Real Estate Investment Trust (REIT) Vornado Realty is taking Wall Street by surprise today, falling to $22.63 and marking a -5.7% change compared to the S&P 500. VNO is -24.34% below its average analyst target price of $29.91, which implies there is more upside for the stock. However, the average analyst rating for the stock is hold -- a more pessimistic outlook than you might expect. Over the last year, Vornado Realty has underperfomed the S&P 500 by -31.5%, moving -44.6%.
Vornado's portfolio is concentrated in the nation's key market - New York City - along with the premier asset in both Chicago and San Francisco. The company is classified within the real estate sector, which includes REITs (Real Estate Investment Trusts, and real estate services and development companies. The sector’s value and performance is, for obvious reasons, strongly correlated with the value of real estate, but some real estate companies, which provide only services for example, may show some resistance to cycles within the real estate market.
Vornado realty's trailing 12 month P/E ratio is 34.3, based on its trailing Eps of $0.66. The company has a forward P/E ratio of 53.9 according to its forward Eps of $0.42 -- which is an estimate of what its earnings will look like in the next quarter. As of the third quarter of 2022, the average Price to Earnings (P/E) ratio for US real estate companies is 27.16, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (Eps), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.
The problem with P/E ratios is that they don't take into account the expected growth in earnings of the stock. Sometimes elevated P/E ratios can be justified by equally elevated growth expectations. We can solve this inconsistency by dividing the company's trailing P/E ratio by its five year earnings growth estimate, which in this case gives us a 3.85 Price to Earnings Growth (PEG) ratio. Since the PEG ratio is greater than 1, the company's is overvalued in terms of its expected growth levels.
To understand a company's long term business prospects, we must consider its gross profit margins, which is the ratio of its gross profits to its revenues. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost. After looking at its annual reports, we obtained the following information on VNO's margins:
- 2021 gross margins: 53.2 %
- 2020 gross margins: 51.6 %
- 2019 gross margins: 54.2 %
- 2018 gross margins: 55.7 %
- Average gross margin: 53.7 %
- Average gross margin growth rate: -1.4 %
- Coefficient of variability (higher numbers indicating more instability): 3.1 %
We can see from the above that Vornado Realty's gross margins are very strong. Potential investors in the stock will want to determine what factors, if any, could derail this attractive growth story.
Companies have many costs that arise independently from their core business: cost of maintaining debt, rent payments, capital expenditures, depreciation, etc. When all of these separate cash flows are taken into account, we are left with the company's free cash flow, which for Vornado Realty was $761,806,000.00 as of its last annual report.
Over the last 4 years, the company's average free cash flow has been $662,806,500.00 and they've been growing at an average rate of 8.7%. With such strong cash flows, the company can not only re-invest in its business, it can afford to offer regular returns to its equity investors in the form of dividends. Over the last 12 months, investors in VNO have received an annualized dividend yield of 8.8% on their capital.
Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts). Vornado realty's P/B ratio of 0.8 indicates that the market value of the company is less than the value of its assets -- a potential indicator of an undervalued stock. The average P/B ratio of the Real Estate sector was 2.39 as of the second quarter of 2022.
Since it has an inflated P/E ratio, an exceptionally low P/B ratio, and a steady stream of strong cash flows with an upwards trend, Vornado Realty is likely undervalued at today's prices. The company has mixed growth indicators because of an inflated PEG ratio and consistently strong gross margins that are stable. We hope you enjoyed this overview of VNO's fundamentals. Be sure to check the numbers for yourself, especially focusing on their trends over the last few years.
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