Is This Utility Cheap According to Graham?
I recently spent some time dissecting Benjamin Graham's The Intelligent Investor, the seminal book on value investing. Along the way, I talked about the Graham number as a means of valuation when it comes to stocks. The formula is pretty straightforward: Multiply earnings per share by book value per share, then multiply that by 22.5, and finally take the square root. The result, in dollars, is the Graham number.
However, a quick check can help determine whether a company might be worthy of a look using the teachings of Graham. He said that in an ideal situation, the P/E ratio and P/B ratio multiplied together should not exceed 22.5, with a maximum P/E ratio of 15 and P/B of 1.5. With that in mind, I looked at the stocks of the S&P 500 that exceeded a P/B of 1.5 but still met the ideal situation mentioned above. I will be making a CAPScall on most of these companies after comparing them to competitors and their current value in relation to their Graham numbers. Up next is utility Exelon (NYS: EXC) .
Who are they?
Exelon is the largest competitive U.S. energy producer, with operations in 47 states, the District of Columbia, and Canada. It recently completed its acquisition of Constellation Energy, further expanding its natural gas service in Maryland. It owns the capacity to produce 35,000 megawatts of electricity, which led it to be ranked as the No. 1 utility on two separate lists published by leading financial publications. However, it has been suffering a bit lately because of low natural gas prices, which has helped push its current yield above 5%, potentially making it a great dividend stock to buy.
What's it worth?
Of the companies on the list below, only CenterPoint Energy (NYS: CNP) is trading further below its Graham number than Exelon, which isn't that far off its Graham number despite being near its 52-week low recently:
Book Value Per Share (MRQ)
|Duke Energy (NYS: DUK)||$1.28||$17.05||$22.16||$20.84|
|NiSource (NYS: NI)||$1.03||$17.73||$20.27||$23.71|
|Southern Energy (NYS: SO)||$2.55||$20.32||$34.14||$43.96|
Source: Yahoo! Finance and author's calculations.
Despite missing on revenue estimates, CenterPoint still beat earnings estimates in its recently ended quarter. Like most utilities, it can be relied on for a nice dividend, though its current 4.2% yield pales in comparison to Exelon's. Duke Energy, the other utility on the list trading below its Graham number, also boasts a nice dividend near 5%, and its position as a provider of the "necessity" of electricity could also make it a great investment as it closes in on its Graham number.
NiSource and Southern are both currently overvalued, at least according to their Graham numbers. Despite missing on both revenue and earnings estimates in February, NiSource's price hasn't moved much since its earnings announcement. It is also the lowest yielder of the utilities on the list, though it still sports an above-average yield around 3.9%. Southern has ridden the dividend wave to within 5% of its 52-week high. Its high payout ratio, currently around 73%, might give new investors pause and lead them to seek out a company with a lower payout ratio.
Utility stocks tend to be considered low-risk propositions since they provide the resources that people need to live their daily lives. Nevertheless, a utility company should not be purchased at any price. The Graham number is but one thing you can look at when valuing companies, and by this metric, Exelon is considered cheap.
Therefore, I will be holding myself accountable on this call by placing a thumbs-up over on my CAPS page. I will also be adding Exelon to My Watchlist to keep an eye on the company and make sure that nothing dramatic happens that would affect my opinion of the company.
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At the time this article was published Fool contributor Robert Eberhard holds no position in any company mentioned. Click here to see his holdings and a short bio or follow him on Twitter. Motley Fool newsletter services have recommended buying shares of Exelon and Southern, as well as creating a write covered strangle position in Exelon. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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