Humana Inc. (NYSE:HUM) may initially attract many value investors due to the consistent growth in the last few years. However, 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. By using theÂ ModernGraham 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 – PASS
- Dividend Record – Has paid a dividend for at least 10 straight years – FAIL
- Earnings Growth – Earnings per share has increased by at least one-third over the last 10 years, using three-year averages at the beginning and end of the period – PASS
- 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 – FAIL
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
|Value Based on 3% Growth||$109.74|
|Value Based on 0% Growth||$64.33|
|Market Implied Growth Rate||7.55%|
Balance Sheet – December 2014
Earnings Per Share
Earnings Per Share – ModernGraham
HUM Dividend data by YCharts
Humana Inc. is suitable for the Enterprising Investor, but not for the more conservative Defensive Investor, who is concerned about the short dividend history, and the high PEmg and PB ratios. The Enterprising Investor, on the other hand, has no initial concerns as the company passes all of the investor type’s requirements. 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, Humana has grown its EPSmg (normalized earnings) from $5.41 in 2010 to $7.57 for 2014. This low level of demonstrated growth does not support the market’s implied estimate for earnings growth of 7.55% over the next 7-10 years. Therefore, the model returns an estimate of intrinsic value falling below the current price, indicating the company is overvalued at the present time.
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