Almost Family Inc. (AFAM) stocks average daily volume was 56,573 shares over the previous 30 days, but have experienced an unusually high trading volume of 522,695,481 shares last July 26, 2012. The company is getting more efficient which is a great thing for the long term. Owning a stock to this company in the long run, can we live with that? Let’s find out.
AFAM Value Investing Approach
The model we used for this investment valuation report adopted the investment style of Benjamin Graham. The philosophy that Graham has is to offer smart investors an opportunity to buy wisely when prices fall sharply and to sell wisely when it advances a great deal. He believed in thorough analysis, which we call fundamental analysis.
The basis for this valuation is the company’s five years of historical financial records. The enterprise value is the initial step in this valuation. I also applied the relative valuation method by using Price to Earnings (P/E), Earning per Share (EPS), Enterprise Value (EV) and Earning Before Interest + Tax + Depreciation + Amortization (EBITDA).
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) It factors liabilities and cash. In other words, enterprise value measures the value of the productive assets that are used in producing its product or services. The market capitalization is the entire value of the company in the stock exchange. It represents the price of equity and long-term debt. Cash and cash equivalents include short-term investment. Enterprise value is the theoretical takeover price. In the event of a buyout, an acquirer would have to take on the company’s debt but would pocket its cash.
Enterprise value differs significantly from market capitalization, and many consider it to be a more accurate representation of a firm’s value. The value of a firm’s debt would need to be paid by the buyer when taking over a company thus, enterprise value provides a much more accurate takeover valuation because it includes debt in its value calculation.
Enterprise Value Formula
Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)
The enterprise value of AFAM is lesser than the market value since it factors debt and cash. Its cash and cash equivalent represents 10 percent average and its total debt was 4 percent average. The EV decreases from 2008 to 2011 but showed an increased in the trailing twelve months at 38 percent, so as to market capitalization at 32 percent. Buying the entire company is paying 100 percent of the company’s equity at $168M.
Benjamin Graham’s Stock Test
Net Current Assets Value Per Share (NCAVPS)
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. This method is one of the oldest documented stock selection methodologies, dating back in the 1930s. Laid below is the formula used to get the results for Almost Family Inc.
Net Current Asset Value (NCAV) = Current Assets – Current Liabilities
NCAVPS = NCAV / # of shares outstanding
As to the results of net current asset value per share valuation, the stock of AFAM was overvalued from 2007 to 2012 trailing twelve months. The 66 percent result was lesser than the market value, thus, the stock is trading above the liquidation value. The market value was over by 89 percent against 66 percent or two-thirds of net current asset value. Therefore, the stock did not pass the stock test of Graham.
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. Almost Family, results are as follows:
The stock of AFAM was undervalued from 2009 to 2012 trailing twelve months because the result was more than 1.2 ratio, therefore, it did not pass the stock test of Benjamin Graham. Let us have a quick overview of Graham’s thinking on this matter. Graham considers only the liquid assets of the company in determining the stock price trading at a discount price. If the result of the valuation is above the ratio, he would not buy. If the price is equal or below the result, then he would buy, he considers the stock selling at a discount.
Benjamin Graham’s Margin of Safety
The margin of safety requires knowing when the buying price 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. The difference between the two values is called the margin of safety. 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 percent to 50 percent below.
The margin of safety represented 73 percent average of the intrinsic value while the intrinsic value was $106.5 average. The price was undervalued from 2007 to 2012 trailing twelve months and the margin of safety was more than the 40 percent requirement of Benjamin Graham in purchasing stock.
Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)
EPS stands for 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), and 2: the average yield of high-grade corporate bonds.
In the calculation of sustainable growth rate (SGR), I have used the return on equity (ROE) and the payout ratio. Since there was no payout ratio, the result for SGR is the same as ROE. There is no payout ratio because the company is not paying dividends from 2007 to 2011.
Return on equity or ROE is an indicator of company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. It shows how many dollars of earnings result from each dollar of equity. The formula for this is::
The above graph showed that the intrinsic value was above the enterprise value line. What does this mean? It means that there was a margin of safety at an average of 73 percent. Further, it tells us that the trading price for the stock of AFAM was undervalued or cheap.made comparisons using the relative ratio and the average ratio in calculating the sustainable growth rate and the intrinsic value; and the results are as follows:
Moreover, I have made comparisons using the relative ratio and the average ratio in calculating the sustainable growth rate and the intrinsic value, and the results are as follows:
|Particulars||Relative Ratio (average)||Average Ratio (average)|
|Sustainable Growth Rate (SGR)||$18.07||$18.75|
|Annual Growth Rate||$45||$46|
|The margin of Safety (MOS)||$77||$82|
|The margin of Safety percentage||73%||74%|
|Return on Equity (ROE)||$18.07||$18.75|
Using the average ratio, it shows that the result was higher than that of the relative ratio. By using the average ratio, we consider the growth of the company from year over year. This shows a fair valuation for Almost Family Inc.
AFAM Relative Valuation Method
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. With this, we can determine the status of the stock price.
The average price to earnings ratio produced a greater result as we see in the table. The result must be compared to enterprise value per share. If the enterprise value is lesser than the result, then stocks are undervalued. On the other hand, if the enterprise value is greater than the result, it means that the stock is overvalued. In the case of AFAM, the stock is trading at an undervalued price.
|Particulars||Relative Price to Earning||Average Price to Earning|
|Price to Earnings||$13 average||$14.42 average|
|P/E*EPS||$31 average||$34 average|
|Percent of P/E*EPS||108% average||122% average|
Enterprise Value/Earning Per Share (EV/EPS)
The purpose of this ratio is to separate price and earnings in enterprise value. By dividing the enterprise value to projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS). If the analysts think that the appropriate ratio is greater or lower than the result, then the stock is either over or undervalued.
The enterprise value was separated to price and earnings wherein the price represents 42% percent and the earnings are 58 percent. The result indicates that the stock is trading at an undervalued price. The investor would know how much dollar he is paying for the price and how much for the earnings. This is the price that an investor is willing to pay. It also gives someone an idea if the price is expensive or cheap.
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. This metric is useful for analyzing and comparing profitability between.
The EV/EBITDA tells us that buying the entire AFAM, an investor will have to wait 7 years average to cover the costs of buying. In other words, it will take 7 times the earnings to cover the purchase price inclusive of the total debt.
As an overview, since the margin of safety is high at 82 percent using the average return on equity. I recommend a BUY on the stock of Almost Family, Inc (AFAM).
Researched and written by Cris