and high PEmg and PB ratios. The Enterprising Investor takes issue with the level of debt relative to the current assets along with the lack of earnings growth over the last five years. 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 seen its EPSmg (normalized earnings) drop from $3.95 in 2011 to only an estimated $3.89 for 2015. This lack of demonstrated growth does not support the market’s implied estimate for earnings growth of 6.78% annually over the next 7-10 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)

Goldman Sachs (GS)

Goldman 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)

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.