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Chuck Carnevale
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Charles (Chuck) C. Carnevale is the creator of F.A.S.T. Graphs™. Chuck is also co-founder of an investment management firm. He has been working in the securities industry since 1970: he has been a partner with a private NYSE member firm, the President of a NASD firm, Vice President and Regional... More
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  • Readers' Choice Calculating Fair Value On Transalta (TAC), Southern Company (SO) And Exelon (EXC) 13 comments
    Jul 25, 2012 9:42 AM | about stocks: TAC, SO, EXC

    (click to enlarge)

    This Instablog is presented in response to questions and comments on a recent pair of articles published on Seeking Alpha. One by David Van Knapp, and one by yours truly:

    http://seekingalpha.com/article/737081-are-dividend-growth-stocks-in-a-bubble?v=1343048267&source=tracking_notify

    http://seekingalpha.com/article/736941-dividend-aristocrats-are-undervalued

    Both articles were dealing with valuation discussions about dividend growth stocks to include utilities. Three utility companies were discussed where I felt there was some confusion regarding their current valuations. Therefore, I offer this Instablog through the lens of FAST Graphs™ the fundamentals analyzer software tool to hopefully cast a light upon the darkness.

    FAST Graphs™ are a "tool to think with" and as such, have no agenda of their own. Instead, they are designed to provide "essential fundamentals at a glance" and allow the user to interpret the data according to their own philosophies, strategies and beliefs. In this context, FAST Graphs™ are the deliverer or reporter of important information.

    Essentially, the FAST Graphs™ stock research tool provides investors many benefits, but there are four things they do especially well.

    · 1. FAST Graphs provide a historical review and instantaneous perspective of how well the business behind the stock has historically performed.

    · 2. FAST Graphs provide an instantaneous perspective of how the market has historically capitalized or priced the company's operating results or business performance.

    · 3. FAST Graphs provide a consensus estimate of leading analysts near term earnings expectations for a company's current fiscal year and next fiscal year followed by a five year consensus estimate.

    · 4. FAST Graphs provide the opportunity to override and therefore input the user's own estimates or expectations of the company's future prospects.

    This Instablog will primarily look at valuation through the lens ofFAST Graphs. I consider this powerful graphing tool an essential first step when attempting to determine both fair value and the potential return that a common stock offers me. However, they are not the final step. Instead, they provide a very efficient mechanism that allows me to determine whether I want to embark on a more comprehensive research effort or not. Consequently, they can save me (and you) from wasting a lot of my time and effort towards a lost cause.

    In addition to providing some short commentary on each of the companies covered with this Instablog, the reader will be provided live working FAST Graphs™ on each selection.

    (Follow this link to free, live, and fully functioning F.A.S.T. Graphs™ on the companies discussed in this Instablog. Run this "tool to think with" through its paces. Draw graphs displaying 2 to 20 years of history. Discover how this tool dynamically re-evaluates valuation based on the company's earnings and price relationship.)

    In order to get the maximum benefit from this powerful stock research tool, it's imperative that multiple graphs covering various time frames are drawn. To be clear, when I use this stock research tool, I start with the 15-year default and then I will expand out to the 20-year, followed by a 10-year, followed by a 5-year, and finally a 2-year graph. This allows me to see the dynamic of the company's growth rates as they change. I suggest that all subscribers run multiple charts on any company they are examining.

    FAST Graphs™ are a dynamic tool that calculates the company's changing growth rates each time a different time period is selected. Therefore, the user can determine such things as whether the company's earnings growth rates are accelerating, decelerating or staying the same, and see major inflection points, if any, in a company's business vividly revealed. This is a major component of the "tools to think with" aspect of this fundamental research tool.

    To summarize and clarify, the following commentary on each of the three companies covered in this Instablog is offered as a valuation preview prior to a more comprehensive research effort. Stated more clearly, what follows is an earnings and price correlated view of each company based solely on the "fundamentals at a glance" provided by this powerful stock research tool.

    Transalta (NYSE:TAC) Undervalued Historically But Future Returns Questionable

    A quick snapshot from the company's website:

    "Beginning as a small, local power company in 1909, we have transformed over the last century to become an experienced and well respected power generator and wholesale marketer of electricity. With approximately $3 billion in annual revenue, more than $9 billion in assets, and power plants in Canada, the United States and Australia, we've proven our worth as a power generator, as a community member, and as a solid investment."

    Let's examine Transalta (TAC), utilizing the four primary features that FAST Graphs™ provide.

    1. FAST Graphs provide a historical review and instantaneous perspective of how well the business behind the stock has historically performed.

    Looking at the 12-year earnings and price correlated FAST Graphs™ shows that Transalta has averaged 7% earnings growth since going public in July of 2001. However, note the cyclical nature of the company's earnings change per year highlighted in yellow at the bottom of the graph. The orange line plots the company's earnings per share and represents a fair value PE of 15.

    2. FAST Graphs provide an instantaneous perspective of how the market has historically capitalized or priced the company's operating results or business performance.

    In this example, we see that the market has normally applied a premium valuation represented by the blue normal PE ratio line. The calculated normal PE ratio has been 23.2. By visually looking at the graph you can see that this stock has traded at the 23.2 PE quite often. However, you can also see periods of time where the price has been above and below this normal valuation. Moreover, the current blended PE of 13.3 appears to represent very attractive valuation from the historical perspective.

    (click to enlarge)

    When reviewing the performance table below, the reader should note that high beginning valuation based on the normal PE to today's low valuation has diminished performance. The dividend component remained strong based on the company's operating earnings growth. However, capital appreciation was hurt by high valuation, but nevertheless has remained positive.

    (click to enlarge)

    3. FAST Graphs provide a consensus estimate of leading analysts near term earnings expectations for a company's current fiscal year and next fiscal year followed by a five year consensus estimate.

    Unfortunately, there are no analysts currently providing estimates for Transalta's near or longer-term earnings growth. Consequently, FAST Graphs™ automatically default to calculating the company's historical EPS growth since 2007, which has only averaged 1% per annum (note that when analyst estimates are not available, FAST Graphs™ are programmed to find the most relevant average historical earnings results of five years or longer). On this basis, the majority of future return would be based on the company's current dividend yield and modest growth expectations. Therefore, although this company may be fairly valued, future returns appear relatively weak based on earnings growth.

    (click to enlarge)

    4. FAST Graphs provide the opportunity to override and therefore input the user's own estimates or expectations of the company's future prospects.

    The following screenshot represents a spot of the FAST Graphs™ navigation bar that allows subscribers to check consensus estimates from Zacks. The user can check these numbers against the Capital IQ data provided on the graph, and if different, input the Zacks' data as an override. Or another common method that many investors use for forecasting is to run the company's five-year historical earnings growth as a proxy for the next five years estimate (note that this is currently the estimate provided since Capital IQ offers no estimates at this time).

    (click to enlarge)

    The following is a screenshot of the excerpt of the report that subscribers can use by clicking on the yellow link above. Note that consistent with Capital IQ, Zacks does not provide long-term estimates on this company either. However, they do provide a rather onerous estimate for this fiscal year with only a minor recovery for the 2013 fiscal year.

    (click to enlarge)

    Southern Company (NYSE:SO) A Classic Picture of Current Overvaluation

    A quick snapshot from the company's website:

    "Based in Atlanta, Southern Company is one of the largest generators of electricity in the nation, serving both regulated and competitive markets across the southeastern United States. We participate in all phases of the electric utility business with more than 42,000 megawatts of electric generating capacity and a grid of transmission and distribution lines that would more than circle the earth. Southern Company and its subsidiaries have been serving the Southeast for more than 100 years."

    Let's examine Southern Company (SO) utilizing the four primary features that FAST Graphs™ provide.

    1. FAST Graphs provide a historical review and instantaneous perspective of how well the business behind the stock has historically performed.

    Southern Company has been only capable of growing earnings at an average rate of 3.5%, however, they achieved this growth rather consistently. Consequently, Southern Company represents a quintessential example of a highly correlated earnings and price relationship. Note how the monthly closing stock price (the black line) consistently tracks the company's orange earnings justified valuation line representing a fair value PE of 15. This correlation is so high that the blue normal PE ratio line calculating a normal historical PE of 16 closely correlates to the earnings line. The only reason the normal PE is higher is because the current overvaluation has slightly separated the lines.

    2. FAST Graphs provide an instantaneous perspective of how the market has historically capitalized or priced the company's operating results or business performance.

    Now here is the critical point that I ask the reader to accept. Regardless of how these lines have been calculated, I ask the reader to note how accurately they reflect fair valuation. Clearly, in every case on Southern Company's graphs where the black price line deviates from the orange line, it very quickly moves back into alignment. These are simple facts that the FAST Graphs™ is simply reporting. Consequently, the current price that has risen above both the orange and blue line vividly illustrates overvaluation from a historical perspective.

    (click to enlarge)

    When looking at performance, note that the only reason that the annual rate of return (closing annualized ROR) has been higher than the company's earnings growth rate is because of today's overvaluation. In contrast, dividend growth has closely tracked the company's operating earnings growth rate, and only deviates due to rounding.

    (click to enlarge)

    3. FAST Graphs provide a consensus estimate of leading analysts near term earnings expectations for a company's current fiscal year and next fiscal year followed by a five year consensus estimate.

    The 21 analysts reporting to Capital IQ expect Southern Company to have slightly below-average earnings growth this fiscal year and above-average growth for next fiscal year followed by a 5.9% five-year estimate (the numbers on the graph are rounded).

    Therefore, on the basis of earnings forecasts, Southern Company would not be considered overvalued per se, but instead fully valued (price sits at the upper end of the valuation corridor represented by the five orange lines). However, the user should validate whether or not this above-average estimated growth rate is believable or not.

    (click to enlarge)

    4. FAST Graphs provide the opportunity to override and therefore input the user's own estimates or expectations of the company's future prospects.

    A cross-check with Zacks provides similar, but not identical estimates with Capital IQ. Therefore, this might suggest that analysts across the board have a reason to believe that Southern Company's earnings growth is due to accelerate above its 3.5% historical average.

    (click to enlarge)

    On the other hand, if we run Southern Company's historical five-year earnings growth rate, we discover that it is slightly below their longer-term average only coming in at 3%. Once again, it's up to the users to evaluate this data and draw their own conclusions. FAST Graphs™ merely reports the information, but never attempts to dictate to the user.

    (click to enlarge)

    Exelon Corp. (NYSE:EXC) A Tale of Failing Earnings

    A quick snapshot from the company's website:

    "As the leading U.S. competitive power generator, Exelon owns approximately 35,000 megawatts of power generation, including the nation's largest nuclear fleet of more than 19,000 megawatts. Our customer-facing retail and wholesale energy business will allow us to grow in the energy products we offer to our customers in 46 states. In addition, the new company is the nation's second-largest regulated distributor of electricity and gas, with more than 6.6 million customers in Maryland, Illinois and Pennsylvania. The three Exelon utilities - BGE, ComEd and PECO - remain headquartered in Baltimore, Chicago and Philadelphia, respectively, and are focused on safety, customer service, reliability and continued infrastructure investment in their service areas. Exelon remains headquartered in Chicago and trades on the NYSE under the ticker symbol EXC."

    Let's examine Exelon Corp. utilizing the four primary features that FAST Graphs™ provide.

    1. FAST Graphs provide a historical review and instantaneous perspective of how well the business behind the stock has historically performed.

    When we examine the historical operating results of Exelon Corp. we see a record of very strong earnings growth up through the great recession of 2008, followed by three consecutive years of falling earnings. Clearly, something has dramatically changed with this business, and FAST Graphs™ has alerted us to want to discover what and why.

    2. FAST Graphs provide an instantaneous perspective of how the market has historically capitalized or priced the company's operating results or business performance.

    From the historical earnings and price correlated graph we also see how the market rewarded Exelon Corp. when earnings growth was strong, and conversely, how it punished the company when earnings faltered. The importance of earnings driving stock prices is vividly revealed.

    (click to enlarge)

    Moreover, when looked at from the perspective of the past five years only, we get an even clearer portrayal of the company's earnings and price relationship. Here we discover that price has very closely followed earnings after reverting to the mean during the latter half of 2008. Since the mean reversion occurred, price has tracked earnings very closely.

    (click to enlarge)

    Exelon Corp. also provides a classic example of the dangers of overvaluation as depicted in the following performance report. The company's stock price had clearly become overvalued going into the summer of 2008, thereby making it very vulnerable to weakening operating results. Once the earnings began to falter, stock price collapsed and existing shareholders received devastating performance.

    (click to enlarge)

    3. FAST Graphs provide a consensus estimate of leading analysts near term earnings expectations for a company's current fiscal year and next fiscal year followed by a five year consensus estimate.

    Here we learn that the consensus of 20 analysts reporting to Capital IQ have very low expectations for Exelon Corp.'s future growth. Consensus expects a large drop in earnings growth this fiscal year, followed by no growth for the next five years which would indicate that the company is overvalued based on future expectations. Consequently, Exelon Corp. is very overvalued based on future earnings estimates (the price is above the highest future orange earnings line). Therefore, the total expected five-year total return calculates the only three tenths of one percent per annum (.03) which includes dividends but alas a decrease in capital value.

    (click to enlarge)

    4. FAST Graphs provide the opportunity to override and therefore input the user's own estimates or expectations of the company's future prospects.

    For added perspective and consideration, the consensus of analysts reporting to Zacks estimate even worse future results than the analysts at Capital IQ. If Zacks is correct, then Exelon Corp. would be even more overvalued than the FAST Graphs™ estimated earnings and return calculator depicts. The important message here is that even though the current PE ratio of only 12 would indicate that Exelon Corp. is undervalued, from the perspective of future earnings growth the graph tells a different story altogether. On the basis of future earnings, Exelon Corp. is overvalued and maybe even dangerously so.

    (click to enlarge)

    Summary and Conclusions

    The core idea behind this Instablog is that numbers, spreadsheets and other mere data points can be misleading if taken out of context. At first glance, looking solely at the numbers alone, Exelon Corp. and Transalta would appear to be undervalued opportunities. However, when looked at from the perspective of past present and future fundamentals, the picture does not appear to be so rosy. Of course, in reality it all depends on what actually happens in the future. In contrast, Southern Company is vividly shown as currently being priced in excess of fundamentals and historical norms.

    At the end of the day, it is the responsibility of each investor to do their due diligence. The idea behind FAST Graphs™ has been to make that job just a little easier and perhaps more efficient. But most importantly of all, the objective of this powerful stock research tool is to provide a clear picture of how a company has performed as a business, how it might perform in the future and how the market has and/or might treat the company's stock in the future.

    Disclosure: No positions at the time of writing.

    Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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Comments (13)
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  • David Van Knapp
    , contributor
    Comments (10140) | Send Message
     
    Chuck, A couple of questions that you might answer here or in your upcoming article on utilities:
    1. How do you calculate the blue line, the "normal" P/E rtaio? How many years does it cover? And how many times per year does it "sample" the P/E to get the ratio that you present with the blue line?
    2. This has always befuddled me. The blue/aqua dividend area for EXC is declining, but their dividend has been frozen (not declining). Why doesn't the blue area just level off at the point that EXC froze their dividend?

     

    Thanks,
    Dave
    23 Jul 2012, 07:17 PM Reply Like
  • Chuck Carnevale
    , contributor
    Comments (6782) | Send Message
     
    Author’s reply » Dave,

     

    Question1: The computer simply attempts to identify what PE that the market has applied over what ever time frame being graphed. It is a trimmed number with the high and low excluded.

     

    Since growth rates change and market valuations change, FAST Graphs calculates and re-calculates the normal PE each time a graph with a different time period is drawn. The tool is dynamic.Therefore, it covers whatever time period you draw: 2,3,4,5 or 10, 15, 20 etc. Everything is calculated annually except for the year we are in.

     

    But here is an important point. The normal PE is best thought of as a barometer or benchmark to measure price against. It allows you to determine if the market is consistently pricing the company higher or lower or right on the blue line. In other words, it is not meant to be an absolute number. Just a measuring stick to think by.

     

    Question 2: Its really a matter of visual perspective. The dividend on EXC looks like its falling because earnings are falling and the dividend is paid out of earnings.

     

    Two things,one notice on the performance table for EXC that the payout ratio appears to be increasing because the same dividend is being paid out of declining earnings. Two un-check the earnings and normal PE ratio boxes on the navigation bar and look at dividends only and you will see what you expect, flat dividends.

     

    Thanks,

     

    Chuck
    23 Jul 2012, 07:49 PM Reply Like
  • dividend_growth
    , contributor
    Comments (2879) | Send Message
     
    Great analysis!

     

    It seems that EXC is indeed a sucker's bet, and I'm not even considering potential nuclear accidents.
    24 Jul 2012, 12:13 AM Reply Like
  • Tom Armistead
    , contributor
    Comments (5237) | Send Message
     
    I owned EXC from from August 2009 to March 2011, with disappointing results.

     

    On their quarterly presentation, the company was presenting a slide that showed the prices they were locking in (hedging) for future years. Future prices started to deteriorate, based on slack demand and cheap natural gas. The analysts picked up on it and started getting negative.

     

    That and their nuclear fleet is very similar to the reactors at Fukishima. The technology is obsolete, and the life of these reactors is being stretched out when probably they should be decommissioned.
    24 Jul 2012, 06:37 AM Reply Like
  • Eddie Herring
    , contributor
    Comments (1927) | Send Message
     
    Chuck - I'm curious about your philosophy concerning use of the FAST graphs when evaluating overvalued versus undervalued. Using SO as an example, the chart clearly shows it overvalued. Do you typically sell when in overvalued territory to protect capital and reap capital gains, or do you simply hold until it gets back to undervalued territory per the graph, and then add to your position? I'm assuming selling or adding also takes into account doing your due diligence on other factors other than just the graph position.
    Eddie
    25 Jul 2012, 11:10 AM Reply Like
  • Chuck Carnevale
    , contributor
    Comments (6782) | Send Message
     
    Author’s reply » elherring ,

     

    Excellent and important questions. First of all, since SO has such a slow growth rate, I would be more prone to sell at even moderate over valuation. However, taxes if any and available alternatives would also factor in. Furthermore, additional research to determine, for example, if there was a material change in the company's growth potential.

     

    In contrast, with a faster growth example, I might need higher over valuation to stimulate a sell. Compounding at higher rates makes certain levels of overvaluation more palatable or even less certain. In other words, future growth may be increasing, but I would still expect it to justify current valuation.

     

    It is important to understand that FAST Graphs are a "tool to think with" meaning they help the user make smarter decisions. However, it is a little more than on, above or below the lines. The tool gives a very efficient perspective, but should not be the final answer. This is why we offer links to other sites, including the company's website to facilitate an easier research effort.

     

    I hope that clarifies things some, but if not feel free to elaborate more,

     

    Chuck
    25 Jul 2012, 11:56 AM Reply Like
  • Eddie Herring
    , contributor
    Comments (1927) | Send Message
     
    Thanks, Chuck. That helps. Appears to me it's like a "timer" that dings you when you might need to take a look at what you have in the oven, so to speak. Lots of other factors to consider in making your determination to buy/sell but it tells you it's time to do some additional evaluation. Looks like it could be a very valuable tool. Thanks.

     

    Eddie
    25 Jul 2012, 12:11 PM Reply Like
  • YellowLab1
    , contributor
    Comments (135) | Send Message
     
    EXC has announced today:

     

    1:23 PM Exelon (EXC) declares $0.525/share quarterly dividend, 38% increase from prior dividend of $0.37925. Forward yield 5.43%. For shareholders of record Aug 15. Payable Sep 10. Ex-div date Aug 13.

     

    Chuck and others:

     

    How does this 38 % dividend increase make you feel about adding, holding or selling positions in EXC ?
    25 Jul 2012, 01:36 PM Reply Like
  • Eddie Herring
    , contributor
    Comments (1927) | Send Message
     
    They don't meet my other criteria to buy so it doesn't affect how I look at them in that regard. One of my deal breakers is a payout ratio above 75% max and I prefer it to be much lower, i.e. 50% or less.
    25 Jul 2012, 02:09 PM Reply Like
  • YellowLab1
    , contributor
    Comments (135) | Send Message
     
    On further review another SA member has noted the following:

     

    This information is misleading at best. The dividend is the same as it has been for a number of quarters. Last quarter there was a split-dividend due to the Constellation Energy acquisition - management made it clear that they understood shareholders desire to keep the dividend at $0.525. The second divvie installment last quarter was $0.37925. There is no increase in EXC's dividend.

     

    Regards, Moses

     

    How does this make you feel about adding, holding, or selling positions in EXC ?
    25 Jul 2012, 02:07 PM Reply Like
  • Chuck Carnevale
    , contributor
    Comments (6782) | Send Message
     
    Author’s reply » YellowLab1,

     

    I see no increase, just the regular $0.525, $2.10/annum--no increase?

     

    Reuters:Exelon Corp Declares Dividend

     

    1:00pm EDT
    Exelon Corp announced that it has declared a regular quarterly dividend of $0.525 per share on Exelon’s common stock. The dividend is payable on Sept. 10, 2012, to shareholders of record of Exelon at New York Time on Aug. 15, 2012.

     

    BusinessWire:
    The Board of Directors of Exelon Corporation declared a regular quarterly dividend of $0.525 per share on Exelon’s common stock. The dividend is payable on Sept. 10, 2012, to shareholders of record of Exelon at 5:00 p.m. New York Time on Aug. 15, 2012.

     

    Where are you getting the $0.38? That would have been a cut. This is the same dividend that has been frozen since 2009.

     

    Regards,

     

    Chuck
    25 Jul 2012, 02:11 PM Reply Like
  • Chuck Carnevale
    , contributor
    Comments (6782) | Send Message
     
    Author’s reply » YellowLab1,

     

    I found the source of confusion, this was a merger related issue. They paid two dividends to total the $0.525 to synchronize the two companies- from their website:

     

    Merger-related Dividend Information:

     

    Shareholders of both Constellation and Exelon will receive pro-rated dividends in order to synchronize the two companies’ dividends so that Constellation shareholders will receive dividends at Constellation’s rate through the day before closing and all Exelon shareholders (including former Constellation shareholders) will receive dividends at Exelon’s rate from the closing date and after. As previously declared by Constellation’s board of directors, a pro-rated dividend equal to $0.23760 per share of Constellation’s common stock will be paid on April 11, 2012, to Constellation shareholders of record at the close of business on March 9, 2012.

     

    The Exelon board of directors previously declared a pro-rated dividend equal to $0.14575 per share of Exelon’s common stock, which will be paid on April 11, 2012, to Exelon shareholders of record at the close of business on March 9, 2012. The Exelon dividend declaration also included a second pro-rated dividend equal to $0.37925 per share of Exelon’s common stock, which will be paid to all Exelon shareholders of record, including the former Constellation shareholders, at 5:00 p.m. New York time on May 15, 2012. This portion of the dividend will be paid on June 8, 2012. Together, the two pro-rated Exelon dividends total $0.525 per share, ensuring that Exelon shareholders will receive their regular quarterly dividend, although it will be paid in two portions.

     

    Regards,

     

    Chuck
    25 Jul 2012, 02:20 PM Reply Like
  • YellowLab1
    , contributor
    Comments (135) | Send Message
     
    Yes Chuck, SA's Homepage "Market Currents" posting is what I copied originally. They have already corrected this as a few of us asked for clarification.
    Guess nothings changed.
    Thanks Chuck.
    Does the unchanged dividend give you any guidance on adding, holding, or selling positions in EXC ?
    25 Jul 2012, 02:23 PM Reply Like
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