Legg Mason Stock Analysis – May 2015 Quarterly Update $LM

Lm_logoRecently, Legg Mason (LM) beat earnings estimates for the quarter, but the market did not respond well. CEO Joe Sullivan believes the company’sinternational focus will allow it to continue to grow its profits over the long-term. These are all strong qualitative conclusions, and should be coupled with strong quantitative analysis in order to compare the opportunity to other possibilities.

Benjamin Graham, the father of value investing, taught that 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 Legg Mason stock analysis giving 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 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 the ModernGraham method, one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries.

LM Chart

LM data by YCharts

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Defensive Investor – Must pass at least 6 of the following 7 tests: Score = 4/7

  1. Adequate Size of Enterprise – Market capitalization of at least $2 billion – PASS
  2. Sufficiently Strong Financial Condition – Current ratio greater than 2 – PASS
  3. Earnings Stability – Positive earnings per share for at least 10 straight years – FAIL
  4. Dividend Record – Has paid a dividend for at least 10 straight years – PASS
  5. 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 – FAIL
  6. Moderate PEmg (price over normalized earnings) ratio – PEmg is less than 20 – FAIL
  7. Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – PASS

Enterprising Investor – Must pass at least 4 of the following 5 tests or be suitable for a Defensive Investor: Score = 4/5

  1. Sufficiently Strong Financial Condition, Part 1 – Current ratio greater than 1.5 – PASS
  2. Sufficiently Strong Financial Condition, Part 2 – Debt-to-Net Current Assets ratio less than 1.1 – PASS
  3. Earnings Stability – Positive earnings per share for at least 5 years – FAIL
  4. Dividend Record – Currently pays a dividend – PASS
  5. Earnings growth – EPSmg greater than 5 years ago – PASS

Valuation Summary

Key Data

Recent Price $53.93
MG Value $41.79
MG Opinion Overvalued
Value Based on 3% Growth $15.74
Value Based on 0% Growth $9.23
Market Implied Growth Rate 20.59%
Net Current Asset Value (NCAV) -$6.53
PEmg 49.69
Current Ratio 2.36
PB Ratio 1.23

Balance Sheet – March 2015

Current Assets $1,922,000,000
Current Liabilities $815,000,000
Total Debt $1,058,000,000
Total Assets $7,074,000,000
Intangible Assets $4,653,000,000
Total Liabilities $2,589,000,000
Outstanding Shares 102,100,000

Earnings Per Share

2015 $2.04
2014 $2.33
2013 -$2.65
2012 $1.54
2011 $1.63
2010 $1.32
2009 -$13.99
2008 $1.86
2007 $4.48
2006 $8.80
2005 $3.53

Earnings Per Share – ModernGraham

2015 $1.09
2014 $0.68
2013 -$0.90
2012 -$0.53
2011 -$1.36
2010 -$1.73

Dividend History

LM Dividend Chart

LM Dividend data by YCharts


Legg Mason qualifies for the Enterprising Investor but not the more conservative Defensive Investor. The Defensive Investor is concerned by the insufficient earnings growth or stability over the last ten years, and the high PEmg ratio. The Enterprising Investor is only concerned by the lack of earnings stability over the last five years. 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 that valuation, it is critical to consider the company’s earnings history. In this case, it has seen its EPSmg (normalized earnings) grow from a loss of $1.36 in 2011 to a gain of $1.09 for 2015. This level of growth is strong but does not support the market’s implied estimate for annual earnings growth of 20.6% over the next 7-10 years, a rate that is only attainable by the rarest of companies.

In recent years, the company’s actual growth in EPSmg has averaged 36% annually, but out of an abundance of caution, the ModernGraham valuation model generates an estimate significantly lower and more sustainable, returning an estimate of intrinsic value well below the current price, indicating that Legg Mason is overvalued at the present time.

Disclaimer:  The author did not hold a position in any other company mentioned in this article at the time of publication and had no intention of changing that position within the next 72 hours.  Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.


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