5 More Undervalued Companies For The Defensive Investor

Summary

• WFC, HCP, AET, CVX, and BEN are all rated as suitable for the Defensive Investor or 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 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. Wells Fargo and Company (WFC)

Wells Fargo qualifies for either Defensive Investors or for Enterprising Investors. In fact, the company passes all of the requirements of both investor types, which is a rare accomplishment. 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 perspective, the company appears significantly undervalued after growing its EPSmg (normalized earnings) from $1.83 in 2010 to an estimated $3.56 for 2014. This strong level of demonstrated growth outpaces the market's implied estimate of 3.00% 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.

WFC data by YCharts

2. HCP, Inc. (HCP)

HCP Inc. is a rare REIT which qualifies for the Defensive Investor and thus also for the Enterprising Investor. The Defensive Investor's only concern at this time is the low current ratio and the Enterprising Investor is willing to overlook concerns regarding the level of debt relative to the current assets because the Defensive Investor is satisfied. 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. As for a valuation, the company appears undervalued after growing its EPSmg (normalized earnings) from $0.66 in 2010 to an estimated $2.12 for 2014. This level of demonstrated growth is greater than the market's implied estimate of 5.52% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham's formula, to return an estimate of intrinsic value above the market price.

HCP data by YCharts

3. Aetna Inc. (AET)

Aetna is suitable for either the Defensive Investor or the Enterprising Investor. The Defensive Investor's only concern with the company is the low current ratio and despite the Enterprising Investor's concerns with the level of debt relative to the current assets, the company qualifies for the investor type by default. 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 $2.03 in 2010 to an estimated $3.20 for 2014. This level of demonstrated growth outpaces the market's implied estimate of 1.22% 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.

AET data by YCharts

4. Chevron Corporation (CVX)

Chevron Corporation qualifies for either the Defensive Investor or the Enterprising Investor. The Defensive Investor's only issue with the company is the low current ratio, while the Enterprising Investor is satisfied by default despite concerns with the 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 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 $8.58 in 2010 to an estimated $11.50 for 2014. This level of demonstrated growth outpaces the market's implied estimate of 1.33% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham's formula, to return an estimate of intrinsic value above the price.

CVX data by YCharts

5. Franklin Resources Inc. (BEN)

Franklin Resources qualifies for either the Defensive Investor or the Enterprising Investor. The Defensive Investor's only issue with the company is the high PB ratio, while the Enterprising Investor has no initial concerns. 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. From a valuation side of things, the company appears to be undervalued after growing its EPSmg (normalized earnings) from $1.91 in 2010 to an estimated $3.27 for 2014. This level of demonstrated growth outpaces the market's implied estimate of 4.27% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham's formula, to return an estimate of intrinsic value above the price.

BEN 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.