Today, we will touch on the valuation of Apollo Group Inc (APOL), another Educational Services in the USA. APOL, however, reported an 11.5 percent decrease in its net earnings, principally due to lower enrollment which was down 5.7 percent; as most educational companies experienced the same scenario like DeVry and other known institutions of the same industry peers. One reason for this is the rising competition in online education startups such as Coursera and Udacity. These programs are giving the students the opportunity to take different courses without having to pay for them.
How long will this industry able to sustain their operations? If you are considering investing in this kind of industry, is it the right time?
APOL Value Investing Approach
Totem’s Pricing Model was prepared in a very simple and easy way to value a company. We adopted an investment style which we think applicable to the company, we looked for companies with a good balance sheet and undervalued stock price. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. This is considered important because this is a great measure of the total value of a firm and is often good starting points for negotiation of a business.
APOL Investment in Enterprise Value
The concept of enterprise value is to arrive at a cost to purchase the entire business. In other words, the Enterprise Value (EV) is the present value of the entire company. Market capitalization, on the other hand, is the total value of the company’s equity shares. In essence, EV is the company’s theoretical takeover price, since the buyer would have to buy all of the stock and pay off existing debt and take all any remaining cash. The table below would give us relevant data about APOL.
The market capitalization of APOL was decreasing from 2008 at a rate of -80 percent. The total debt represents 7 percent while the cash and cash equivalent were 17 percent greater than the debt. Thus, this makes the enterprise value lesser than the market value because the remaining cash was deducted to the enterprise value. Buying the entire business of APOL is paying 100 percent of its equity, no debt.
The takeover price of the entire business to date, May 27, 2013, is $1.3 billion at $11.48 per share. Moreover, the market price to date was $20.99 per share.
The Net Current Asset Value Per Share (NCAVPS)
The net current asset value approach indicates that the stock price of APOL was overvalued in five years. The average 66 percent ratio represents $1.87 against the market price of $45.40, average.
Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation
Market Capitalization / NCAV = Result (must be lesser than 1.2)
The stock price of APOL was overvalued in the last five years because the ratio was more than 1.2 ratio.
The margin of Safety (MOS)
The basic meaning of “Margin of Safety” is that investors should only purchase security when the market price is trading at a discount to its intrinsic value, in other words, the market price should be lower than the intrinsic value or true price.
The margin of Safety is the difference between the market price and the intrinsic value, in other words, buying stocks when the market price is lower than its true value.
Margin of Safety = Enterprise Value – Intrinsic Value.
The table below shows the historical calculation for the margin of safety.
The table shows that the average margin of safety on the stock of APOL was 90 percent. This means there is safety in buying the stock of APOL and can be a good candidate for a Buy.
Intrinsic Value formula
Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)
The explanation in the calculation of intrinsic value was as follows:
- EPS: the company’s last 12-month earnings per share;
- G: the company’s long-term (five years) sustainable growth estimate;
- 9: the constant represents the appropriate P-E ratio for a no-growth company and
- 2: the average yield on high-grade corporate bonds.
The average earning per share were $3.50 and the annual growth rate was 104 percent. What is earning per share (EPS)? EPS represents the portion of a company’s earnings, net of taxes and preferred stock dividends that are allocated to each share of common stock. The figure can be calculated by dividing net income earned in a given reporting period by the total number of shares outstanding during the same term. Because the number of shares outstanding can fluctuate, a weighted average is typically used.
The formula for earning per share was:
Sustainable Growth Rate
The table above shows that the average return on equity was 47.49 percent, the same as the sustainable growth rate because there was a zero payout ratio. APOL is not paying cash dividends to its shareholders’ since 2008.
Return on Equity
Return on Equity shows how many dollars of earnings result from each dollar of equity.
Relative and Average Approach
The table below is the summary of the results of using the relative and average approach.
The table above shows the relative approach produced higher results; the average approach takes into consideration the past period’s performance of the company. If the past period is lower, the current result will be lower as well, and vice versa.
The above graph above, the intrinsic value line was erratic in movement, uptrend, and downtrend, however, the overall view, it deteriorates from 2008, ranging 403 down to 234 a 42 percent drop. The graph indicates a 90 percent average margin of safety, calculating the difference between enterprise value and the intrinsic value. Whether the company is in good or bad financial condition it will show in the intrinsic value line. If the earnings of the company are stable, the IV will also show a stable line. This is because the intrinsic value factors the growth of the company.
APOL Relative Valuation Methods
The concept of relative valuation methods for valuing a stock is to compare market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.
Price to Earnings/Earning Per Share (P/E*EPS)
Multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share.
The P/E*EPS indicates that the overall stock price was undervalued. Because the price was lower by a 17 percent average than the P/E*EPS ratio. Thus, the stock price was cheap.
Another way of calculating this valuation is by using the Average approach. The table will show us the difference of using these two approaches.
It shows that the relative approach has a higher price to earnings than by the results of the average approach. Because the average approach takes into consideration the past period performance.
The Enterprise value (EV) /Earning per Share (EPS) or (EV/EPS)
The use of this ratio is, to separate price and earnings in the enterprise value. By dividing the enterprise value of projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS).
This valuation is the separation of price and earnings in the enterprise value. The price (P/E) that was separated from the enterprise value was 29 percent. And the remaining 79 percent representing the earnings (EPS). This valuation is either over or undervalued.
Enterprise Value (EV) / Earnings before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)
It is used to compare the value of the company inclusive of debt to the actual cash earnings. This measure is useful for analyzing and comparing profitability between companies and industries. It tells us how long it would take for the earnings of the company to pay off the price of buying the entire business, including debt.
The EV/EBITDA tells us that it will take 6 years to recover the cost of purchasing the entire business of APOL. In other words, it will take 6 times of the cash earnings of the company to recover the buying cost.
- The market capitalization of APOL, in general, was decreasing from 2008 at a rate of -80 percent. The total debt represents 7 percent while the cash and cash equivalent were 17 percent greater than the debt. Buying the entire business of APOL is paying 100 percent of its equity, no debt.
- The takeover price of the entire business to date, May 27, 2013, is $1.3 billion at $11.48 per share. Moreover, the market price to date was $20.99 per share.
- The price was expensive using Graham’s MC/NCAV method.
Margin of Safety
- Furthermore, the average margin of safety on the stock of APOL was 90 percent. Further, the average earning per share was $3.50 and the annual growth rate was 104 percent. In addition, the average return on equity was 47.49 percent. The same result for the sustainable growth rate because there was a zero payout ratio.
- The price was lower by a 17 percent average than the P/E*EPS ratio. The price (P/E) that was separated was 29 percent and the remaining 79 percent is the earnings (EPS). This valuation is either over or undervalued depending on the analyst’s own discretion.
- The EV/EBITDA tells us that it will take 6 years to recover the cost of purchasing the entire business. In other words, it will take 6 times of the cash earnings of the company to recover the buying costs.
- On the other hand, the EBITDA/EV was 17 percent. It means the earnings before tax plus depreciation and interest expense represent 17 percent of the enterprise value.
The margin of safety was high at 90 percent average. In addition, the growth of the company was satisfactory including its return on equity. Its price to earnings ratio and the earnings per share was acceptable. Apollo Group Inc (APOL) was undervalued and a good candidate for a BUY.
Research and written by Criselda