Kaman Corporation (KAMN) is a diversified company that conducts business in two segments: Aerospace and Industrial Distribution. Kaman have been recognized for technological breakthroughs and innovative solutions to critical challenges.
Value Investing Approach for Kaman
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. 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
The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise Value EV) is the present value of the entire company. Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash.
Formula: Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)
Total Debt = Short Term Debt + Long Term Debt
The buying price for the entire company of Kaman Corporation was $1034, inclusive of total debt minus cash and cash equivalent at $40 per share. Market capitalization has up and down trend by 49, 29, 27, -5 and 14 percent from 2008 to 2012 trailing twelve months (TTM), while enterprise value shows a decreased by -35 percent in 2008 and during 2009 to 2012 TTM it shows an increased by 17, 42, 1 and 13 percent, respectively.
Buying the entire company is also paying for the total debt of the company. The net of total debt and cash added was 27 percent average and 15 percent in 2012 TTM. The distribution of the buying price would be as follows:
|Average||Operating assets 100%||Equity 85%+ Total debt (net) 15%|
|ttm 2012||Operating assets 100%||Equity 73% + Total debt (net) 27%|
Buying the company, you pay 73 percent of the equity and 27 percent of total debt (net of cash) of the company in the trailing twelve months. This is how the whole buying price will be distributed.
We are through with enterprise value. Let us now move on with Benjamin Graham’s Stock Test. There are several sub-categories on this topic.
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 concept of this method is to identify stocks trading at a discount to the company’s net current asset value per share, specifically two-thirds or 66 percent of NCAV. This method is one of the oldest documented stock selection methodologies, dating back in the 1930s. To get the result, we use this formula:
Net Current Asset Value = Current Assets – Current Liabilities
NCAVPS = NCAV / # of shares outstanding
Net current asset value was computed by deducting total liabilities to total assets and divide it by the number of shares outstanding. I took 66 percent of it and compared it to the price per share. Graham would buy stocks if the price is lower than the 66 percent by at least 40 percent to 50 percent. The price was higher than the computed 66 percent. Therefore, it indicates the price was overvalued by 71 percent.
The stocks of Kaman Corporation are not advisable for buying considering the NCAVPS valuation because the price was expensive as per the NCAV approach.
Market Value/Net Current Asset Value (MV/NCAV)
Another stock test by Graham is by using market capitalization and dividing it to NCAV. If the result does not exceed the ratio of 1.2, then the stock passes the test for buying.
The ratio exceeds the 1.2 ratios, therefore the price is overvalued and did not pass Graham’s stock test. The price was not advisable for making an investment at this period. The average ratio of 2.32 doubled the 1.2 minimal, indicating that the price was 194 percent above the minimum.
Benjamin Graham’s Margin of Safety
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. 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.
As we can see in the table above, there were zero margins of safety for Kaman from 2007 to 2012 trailing twelve months, because the price was higher than the true value of the stocks. The intrinsic value represents 59 percent average of the enterprise value.
The margin of safety represents an excess of intrinsic value over market price, or alternatively, a discount off the price below the intrinsic value of at least 40 to 50 percent is desirable. There were zero margins of safety.
Intrinsic Value = Current Earnings x (8.5 + 2 x Expected Annual Growth Rate).
For the intrinsic value, I used the sustainable growth rate in lieu of Graham’s earning per share growth as it measures the company’s profitability.
The sustainable growth rate for Kaman was 1.04 average, this is the growth that the company can accommodate without borrowing outside and its return on equity was 1.65 average, this indicates how much profit the company can generate with the money invested in common stock. The ratios were trending up from 2009 to the trailing twelve months.
The Intrinsic Value
Moving on, in order to understand the relationship between price and value, the graph below will show us the relationship between the enterprise value and the intrinsic value.
The distance between the two lines, enterprise value, and intrinsic value line was 41 percent average, meaning the stock was trading 41 percent above its true value. There were zero margins of safety for Kaman and the price was overvalued and expensive.
Kaman Relative Valuation Method
The relative valuation methods for valuing a stock are 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 (PE*EPS) Ratio
This method will determine whether the stocks are undervalued or overvalued. By multiplying the Price to Earnings (P/E) ratio with the Earning per Share (EPS). Then comparing it to the enterprise value per share, we can determine the status of the stock price.
Formula: (PE*EPS) = Result
It shows that from 2008 to 2012 TTM, the price was greater than the PE*EPS ratio. Therefore it indicates an overvalued price and the price was expensive.
P/E Ratio indicates the multiple that an investor is willing to pay for a dollar of a company’s earning. It shows the number of times a stock price is trading relative to its earnings or stock price fluctuate. On the other hand, EPS serves as an indicator of a company’s profitability. EPS is a major component used to calculate the P/E valuation ratio. If the stock is trading at market value less than the (P/E*EPS) result, the price is undervalued. If the EV price is trading greater than the result, the stock is overvalued. In the case of Kaman, the price was overvalued and expensive.
Enterprise Value/Earning per Share (EV/EPS)
The use of this ratio is its separate price and earnings in enterprise value.
Enterprise Value / Earning per Share = Separated Price
Enterprise Value – Separated Price = Earnings
Enterprise value was separated to price and earnings. Earnings were averaging 40 percent while the price represents 60 percent average. Enterprise value represents the buying price. Buying the entire business will cost $1034 at $40 per share. The investor will be paying a price of $594M plus $440M earnings in the trailing twelve months. This is the amount an investor is willing to pay.
Enterprise Value (EV)/ Earning 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. It is useful for analyzing and comparing profitability between companies and industries. This metric 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.
Formula: Enterprise Value/ EBITDA
EBITDA = Income before Tax + Interest Expense + Depreciation/Amortization
Buying the entire company it would take 10 years to cover up the costs of buying including total debt. In other terms, it would take 10 times for the earnings of the company to recover the cost.
Overview, the stock was trading at an overvalued price almost 100 percent of the trading price. Meaning, the stock price was expensive. A SELL on the stock of Kaman is recommended because the stock price was expensive.
Researched and Written by Cris