Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. 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 companyÂ or by reviewing theÂ 5 Most Undervalued Companies for the Defensive Investor – May 2015.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 Xylem Inc. (XYL)Â fares in theÂ ModernGraham valuation model.
Company ProfileÂ (obtained fromÂ Google Finance): Xylem Inc. (Xylem) is engaged in design, manufacturing, and application of engineered technologies for the water industry. The Company is an equipment and service provider for water and wastewater applications with a portfolio of products and services addressing the full cycle of water, from collection, distribution and use to the return of water to the environment. It operates in two segments: Water Infrastructure and Applied Water. The Water Infrastructure segment focuses on the transportation, treatment and testing of water, offering a range of products, including water and wastewater pumps, treatment and testing equipment, and controls and systems. Key brands in this segment include Flygt, Wedeco, Godwin Pumps, WTW, Sanitaire, AADI and Leopold. The Applied Water segment encompasses the uses of water and focuses on the residential, commercial, industrial and agricultural markets.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 2/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion -Â 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 FAIL
- Dividend Record – has paid a dividend for at least 10 straight years -Â FAIL
- 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 FAIL
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 5/5
- 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 -Â PASS
- Earnings Stability – positive earnings per share for at least 5 years – PASS
- Dividend Record – currently pays a dividend -Â PASS
- Earnings growth – EPSmg greater than 5 years ago -Â PASS
|Value Based on 3% Growth||$23.93|
|Value Based on 0% Growth||$14.03|
|Market Implied Growth Rate||6.95%|
|Net Current Asset Value (NCAV)||-$3.59|
Balance Sheet – MarchÂ 2015
Earnings Per Share
Earnings Per ShareÂ – ModernGraham
Xylem Inc.Â is suitableÂ for the Enterprising Investor but notÂ for the Defensive Investor. Â The Defensive Investor is concerned by the the insufficient earnings stability or growth over the last ten years, the short dividend historyÂ andÂ the high PEmg and PB ratios, while the Enterprising Investor has no initial concerns. Â As a result, Enterprising InvestorsÂ following the ModernGraham approach based on Benjamin Graham’s methods should feel very comfortable proceeding with further research and comparing the company to other opportunities. Â From a valuation side of things,Â the company appears to be overvaluedÂ after growingÂ its EPSmg (normalized earnings) from $1.26 in 2011 to an estimated $1.65 for 2015. Â This level of demonstrated growth does not supportÂ the market’s implied estimate of 6.95%Â earnings growth and leads the ModernGrahamÂ valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value well aboveÂ the price.
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 Xylem Inc. (XYL)? 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 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.