When a company has seen a lengthy rise in price, some investors have a tendency to believe that it must be a good investment because it keeps going up. However, this is a common way of engaging in rampant speculation, and as Benjamin Graham taught, speculating has only a very limited role in investing. Intelligent Investors know to do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. 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 company. 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 Ecolab Inc. fares in the ModernGraham valuation model.
ECL data by YCharts
Defensive Investor - must pass at least 6 of the following 7 tests: Score = 4/7
- 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 - FAIL
Enterprising Investor - must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5
- Sufficiently Strong Financial Condition, Part 1 - current ratio greater than 1.5 - FAIL
- 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||$37.73|
|Value Based on 0% Growth||$22.12|
|Market Implied Growth Rate||15.57%|
Balance Sheet - 9/30/2013
Earnings Per Share
Earnings Per Share - ModernGraham
ECL Dividend data by YCharts
Ecolab is not suitable for either the Defensive Investor or the Enterprising Investor. For the Defensive Investor, the company's current ratio is too low, and the company is trading at PEmg and PB ratios that are too high. The Enterprising Investor is turned off by the company's high level of debt relative to its current assets. As a result, value investors seeking to follow the ModernGraham approach based on Benjamin Graham's methods may wish to seek other opportunities through a review of companies that pass the ModernGraham requirements.
From a valuation point of view, the company appears to be overvalued. Though it has grown its EPSmg (normalized earnings) from $1.58 in 2008 to an estimated $2.60 for 2013, this level of demonstrated historical growth does not support the market's implied estimate for growth of 15.57%. The ModernGraham valuation model then returns an intrinsic value that is less than the market's 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 Ecolab Inc.? Where do you see the company going in the future? Is there a company you like better?
Disclosure: The author did not hold a position in Ecolab Inc. (ECL) or any of the other companies listed in this article at the time of publication and had no intention of changing that position within the next 72 hours.