Some will look at a company's chart and sometimes conclude that since the company is trading below a level that it has traded in the past, it must be a good time to buy. That can be especially true when it involves companies that may be particularly sensitive to business cycles.
The Baker Hughes chart of stock price shows the company tends to move in cycles, but all of that sort of discussion is speculation. Benjamin Graham taught us to not speculate regarding our investments, but rather to base our decisions on factual data. 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 Baker Hughes Inc. fares in the ModernGraham valuation model.
BHI data by YCharts
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 - 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 - 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 - FAIL
- 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 - PASS
- 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 - FAIL
Balance Sheet - 12/31/2013
|Value Based on 3% Growth||$40.22|
|Value Based on 0% Growth||$23.58|
|Market Implied Growth Rate||6.78%|
|Net Current Asset Value (NCAV)||$2.45|
Earnings Per Share
Earnings Per Share - ModernGraham
BHI Dividend data by YCharts
Baker Hughes Inc. does not qualify for the Defensive Investor but does qualify for the Enterprising Investor. The Defensive Investor is not interested because of its lack of sufficient earnings growth over the ten-year period and its high PEmg ratio. The Enterprising Investor's only gripe is the lack of earnings growth over the five-year period. As a result, Enterprising Investors following the ModernGraham approach based on Benjamin Graham's methods will feel comfortable proceeding with further research into the company, including a review of ModernGraham's valuation of National Oilwell Varco (NYSE:NOV) and ModernGraham's valuation of Schlumberger Ltd. (NYSE:SLB). From a valuation standpoint, the company does not fare well in the ModernGraham valuation model after seeing its EPSmg (normalized earnings) drop from $4.92 in 2008 to $2.77 for 2013. This fall in earnings does not support the market's implied estimate of earnings growth of 6.78%, leading the model to return an estimate of intrinsic value that is well below the market price. Even if the company were to manage to achieve 3% growth, which would be contrary to the historical trend, it would still be overvalued.
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 Baker Hughes 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 Baker Hughes Inc. (NYSE:BHI) 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.