Systemax Inc. (SYX) is a leading retailer of brand name and private label products, including industrial, and material handling supplies.
Value Investing Approach for SYX
This Pricing Model was prepared in a very simple and easy way to value a company for business valuation. Furthermore, she added that his model adopts the investment style of Benjamin Graham, the father of Value Investing.
The essence of Graham’s Value Investing is that any investment should be worth substantially more than an investor has to pay for it. He believes in thorough analysis, which we call fundamental analysis. He looks for companies with strong balance sheet or those with little debt, above average profit margin and ample cash flow. His Philosophy was to buy wisely when prices fall and to sell wisely when the price rises a great deal.
My basis in valuation is the company’s five-year historical financial records, the balance sheet, income statement, and cash flow statement.
In this model, we calculate first the enterprise value as our first step in valuation. I consider this important because this is a great measure for the total value of a firm and is often a great starting point for negotiation for a business.
The Investment in Enterprise Value
Enterprise Value (EV) is the present value of the entire company. EV takes into account the balance sheet, so it is a much more accurate measure of a company’s true market value than market capitalization. It measures the value of the productive assets that produced its product or services, both equity capital (market capitalization) and debt capital. Market capitalization is the total value of the company’s equity shares.
EV is a capital structure neutral metric. This makes enterprise value extremely useful in analyzing and comparing companies with different capital structure. 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 while pocketing any remaining cash.
Enterprise Value Table
The market value of Systemax, Inc. fell down at a rate of -5 percent average, alongside the enterprise value at a rate of -2 percent average. Total debt represented 2 percent of the enterprise value while, cash and cash equivalent represented 24 percent of the enterprise value, thus enterprise value was lower by 22 percent than the market value.
The market capitalization to date, October 10, 2012, was $449 at $12.13 per share. Buying the entire business to date will cost $297.3 at $8 per share, this is the buying price, and it represents 100 percent equity.
Benjamin Graham’s Stock Test
Net Current Asset Value (NCAV) Approach
Graham developed and tested the net current asset value (NCAV) approach between 1930 and 1932. According to his report, the average return, over a 30-year period, on diversified portfolios of net current asset stocks was about 20 percent. An outside study showed that from 1970 to 1983, an investor could have earned an average return of 29.4 percent by purchasing stocks that fulfilled Graham’s requirement and holding them for one year.
Net Current Asset Value (NCAV) Method
I dig up some research and studies have all shown that the net current asset value (NCAV) method of selecting stocks has outperformed the market significantly.
Graham was looking for firms trading so cheap that there was little danger of falling further, which I find realistic and practical. His strategy was indeed risky at first but it calls for selling when a firm’s share price trades up to its net current asset value.
The reason for this according to Graham is when a stock is trading below the net current asset value per share, they are essentially trading below the company’s liquidation value and therefore, the stocks are trading in the bargain, and it is worth buying.
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 net current asset value.
The result for the net current asset value method for SYX was that the price was trading at an overvalued price from 2007 to 2012 because the enterprise value was greater than 66 percent of NCAVPS. This means that the stocks did not pass the stock test of Benjamin Graham. The two-thirds was 43 percent of the enterprise value, therefore the price was overvalued.
Market Value/Net Current Asset Value (MV/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. So, let us see if the stock of SYX passes the stock test.
Using the market value/net current asset value valuation, it indicates that the stock of Systemax Inc. was trading at an overvalued price from 2007 to 2011 because the ratio exceeded 1.2.
The MV/NCAV valuation tells us that the stocks of SYX did not pass the stock test of Benjamin Graham in 2007 to 2011, however, in ttm8, the stock passed the test.
Benjamin Graham’s Margin of Safety (MOS)
You should be aware that Margin of Safety requires knowing when the buying price of the stocks is low in absolute terms, rather than merely relative to the market as a whole. This formula 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” at the same time, buying with the difference between the two values is called the margin of safety. Value buying with a sufficient margin of safety is needed for a stock to be considered a true value investor.
Buying stock at minimum 40-50 percent
Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. I used enterprise value because it takes into account the balance sheet so it is a much more accurate measure of the company’s true market value than market capitalization. Let us find out and walk through the margin of safety table below for Systemax Inc.
After looking into the table above, I came to the realization that the intrinsic value of SYX was greater than the enterprise value, therefore, there was the margin of safety from 2007 to ttm6 2012 at an average of 73 percent. The highest margin of safety was in 2008 at 90 percent, while its lowest was in ttm6 at 57 percent. As far as I can remember, Benjamin Graham would consider buying if the price was lower the intrinsic value by 40-50 percent. The intrinsic value of SYX was erratic in movement but generally, it was deteriorating. The intrinsic value is the true value of the stock of SYX.
Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)
The explanation for 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 price to earnings ratio for a no-growth company as proposed by Benjamin Graham (Graham proposed 8.5, instead, we used 9), 2: the average yield of high-grade corporate bonds.
The intrinsic value was dropping at a rate of -22 percent from $103 down to $18.38. The sustainable growth rate was 26 percent average, while the annual growth rate for SYX was represented at a 70 percent average of the intrinsic value.
Sustainable Growth Rate (SGR)
The sustainable growth rate was generally decreasing. There was no payout ratio because SYX was not paying dividends to its shareholders. Thus, the return on equity was the same as the sustainable growth rate.
The true value of the stocks deteriorates from $103 to $18 in its 5 years of operation. However, the enterprise value deteriorates at 50 percent. The space between the EV line and IV line represents the margin of safety. The intrinsic value was higher than the enterprise value, meaning there was a margin of safety. The margin of safety for SYX was 73 percent average.
Relative and Average Approaches
The methods used in calculating the growth of SYX is by using the relative and the average return on equity. The table below will show us the result of the two approaches.
Using the average approach produces a higher result of growth, intrinsic value and margin of safety. Using the average, we consider the previous performance of the company.
SYX Relative Valuation Methods
The relative valuation methods for valuing a stock are comparing 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)
This valuation will determine whether the stocks are undervalued or overvalued. By multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS). Then comparing it to the enterprise value per share, we can determine the status of the stock price.
The P/E*EPS the stocks of SYX were trading undervalued because the enterprise value was lesser than the P/E*EPS ratio. The P/E*EPS was represented at 129 percent over enterprise value, in other words, the price was cheap.
The average price to earnings ratio produces a higher P/E*EPS, meaning, the price was undervalued.
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.
The price (P/E) was 76 percent, while the earnings (EPS) was 24 percent average.
Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)
This metric is used in estimating business valuation. This metric is useful for analyzing and comparing profitability between companies and industries.
EV/EBITDA valuation means that you will have to wait five years to cover the cost of buying. It is a long period of waiting since it will take 5 times the earnings to cover the purchase price.
Total debt was 2 percent average, while cash and cash equivalent was 24 percent average. Buying the entire business to date, October 10, 2012, the costs will be $297 at $8 per share. The market capitalization to date was $449 at $12.13 per share.
Using the net current asset value approach, stocks were trading overvalued. Because 66 percent of NVAV was lesser than the enterprise value. In other words, the price was above the liquidation value of SYX. In addition, the price was overvalued because the result was more than a 1.2 ratio. Therefore, the NCAV approach did not pass the Benjamin Graham’s stock test.
Margin of safety
On the other hand, the margin of safety was 73 percent using relative ROE; 76 percent using the average ROE. The sustainable growth rate was 26 percent.
The price was undervalued in the P/E*EPS, while in EV/EPS price (P/E) was 76 percent. In addition, the earnings (EPS) was 24 percent. The price was overvalued.
Moreover, the EV/EBITDA tells us that it will take 5 years of the earnings to cover the costs of buying.
Overview, although there was a margin of safety, the stock of SYX was trading at an overvalued price. Therefore, I recommend that the stock of Systemax Inc be HOLD.
Written by Cris