The First Marblehead Corporation (FMD), a focus on finance company, education financing marketplace in the United States. Headquartered in Boston, MA and was founded in 1991.
Value Investing Approach
This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham. The essence is that any investment should be purchased at a discount, meaning the true value should be more than the market value. Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.
The Investment in Enterprise Value
Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)
The market value of The First Marblehead Corporation was decreasing in value that during 2008, it was deteriorated by 91 percent and 1 percent of the succeeding periods thereafter. The total debt of the company was 88 percent average of the enterprise value, while its cash and cash equivalent were a 10 percent average, thus the enterprise value was greater by 78 percent against the market capitalization. Purchasing the entire business of FMD would be paying 22 percent of its equity and 78 percent of its total debt. This is the price that an investor is willing to pay in buying FMD.
The costs of buying the entire business of FMD to date, November 11, 2012, will cost $0.00 because its cash and cash equivalent were greater than the market capitalization and there was zero debt in the current year ttm9 2012. I’m a bit confused so I asked Cris to further elaborate. And she said, “It is like buying at a discount or buying for free because the market capitalization is $96 and the cash and cash equivalent is $127. This means you pocketed the $31 ($127-$96) cash. The market price to date was $0.84 per share.”
Benjamin Graham’s Stock Test
Net Current Asset Value (NCAV) Approach
The Net Current Asset Value (NCAV) is a method from Benjamin Graham to identify whether the stock is trading below the company’s net current asset value per share, specifically two-thirds or 66 percent of net current asset value. Meaning they are essentially trading below the company’s liquidation value and therefore, the stocks is trading in a bargain, and it is worth buying.
Net Current Asset Value (NCAV) Method
The net current asset value approach tells us that the stock of FMD was trading at an overvalued price for the period 2007 to ttm9 2012 because the market value was greater than the 66 percent ratio. The 66 percent represents only 19 percent of the market value, therefore, the price was expensive.
I tell us further that the stock was trading above the liquidation value of The First Marblehead Corporation itself, therefore, the stock did not pass the stock test of Benjamin Graham.
Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation
Another stock test by Graham is by using market capitalization and dividing it to net current asset value (NCAV). If the result does not exceed the ratio of 1.2, then the stock passes the test for buying. We gonna go moving and discuss the table below. Want to find out if the stock of VSEC passed the stock test.
Benjamin Graham’s Margin of Safety (MOS)
The margin of safety is used to identify the difference between company value and price. Value investing is based on the assumption that two values are attached to all companies – the market price and the company’s business value or true value. Graham called it the intrinsic value. The difference between the two values is called the margin of safety. According to Graham, the investor should invest only if the market price is trading at a discount to its intrinsic value. Value investing is buying with a sufficient margin of safety. Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. The enterprise value is used because I think it is a much more accurate measure of the company’s true market value than market capitalization.
The First Marblehead Corporation’s margin of safety was 53 percent on average. During ttm9, the margin of safety was 100 percent because the enterprise value was zero dollars. There was a zero margin of safety for 2007 and 2010.
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 as proposed by Graham (Graham proposed an 8.5, but we changed it to 9), 2: the average yield of high-grade corporate bonds.
The table above showed that intrinsic value’s average was $147, SGR was negative 24 and EPS was 2 percent.
Sustainable Growth Rate (SGR)
Sustainable growth rate (SGR), on the other hand, shows how fast a company can grow using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate for a company, you need to know its return on equity (ROE). You also need to know the dividend payout ratio. From there, multiply the company’s ROE by its blowback ratio, which is equal to 1 minus the dividend payout ratio.
The return on equity of FMS was negative 24 on average, same as the sustainable growth rate because there was no payout ratio for FMD. The company was not paying cash dividends to its shareholders.
There are two approaches in computing the sustainable growth rate and that is by using the relative return on equity and the other one is by using the average ratio. To make it clearer, she said she summarized the results of these two approaches in the table below.
By using the average approach, we get a higher percentage margin of safety at 69 percent against the relative approach which was about 53 percent.
The Intrinsic Value Graph
The intrinsic value line soared up very high in 2008 at 255 percent because the growth of FMD was negative and it’s earning per share was also negative. Its net earnings in 2008 were negative 827 percent. Then the following period, 2009 it slopes down at negative 76 percent, the net earnings were again negative at 125 percent. Until 2010, it was sloping down below zero at -20. Then, it started to raise up to 544 percent in 2011.
The space in between the two lines, the enterprise value line and the intrinsic value line is the margin of safety. The average margin of safety was 53 percent.
FMD Relative Valuation Methods
The relative valuation methods for valuing a stock is to compare the 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)
The P/E*EPS valuation indicates that the price of FMD was overvalued. It was overvalued because the enterprise value per share was greater than the P/E*EPS ratio. The P/E*EPS ratio represents -36 percent of the enterprise value.
The price of FMD was expensive from 2007 to ttm9 2012. I used the relative approach in this valuation. But there is also another approach to calculating P/E*EPS valuation and this is by using the average price to earnings.
By using the average approach, it has a positive price to earnings ratio compared to by using the relative ratio where it produced a negative result. In an average approach, we consider the previous performance of FMD.
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).
For EV/EPS valuation, the price (P/E) out of the enterprise value was negative 1 percent, while the earnings (EPS) were 101 percent. This might indicate that the price was expensive because the enterprise value represents 100 percent earnings.
Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)
This metric is used in estimating business valuation. It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries. It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.
The EV/EBITDA valuation shows an average of negative 31 results for FMD. This means, there was no definite period to cover the cost of buying. However as mentioned earlier, enterprise value valuation indicates that buying FMD would be a discount or like buying for free.
One more idea about this valuation is this will also tell us the profitability of the company. Wherein, The First Marblehead Corporation shows that the financials of the company was not favorable. Since its net earnings were negative 1244 percent. FMD suffered losses since 2007 for the trailing twelve months 2012.
The market value of FMD was decreasing at a rate of 26 percent average. The total debt represents 88 percent average and its cash and cash equivalent represent 10 percent average. Thus the enterprise value was greater by 78 percent against the market value. Purchasing the entire business of FMD would be paying 22 percent of its equity and 78 percent of its total debt.
Buying the entire business of FMD to date, November 11, 2012, will cost zero dollars. Because its cash and cash equivalent were greater than the market capitalization and the company has zero debt. It is like buying for free, the investor will pocket the remaining cash of $31 ($127-$96).
Net Current Asset Value Approach
The net current asset value approach indicates that the stock of FMD has not passed the stock test. Because the stock was trading above the liquidation value of FMD. While in MC/NCAV the result shows that the ratio exceeded the 1.2 ratios. Therefore the price was expensive.
The current MOS was 100 percent because the EV was zero value. The growth for FMD was negative, meaning zero. Moreover, the relative valuation shows that the price was expensive. Because the enterprise value was greater than the P/E*EPS ratio from 2007 to the ttm9 2012. While in EV/EPS it also tells us that the price was -1 percent and the earnings were 101 percent average. Therefore the price was expensive.
EV/EBITDA valuation shows an average of -31 times for the company. In other words, there was no definite period to cover the cost of buying the entire business. However, we can take into consideration the result of enterprise value valuation. Wherein, buying FMD is like buying for free, since, there was zero enterprise value. An investor will pocket the remaining cash of $31 million.
Overall, the margin of safety was 53 percent average. Moreover, the stock was trading at an overvalued price. In other words, the price was expensive. Therefore, I recommend a SELL in the stock of The First Marblehead Corporation (FMD).
Researched and Written by Cris