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. 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. 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. This is 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. By using the ModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. What follows is a specific look at how Essex Property Trust Inc. (ESS) fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): Essex Property Trust, Inc. (Essex) is a self-administered and self-managed real estate investment trust (REIT). The Company is engaged primarily in the ownership, operation, management, acquisition, development and redevelopment of apartment communities. As of December 31, 2014, the Company owned or held an interest in 239 communities, aggregating 57,455 units, located along the West Coast, as well as four commercial buildings (totaling approximately 325,200 square feet), and 12 active development projects with 2,920 units in various stages of development. The Company’s apartment communities are located in Southern California, which include Los Angeles, Orange, Riverside, San Diego, Santa Barbara, and Ventura counties; Northern California, which include the San Francisco Bay Area, and Seattle Metro, which include Seattle metropolitan area.
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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 – FAIL
- 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 – 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 – PASS
- Moderate PEmg 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 – 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 – 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 – PASS
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – PASS
|Value Based on 3% Growth||$72.81|
|Value Based on 0% Growth||$42.68|
|Market Implied Growth Rate||17.92%|
|Net Current Asset Value (NCAV)||-$83.68|
Balance Sheet – March 2015
Earnings Per Share
Earnings Per Share – ModernGraham
Essex Property Trust Inc. is suitable for the Enterprising Investor but not the more conservative Defensive Investor. The Defensive Investor is concerned with the low current ratio, and the high PEmg ratio. The Enterprising Investor is only concerned with the high level of debt relative to the net current assets. As a result, all Enterprising Investors following the ModernGraham approach should feel comfortable proceeding with the valuation. From a valuation side of things, the company appears to be overvalued after growing its EPSmg (normalized earnings) from $1.86 in 2011 to an estimated $5.02 for 2015. This level of growth does not support the market’s implied estimate of 17.92% 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.
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. What do you think? What value would you put on Essex Property Trust Inc. (ESS)? Where do you see the company going in the future? Is there a company you like better? Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.
Disclaimer: 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. Logo taken from the web; this article is not affiliated with the company in any manner.