Here is a look at how General Dynamics Corp. (GD) fares in ModernGraham's opinion, based on an updated and modernized version of Benjamin Graham's requirements of defensive and enterprising investors from The Intelligent Investor:
Defensive and Enterprising Investor Tests (What is the significance of these tests, and what is PEmg ratio?) :
Defensive Investor - must pass at least 6 of the following 7 tests: Score = 4/7
- Adequate Size of Enterprise - market capitalization of at least $2 billion - PASS
- Sufficiently Strong Financial Condition - current ratio greater than 2 - FAIL
- Earnings Stability - positive earnings per share for at least 10 straight years - FAIL
- Dividend Record - has paid a dividend for at least 10 straight years - PASS
- Earnings Growth - earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period - FAIL
- Moderate PEmg ratio - PEmg is less than 20 - PASS
- Moderate Price to Assets - PB ratio is less than 2.5 or PB x PEmg is less than 50 - PASS
Enterprising Investor - must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 2/5
- Sufficiently Strong Financial Condition, Part 1 - current ratio greater than 1.5 - FAIL
- Sufficiently Strong Financial Condition, Part 2 - Debt to Net Current Assets ratio less than 1.1 - PASS
- Earnings Stability - positive earnings per share for at least 5 years - FAIL
- Dividend Record - currently pays a dividend - PASS
- Earnings growth - EPSmg greater than 5 years ago - FAIL
Valuation Summary (Explanation of the ModernGraham Valuation Model)
Key Data:
| MG Value | $21 |
| MG Opinion | Overvalued |
| Value Based on 3% Growth | $69 |
| Value Based on 0% Growth | $41 |
| Market Implied Growth Rate | 5.41% |
| Net Current Asset Value (NCAV) | -$16.32 |
| PEmg | 19.32 |
| Current Ratio | 1.42 |
| PB Ratio | 2.58 |
Balance Sheet - 9/30/2013
| Current Assets | $17,118,000,000 |
| Current Liabilities | $12,065,000,000 |
| Total Debt | $3,908,000,000 |
| Total Assets | $35,471,000,000 |
| Intangible Assets | $13,256,000,000 |
| Total Liabilities | $22,866,000,000 |
| Outstanding Shares | 352,200,000 |
Earnings Per Share - Diluted
| 2013 (estimate) | $6.95 |
| 2012 | -$0.94 |
| 2011 | $6.94 |
| 2010 | $6.82 |
| 2009 | $6.20 |
| 2008 | $6.22 |
| 2007 | $5.10 |
| 2006 | $4.20 |
| 2005 | $3.63 |
| 2004 | $2.99 |
| 2003 | $2.50 |
| 2002 | $2.56 |
Earnings Per Share - Modern Graham (Calculating EPSmg)
| 2013 (estimate) | $4.78 |
| 2012 | $4.14 |
| 2011 | $6.54 |
| 2010 | $6.13 |
| 2009 | $5.55 |
| 2008 | $4.96 |
Conclusion:
General Dynamics Corp is a company that is still damaged considerably by an extremely poor 2012 showing. That year, the company's EPS totaled a negative $0.94, a result that has had a clear effect on the company's EPSmg (normalized earnings) as well as its performance in the tests for the Defensive Investor and Enterprising Investor. The company fails to pass the requirements of either investor type because of the poor 2012 showing. And let's be clear here - even if the negative earnings of 2012 are related to a one-time charge or some exceptionally abnormal event, the fact remains that the company lost money that year, a result that is unacceptable to Intelligent Investors. After all, that violates the first key rule of our 7 Key Tips to Value Investing.
From purely a valuation perspective, the negative earnings of 2012 also has a profound effect. By lowering the EPSmg for 2012 and 2013, it has significantly lowered the level of earnings growth we may be able to anticipate. Therefore, the market seems to overvalue the company at this time by anticipating a growth rate of over 5% when the historical performance does not support it. Any potential investor in General Dynamics would be very wise to consult with a registered broker and do considerably more research into the company before entering into any investment position.
Disclaimer: The author did not hold a position in General Dynamics Corp at the time of publication and had no intention of entering into a position within the next 72 hours.
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