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 – July 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 stock analysis showing a specific look at how Psychemedics Corporation (PMD)Â fares in theÂ ModernGraham valuation model.
Company ProfileÂ (obtained fromÂ Google Finance): Psychemedics Corporation (Psychemedics) provides testing services for the detection of drugs of abuse through the analysis of hair samples. The Companyâ€™s testing methods utilize a technology that digests the hair and releases drugs trapped in the hair without destroying the drugs. The Companyâ€™s primary application of its technology is as a testing service that analyzes hair samples for the presence of certain drugs of abuse. The Company performs a custom-designed enzyme immunoassay (EIA) on the liquid supernatant, with confirmation testing by mass spectrometry. Psychemedics provides screening and confirmation by mass spectrometry using various practices for cocaine, marijuana, phencyclidine (PCP), amphetamines, including ecstasy, and opiates, including heroin, hydrocodone, hydromorphone, oxycodone and codeine. The Company also offers a test for alcohol using hair, which measures average alcohol consumption over a period of approximately three months.
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Defensive Investor – must pass at least 6 of the following 7 tests: Score = 3/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion -Â FAIL
- Sufficiently Strong Financial Condition – current ratio greater than 2 -Â 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 -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 FAIL
Enterprising Investor – must pass at least 4Â 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 -Â PASS
- Dividend Record – currently pays a dividend -Â PASS
- Earnings growth – EPSmg greater than 5 years ago -Â PASS
|Value Based on 3% Growth||$8.09|
|Value Based on 0% Growth||$4.74|
|Market Implied Growth Rate||5.96%|
Balance Sheet – JuneÂ 2015
Earnings Per Share
Earnings Per ShareÂ – ModernGraham
Psychemedics CorporationÂ qualifies for the Enterprising Investor but not the more conservative Defensive Investor. Â The Defensive Investor is concerned with the company size,Â insufficient earnings growth over the last ten years,Â and the high PEmg and PB ratios. Â The Enterprising Investor has no initial concerns. Â As a result, all Enterprising InvestorsÂ following the ModernGraham approach based on Benjamin Graham’s methods should feel comfortable proceeding with the evaluation.
As for a valuation,Â the company appears to be overvalued after growingÂ itsÂ EPSmg (normalized earnings) from $0.55 in 2011 to only an estimated $0.56 for 2015. Â This level of demonstrated earnings growthÂ does not supportÂ the market’s implied estimate of 5.96% annual earnings growth over the next 7-10 years.Â As a result, the ModernGrahamÂ valuation model, based on Benjamin Graham’s formula, returns an estimate of intrinsic value belowÂ 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 Psychemedics Corporation (PMD)? 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 aÂ position in any company mentioned in this articleÂ 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.