Bed, Bath & Beyond (BBBY) has shown very strong earnings growth over the last several years, which will immediately intrigue many investors, even though the company’s most recently quarterly results disappointed some analysts. For example, Treetis has concerns that earnings will continue to slowwhile competition heats up. On the other hand, Equity Watch takes a longer term view and expects the company’s future to be bright.
However, Benjamin Graham, the father of value investing, taught that investors must take emotion out of the equation, 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’s a 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 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 the ModernGraham method, one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries.
BBBY data by YCharts
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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 – 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 1/3rd over the last 10 years, using 3-year averages at the beginning and end of the period – PASS
- Moderate PEmg (price over normalized earnings) ratio – PEmg is less than 20 – PASS
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – FAIL
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 – PASS
- Sufficiently Strong Financial Condition, Part 2 – Debt-to-Net Current Assets ratio less than 1.1 – PASS
- Earnings Stability – Positive earnings per share for at least 5 years – PASS
- Dividend Record – Currently pays a dividend – FAIL
- Earnings growth – EPSmg greater than 5 years ago – PASS
|Value Based on 3% Growth||$67.07|
|Value Based on 0% Growth||$39.32|
|Market Implied Growth Rate||3.44%|
|Net Current Asset Value (NCAV)||$0.38|
Balance Sheet – February 2015
Earnings Per Share
Earnings Per Share – ModernGraham
Bed Bath & Beyond does not pay a dividend.
Bed, Bath & Beyond performs well in the ModernGraham model and is suitable for Enterprising Investors. The Defensive Investor is concerned with the lack of dividends and the high PB ratio, while the Enterprising Investor is only concerned by the lack of dividends. As a result, 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 $2.38 in 2011 to $4.63 for 2015. This is a strong level of demonstrated growth, which is well above the market’s implied estimate of 3.44% annual earnings growth over the next 7-10 years.
Here, actual growth in EPSmg over the last several years has averaged over 18% annually, so the market is expecting a very significant 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 estimates a growth figure much higher than the market’s implied rate. Therefore, the model returns an estimate of intrinsic value well above the current price, indicating the company is significantly undervalued at the present time.
Disclaimer: Â 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 that position within the next 72 hours. Â Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.