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Benjamin Graham taught that Intelligent Investors must 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 Zoetis Inc. fares in the ModernGraham valuation model.

ZTS Chart

ZTS data by YCharts

Defensive Investor - must pass at least 6 of the following 7 tests: Score = 2/7

  1. Adequate Size of Enterprise - market capitalization of at least $2 billion - PASS
  2. Sufficiently Strong Financial Condition - current ratio greater than 2 - PASS
  3. Earnings Stability - positive earnings per share for at least 10 straight years - FAIL
  4. Dividend Record - has paid a dividend for at least 10 straight years - FAIL
  5. 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
  6. Moderate PEmg ratio - PEmg is less than 20 - FAIL
  7. 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

  1. Sufficiently Strong Financial Condition, Part 1 - current ratio greater than 1.5 - PASS
  2. Sufficiently Strong Financial Condition, Part 2 - Debt to Net Current Assets ratio less than 1.1 - FAIL
  3. Earnings Stability - positive earnings per share for at least 5 years - FAIL
  4. Dividend Record - currently pays a dividend - PASS
  5. Earnings growth - EPSmg greater than 5 years ago - PASS

Valuation Summary

Key Data:

Recent Price$29.01
MG Value$26.28
MG OpinionOvervalued
Value Based on 3% Growth$9.90
Value Based on 0% Growth$5.80
Market Implied Growth Rate17.00%
Net Current Asset Value (NCAV)-$4.52
PEmg42.50
Current Ratio2.37
PB Ratio15.43

Balance Sheet - 12/31/2013

Current Assets$3,357,000,000
Current Liabilities$1,415,000,000
Total Debt$3,642,000,000
Total Assets$6,558,000,000
Intangible Assets$1,785,000,000
Total Liabilities$5,618,000,000
Outstanding Shares500,000,000

Earnings Per Share

2013$1.01
2012$0.87
2011$0.49
2010$0.22
2009-$0.20
2008$0.00
2007$0.00
2006$0.00
2005$0.00
2004$0.00

Earnings Per Share - ModernGraham

2013$0.68
2012$0.44
2011$0.18
2010$0.02
2009-$0.07
2008$0.00

Dividend History

ZTS Dividend Chart

ZTS Dividend data by YCharts

Conclusion:

As a recent spin-off, Zoetis has an uphill battle in the ModernGraham approach, and contains too much speculation for Intelligent Investors. Spin-offs inherently have speculation because of the uncertainty surrounding earnings results from before the spin-off (i.e. how does one determine how much the company would have earned as a stand-alone during that time?), and speculation is one of the greatest contributors to risk in investing. Zoetis is no exception, and is not yet suitable for either the Defensive Investor or the Enterprising Investor. The company needs more time to demonstrate the stability needed in order to qualify for the Defensive Investor, and the company needs to improve its debt level relative to current assets in order to qualify for the Enterprising Investor.

In the meantime, value investors seeking to follow the ModernGraham approach based on Benjamin Graham's methods should explore other opportunities through a review of 5 Low PEmg Companies for the Defensive Investor and Glance at the Dow. From a valuation standpoint, the company appears to be overvalued, and the market is currently implying an estimate of 17% earnings growth, a rate which is not yet supported by the demonstrated historical earnings.

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 Zoetis 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 Zoetis Inc. (NYSE:ZTS) 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.

Source: ModernGraham Annual Valuation Of Zoetis Inc.