5 Companies For Defensive Investors With Low PE Ratios

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 |  Includes: BBBY, CA, CF, JPM, OLN
by: Benjamin Clark

Summary

These 5 companies are suitable for Defensive Investors following the ModernGraham approach based on Benjamin Graham's methods.

All 5 have a PEmg ratio (Price-to-Earnings based on normalized earnings) of 14.5 or less.

Each company is also undervalued according to the ModernGraham valuation model based on Benjamin Graham's formula.

There are a number of great companies in the market today. By using the ModernGraham Valuation Model, I've selected five companies with low PEmg Ratios which have been determined to be undervalued based on a formula taught by Benjamin Graham. This video explains what the PEmg Ratio is.

Each company has been determined to be suitable for the Defensive 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. CF Industries Holdings, Inc. (NYSE:CF)

With a PEmg ratio of 12.12, CF Industries is a very intriguing company for both Defensive Investors and Enterprising Investors. The Defensive Investor's only concern is the lack of earnings stability over the last ten years, while the Enterprising Investor's only issue is with the level of debt relative to the net current assets. As a result, value 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. Looking at the company from a valuation angle shows the company to be significantly undervalued after growing its EPSmg (normalized earnings) from $7.11 in 2010 to an estimated $21.47 for 2014. This strong level of demonstrated growth greatly exceeds the market's implied estimate of 1.23% 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.

CF Chart

CF data by YCharts

2. JPMorgan Chase (NYSE:JPM)

JPMorgan Chase has a PEmg ratio of 12.27 and is suitable for either the Defensive Investor or the Enterprising Investor, as the company passes all of the requirements of either investor type. As a result, value 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 undervalued after growing its EPSmg (normalized earnings) from $2.92 in 2010 to an estimated $4.82 for 2014. This level of demonstrated growth outpaces the market's implied estimate of 1.82% 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.

JPM Chart

JPM data by YCharts

3. CA, Inc. (NASDAQ:CA)

CA Incorporated qualifies for either the Defensive Investor or the Enterprising Investor with a PEmg ratio of 13.52. The Defensive Investor's only concern is the low current ratio, and the company qualifies for the Enterprising Investor by default. As a result, value investors following the ModernGraham approach based on Benjamin Graham's methods should feel comfortable proceeding with 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 $1.32 in 2011 to an estimated $2.08 for 2015. This level of demonstrated growth outpaces the market's implied estimate of 2.53% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham's formula, to return an estimate of intrinsic value above the price.

CA Chart

CA data by YCharts

4. Olin Corporation (NYSE:OLN)

With a PEmg ratio of 13.87, Olin Corp. is suitable for either the Defensive Investor or the Enterprising Investor. The Defensive Investor's only concern at this point is the insufficient earnings growth over the last ten years, and the Enterprising Investor's only issue is the high level of debt relative to the current assets. As a result, value 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 $1.46 in 2010 to an estimated $1.96 for 2014. This solid level of demonstrated growth is greater than the market's implied estimate of 2.51% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham's formula, to return an estimate of intrinsic value above the price.

OLN Chart

OLN data by YCharts

5. Bed Bath & Beyond Inc. (NASDAQ:BBBY)

Bed Bath & Beyond qualifies for either the Defensive Investor or the Enterprising Investor and has a PEmg ratio of 14.13. The only issue for either investor type is the lack of dividend payments. As a result, value 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 $2.38 in 2011 to an estimated $4.55 for 2014. This level of demonstrated growth outpaces the market's implied estimate of 2.52% 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.

BBBY Chart

BBBY data by YCharts

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.