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Summary

  • DFS, COF, DHI, ALL, and NOC are all rated as suitable for the Enterprising Investor following the ModernGraham approach.
  • All five are found to be significantly undervalued according to the ModernGraham valuation model.
  • The market is implying a low growth rate, despite the demonstrated growth each company has achieved.

There are a number of great companies in the market today. By using the ModernGraham Valuation Model, I've selected five companies which have been determined to be undervalued based on a formula taught by Benjamin Graham. Each company has been determined to be suitable for the Enterprising Investor, according to the ModernGraham approach, which is a modernized version of legendary value investor Benjamin Graham's requirements for Intelligent Investing.

Defensive Investors are defined as investors who are not able or willing to do substantial research into individual investments, and therefore need to select only the companies that present the least amount of risk. Enterprising Investors, on the other hand, are able to do substantial research and can select companies that present a moderate (though still low) amount of risk. Each company suitable for the Defensive Investor is also suitable for Enterprising Investors.

To be considered by the Defensive Investor, a company must pass at least 6 of the following 7 tests.

  1. Adequate Size of Enterprise - market capitalization of at least $2 billion
  2. Sufficiently Strong Financial Condition - current ratio greater than 2
  3. Earnings Stability - positive earnings per share for at least 10 straight years
  4. Dividend Record - has paid a dividend for at least 10 straight years
  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
  6. Moderate PEmg ratio (price over normalized earnings) - PEmg is less than 20
  7. Moderate Price to Assets - PB ratio is less than 2.5 or PB x PEmg is less than 50

Note: If the company is a financial or insurance company, test #2 regarding the financial condition is not required; however, the company must pass all six of the remaining tests.

To be considered by the Enterprising Investor, a company must pass at least 4 of the following 5 tests or be suitable for the Defensive Investor.

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

Note: If the company is a financial or insurance company, tests #1 and #2 regarding the financial condition are not required; however, the company must pass all three of the remaining tests.

The ModernGraham valuation model is based on Benjamin Graham's formula, Intrinsic Value = EPS x (8.5 x 2g), and is intended to give a good estimate of a company's value. ModernGraham uses a normalized EPS figure ("EPSmg") based on the last five years of earnings data, and a cumulative average growth rate based on the change in EPSmg over the last five years. This article on ModernGraham explains some of the background of the formula and performs a simple back-test.

To see the detailed full valuations of each of the following companies, please visit the ModernGraham Valuation Index.

1. Discover Financial Services (NYSE:DFS)

Discover Financial Services is suitable for the Enterprising Investor as the company passes all of the investor type's requirements, but is not suitable for the Defensive Investor as its dividend history is too short. As a result, Enterprising Investors following the ModernGraham approach based on Benjamin Graham's methods should feel comfortable proceeding with further research into the company and comparing it to other opportunities. From a valuation side of things, the company appears undervalued after growing its EPSmg (normalized earnings) from $1.78 in 2010 to an estimated $4.56 for 2014. This level of demonstrated growth outpaces the market's implied estimate of 2.34% earnings growth and leads the ModernGraham valuation model, which is based on Benjamin Graham's formula, to return an estimate of intrinsic value above the market price.

DFS Chart

DFS data by YCharts

2. Capital One Financial (NYSE:COF)

Capital One is suitable for Enterprising Investors but not for Defensive Investors. The Defensive Investor is concerned by the lack of sufficient earnings growth over the last ten years, but the company passes all of the requirements of the Enterprising Investor. As a result, Enterprising Investors following the ModernGraham approach based on Benjamin Graham's methods should explore other opportunities. As for a valuation, the company appears undervalued after growing its EPSmg (normalized earnings) from $3.90 in 2010 to an estimated $6.96 for 2014. This strong level of demonstrated growth outpaces the market's implied estimate of 1.78% earnings growth and leads the ModernGraham valuation model, which is based on Benjamin Graham's formula, to return an estimate of intrinsic value well above the market price.

COF Chart

COF data by YCharts

3. D.R. Horton Inc. (NYSE:DHI)

D&R Horton is suitable for the Enterprising Investor but not the Defensive Investor. The Defensive Investor has concerns with the insufficient earnings growth or stability over the last ten years. The Enterprising Investor has no major concerns at this time. As a result, Enterprising Investors following the ModernGraham approach based on Benjamin Graham's methods should feel comfortable proceeding with further research into the company and comparing it to other opportunities. From a valuation side of things, the company appears to be undervalued after growing its EPSmg (normalized earnings) from a loss of $1.91 in 2010 to an estimated gain of $1.51 for 2014. This level of demonstrated growth outpaces the market's implied estimate of 3.74% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham's formula, to return an estimate of intrinsic value above the price.

DHI Chart

DHI data by YCharts

4. The Allstate Corporation (NYSE:ALL)

Allstate Corp is suitable for Enterprising Investors but not for Defensive Investors, who are concerned with the lack of earnings stability over the last ten years and the lack of earnings growth over the same period. The company passes all of the Enterprising Investor's requirements. As a result, Enterprising Investors following the ModernGraham approach based on Benjamin Graham's methods should explore other opportunities. As for a valuation, the company appears to be undervalued after growing its EPSmg (normalized earnings) from $1.95 in 2010 to an estimated $3.98 for 2014. This level of demonstrated growth outpaces the market's implied estimate of 3.15% earnings growth and leads the ModernGraham valuation model, which is based on Benjamin Graham's formula, to return an estimate of intrinsic value well above the market price.

ALL Chart

ALL data by YCharts

5. Northrop Grumman Corporation (NYSE:NOC)

Northrop Grumman qualifies for Enterprising Investors but not for Defensive Investors. The Defensive Investor has concerns regarding the low current ratio and the lack of earnings stability over the last ten years, but the Enterprising Investor's only concern is the high level of debt relative to the net current assets. As a result, Enterprising Investors following the ModernGraham approach based on Benjamin Graham's methods should feel comfortable proceeding with further research into the company and comparing it to other opportunities. As for a valuation, the company appears to be undervalued after growing its EPSmg (normalized earnings) from $3.77 in 2010 to an estimated $8.08 for 2014. This low level of demonstrated growth outpaces the market's implied estimate of 3.39% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham's formula, to return an estimate of intrinsic value well above the price.

NOC Chart

NOC data by YCharts

Source: 5 Undervalued Companies For The Enterprising Investor