Tuesday Morning Corporation (TUES) is an American discount, an off-price retailer specializing in domestic and international, designer and name-brand closeout merchandise. The company has stores across the United States. Wikipedia
Value Investing Approach for TUES
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 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.
Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)
The table above you will notice that the enterprise value has an erratic movement of up and down from 2007 to 2011 and the trailing twelve months at average 9 percent. The total debt (net of cash) was -5 percent average, meaning cash was greater than total debt. The market cap was trending erratically at a rate of 17 percent average.
The enterprise value, as we can see in the table, had an inconsistent movement of up and down from 2007 to 2011 and the trailing twelve months (TTM) at an average 9 percent. The total debt (net of cash)was -5 percent average, meaning cash was greater than total debt. The market capitalization (market cap) was trending erratically at a rate of 17 percent average.
|Enterprise value $140 (100%)||Equity $140 (100%)|
From 2009 to 2012 TTM, the company has no short and long term debts. Usually, companies with low debt, high cash of higher quality are more likely to survive an economic downturn and problems and have the possibility of rewarding the stockholders.
Benjamin Graham’s Stock Test
Net Current Asset 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 NCAV. This method is one of the oldest documented stock selection methodologies, dating back in the 1930s. To arrive at the results, we use the formula below:
Net Current Asset Value (NCAV) = Current Assets – Current Liabilities
NCAVPS = NCAV / # of shares outstanding
The table shows that market price and enterprise value were greater than the computed 66 percent of net current asset value during 2007, 2010, 2011 and the TTM. Meaning, the price is trading at an overvalued price. While in 2008 and 2009, the enterprise value per share was lesser than the computed 66 percent of the NCAV by -38 and 6percent, respectively. This means the price was trading undervalued.
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 result showed that during 2008, 2009, 2011 and the trailing twelve months, the ratio did not exceed the 1.2, therefore, the stock us undervalued price. However, during 2010 it was overvalued and in 2007 the stock trade at fair value. This illustrated that the stocks of TUES passed the stock test of Benjamin Graham and worth buying
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. 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 table above showed that in 2007, 2009, 2010 and 2012, trailing twelve months, there was no margin of safety because the price was higher than the intrinsic value. It indicated that the price was expensive during these periods. While in 2008 and 2011 there was the margin of safety at 78 and 18 percent, respectively, meaning the price was cheap during these periods. The margin of safety represents a 16 percent average from 2007 to 2012, TTM.
Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)
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.
And for the annual growth rate using ROE: sustainable growth rate, TUES results are:
Above calculation showed that TUES has no payout ratio. This means the company is not paying any dividends from 2007 to 2012 trailing twelve months. So, the growth that was used in the calculation of intrinsic value was also the return on equity. The ROE has an erratic movement.
Return on Equity (ROE)
On the other hand, return on equity or ROE for short is an indicator of company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. It is also known as return on net worth. Return on equity shows how many dollars of earnings result from each dollar of equity and the formula is:
I would like to consider using the average ROE rather than the relative ROE. The table below will show us the differences between the two ratios.
Relative ratioAverage ratio
|SGR||2.97||2.95||Annual growth rate||14.9||15.0||ROE||2.95||2.95||Intrinsic value||3.0/85% of EV||2.58/73% of EV||Margin of safety||16% average||15% average|
The intrinsic value (IV) showed erratic movement, while the enterprise value (EV) was stable between $2 and $4. In 2008, the distance of intrinsic value with the price is at 78 percent and that is the margin of safety. This is the excess of the intrinsic value over the price. It means the price is trading below the true value of the stocks. This is the way the margin of safety works. In 2009, the intrinsic value line was below the price, meaning the stocks are trading above the true value of the stocks, same as in 2010 and the trailing twelve months, the price was expensive.
TUES Relative Value Method
Price to Earnings*Earning Per Share (P/E*EPS)
This method 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) and comparing it to the enterprise value per share, we can determine the status of the stock price.
Using the P/E*EPS ratio valuation in determining the undervalued stocks, the result of the calculation showed that the enterprise value per share was undervalued in 2007 to 2012, trailing twelve months, except in 2009. The enterprise value per share was lesser than the P/E*EPS result by 43 percent average. The price was trading at an undervalued price.
Price to Earnings
Price to earnings 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 that a stock price is trading relative to its earning. While EPS serves as an indicator of a company’s profitability.
Considering the average price to earnings ratio in calculating the P/E*EPS valuation, the results are as follows:
|Metrics||Relative Ratio||Average Ratio|
|Price to Earning||61 average||74 average|
|P/E*EPS||8 average||12 average|
|% of EV over P/E*EPS||43% average||46% average|
Enterprise Value/Earning Per Share (EV/EPS)
The use of EV/EPS ratio is dividing the market price by its projected earnings per share (EPS). By dividing the two ratios, the calculated result produces the price and the difference is the earnings. This separates the price and earnings from the enterprise value.
The table above shows that the price and earnings were separated from the enterprise value. The earnings have a greater percentage than that of the price. The price to earnings (P/E) was 17 percent average and the earning per share (EPS) represents 83 percent average. The price of TUES was undervalued. This is a number of earnings that the investors are willing to pay for every dollar of the buying price.
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. 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 enterprise value/EBITDA indicate the number of times to cover up for the costs of buying the whole enterprise. In the case of Tues, the results show an average of 15 years or 15 times for the earnings of the company to cover the buying price. In the table, it showed that in 2011 and the trailing twelve months, it would take only 2 years and 1 year respectively to cover the purchase price inclusive of total debt (net of cash). Since, enterprise value factors debt and cash, the enterprise value decreases because the cash increased by percent 300, -21 and 105 in 2010 to the trailing twelve months. The EBITDA increased by $16M in 2011 and $3M in the trailing twelve months, therefore, the enterprise value decreased.
In valuing the stocks of TUES, after performing the Benjamin Graham’s stock test, tells us that in net current asset value per share (NCAVPS) valuation, the stocks did not pass the test because the stock is trading above the liquidation value of the company. While the market value/net current asset valuation (MV/NCAV) valuation it shows that the stock of TUES the test except in 2010 because it did not exceed the 1.2 ratios.
On the other hand, the margin of safety approach tells us that there was a margin of safety during 2008 and 2011 was 78 and 18 percent, respectively. Intrinsic value represents 84 percent average of the price and the margin of safety was -16 percent on average from its 5 years of operation. While using the average return on equity in calculating the sustainable growth rate, the average margin of safety was 15 percent.
On the other hand, the price was undervalued in the P/E*EPS valuation. Because the price was lower than the result. Using the average price to an earning ratio in calculating the P/E*EPS valuation, it gives us a higher result. The result was 12 average against 8 average in relative P/E. And the price to earning was 74 in average P/E against 61 in relative P/E. The overall result for this valuation was, the stock price was undervalued.
While the enterprise value/earning per share (EV/EPS) valuation indicate that the price (P/E) represents a 17 percent average and the earnings (EPS) represents 83 percent average.
Further, EV/EBITDA indicates an average of 15 years to cover the costs of buying or 15 times the earnings to cover the costs of buying. However, in 2011, it shows only 2 years to cover the costs of buying the entire business inclusive of total debt. The reason for this is, TUES has no debt but greater cash that makes the enterprise value to decrease, thus resulting in lesser years of waiting.
The relative valuation method indicates that the price was undervalued from 2007 to 2012 ttm. The MV/NCAV valuation tells us that the stock of TUES passes the stock test of Graham. Because it does not exceed the 1.2 ratios. The company’s sustainable growth rate and the annual growth rate at 2.95 average and 15.0 average, respectively, were both favorable. So, I recommend a BUY in the stock of Tuesday Morning Corporation (TUES).
Research and written by Cris