Bank of New York Mellon (NYSE:BK) presents an intriguing investment possibility for value investors, especially due to the strong earnings growth in recent years. Benjamin Graham, the father of value investing, taught that looking at the price cannot be the sole factor in investment decisions, as the most important aspect to consider is whether the company is trading at a discount relative to its intrinsic value. It is through a thorough fundamental analysis that the investor is able to make a determination about a potential investment’s merits. Here is an updated look at how the company fares in the ModernGraham valuation model.
The model is inspired by the teachings of Benjamin Graham and considers numerous metrics intended to help the investor reduce risk levels. The first part of the analysis is to determine whether the company is suitable for the very conservative Defensive Investor, or the less conservative Enterprising Investor who is willing to spend a greater amount of time conducting further research.
In addition, Graham strongly suggested that investors avoid speculation in order to remove the subjective elements of emotion. This is best achieved by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another company. By using theModernGraham method, one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries.
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Defensive Investor – Must pass all 6 of the following tests: Score = 3/6.
- Adequate Size of Enterprise – Market capitalization of at least $2 billion – PASS
- 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 (price over normalized earnings) 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 all 3 of the following tests or be suitable for a defensive investor: Score = 3/3.
- 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
|MG Opinion||Fairly Valued|
|Value Based on 3% Growth||$28.06|
|Value Based on 0% Growth||$16.45|
|Market Implied Growth Rate||6.38%|
Balance Sheet – December 2014
Earnings Per Share
Earnings Per Share – ModernGraham
Bank of New York Mellon passes all of the initial requirements of the Enterprising Investor but not the Defensive Investor. The more conservative of the two investor types is concerned by the insufficient level of earnings growth and lack of earnings stability over the last ten years, along with the high PEmg ratio. As a result, all Enterprising Investors should feel very comfortable proceeding to the next part of the analysis, which is a determination of the company’s intrinsic value.
When it comes to valuation, it is critical to consider the company’s earnings history. In this case, the company has grown its EPSmg (normalized earnings) from $1.17 in 2010 to $1.94 for 2014. This is a strong level of demonstrated growth, which is well above the market’s implied estimate for earnings growth of only 6.4% over the next 7-10 years. In fact, the historical growth is around 13% per year, so the market is expecting a drop in earnings growth. The ModernGraham valuation model reduces the historical growth to a more conservative figure, assuming that some slowdown will occur, but still returns an estimate of intrinsic value falling above the current price, indicating the company is undervalued at the present time.