Here is a look at how Covidien Ltd (COV) fares in ModernGraham's opinion, based on an updated and modernized version of Benjamin Graham's requirements of defensive and enterprising investors from The Intelligent Investor:
Defensive and Enterprising Investor Tests (What is the significance of these tests, and what is PEmg ratio?):
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 - PASS
- Sufficiently Strong Financial Condition - current ratio greater than 2 - PASS
- Earnings Stability - positive earnings per share for at least 10 straight years - FAIL
- Dividend Record - has paid a dividend for at least 10 straight years - 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 - 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 - 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 - 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
Valuation Summary (Explanation of the ModernGraham Valuation Model)
|Value Based on 3% Growth||$50.30|
|Value Based on 0% Growth||$29.48|
|Market Implied Growth Rate||5.79%|
|Net Current Asset Value (NCAV)||-$10.62|
Balance Sheet - 9/30/2013
Earnings Per Share
Earnings Per Share - ModernGraham
Covidien Ltd is a company that presents a great opportunity for Enterprising Investors. The company does not qualify for the Defensive Investor, though, because of its lack of earnings stability, dividend history, and it is currently trading at high PEmg and PB ratios. The company does qualify for the Enterprising Investor, and this type of value investor following Benjamin Graham's methods should feel comfortable proceeding with further research. One suggestion for further research would be a review of ModernGraham's valuation of Johnson & Johnson (NYSE:JNJ).
From a valuation perspective, the company has grown EPSmg (normalized earnings) from $1.83 in 2008 to $3.47 in 2013. This level of earnings growth more than supports the market's implied growth estimate of 5.79%, and the company appears to be undervalued at the present time.
What do you think? Do you agree that Covidien Ltd. is undervalued? What would be your assessment? Is the company suitable only for Enterprising Investors?
Disclosure: The author did not hold a position in Covidien Ltd (COV) at the time of publication and had no intention of changing that position within the next 72 hours.