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. Â 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. Â 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. Â This isÂ 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. Â By using theÂ ModernGraham methodÂ one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. Â What follows is a specific look at how Health Care REIT Inc. (HCN) fares in theÂ ModernGraham valuation model.
Company ProfileÂ (obtained fromÂ Google Finance): Health Care REIT, Inc. is a real estate investment trust (REIT). The Companyâ€™s portfolio has range of seniors housing and healthcare real estate, including seniors housing communities, skilled nursing/post-acute facilities, medical office buildings, inpatient and outpatient medical centers and life science facilities. The Company operates in three segments: seniors housing triple-net, seniors housing operating and medical facilities. Its properties consists of land, building, improvements and related rights. The Companyâ€™s hospitals and seniors housing triple-net properties are leased to operators under long-term operating leases. Its medical office building portfolio is primarily self-managed and consists principally of multi-tenant properties leased to health care providers.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 5/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 -Â PASS
- Earnings Stability – positive earnings per share for at least 10 straight years -Â PASS
- Dividend Record – has paid a dividend for at least 10 straight years -Â 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 -Â FAIL
- Moderate PEmg ratio – PEmg is less than 20 -Â FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 -Â PASS
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 4/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 -Â PASS
- 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 -Â PASS
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – PASS
|Value Based on 3% Growth||$29.34|
|Value Based on 0% Growth||$17.20|
|Market Implied Growth Rate||13.08%|
|Net Current Asset Value (NCAV)||-$32.08|
Balance Sheet -Â March 2015
Earnings Per Share
Earnings Per Share – ModernGraham
Health Care REIT Inc.Â is suitable for the Enterprising Investor but not for the more conservative Defensive Investor. Â The Defensive Investor is concerned with the insufficientÂ earnings growth over the last ten years, and the high PEmg ratio. Â The Enterprising Investor is only concerned with the high level of debt relative to the net current assets. Â As a result, Enterprising Investors following the ModernGraham approach should feel comfortable proceeding with further research into the company. Â From a valuation side of things, the company appears to be overvalued afterÂ growing its EPSmg (normalized earnings) from $1.28 in 2011 to only an estimated $2.02Â forÂ 2015. Â This level of growth does not support the market’s implied estimate of 13.08% annual earnings growth over the next 7-10 years, leading the ModernGraham valuation model to return an estimate of intrinsic value falling below the current price. Â As a result, the company is considered to be overvalued at this time.
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. Â What do you think? Â What value would you put on Health Care REIT Inc. (HCN)? Â Where do you see the company going in the future? Â Is there a company you like better? Â Leave aÂ comment on ourÂ Facebook pageÂ or mentionÂ @ModernGrahamÂ on Twitter to discuss.
Disclaimer: Â The author did not hold a position in any company mentioned in the article at the time of publication and had no intention of changing that position within the next 72 hours. Â Logo taken from wikipedia; this article is not affiliated with the company in any manner.