Many investors turn to Benjamin Graham's so-called “Graham number” to calculate the fair price of a stock. The Graham number is √(22.5 * 5 year average earnings per share * book value per share), which for NextEra Energy gives us a fair price of $43.51. In comparison, the stock’s market price is $62.58 per share. NextEra Energy’s current market price is -30.5% above its Graham number, which implies that there is upside potential -- even for a conservative investors who require a significant margin of safety.
The Graham number is often used in isolation, but in fact it is only one part of a check list for choosing defensive stocks that he laid out in Chapter 14 of The Intelligent Investor. The analysis requires us to look at the following fundamentals of NextEra Energy:
Sales Revenue Should Be No Less Than $500 million
For NextEra Energy, average sales revenue over the last 4 years has been $37.58 Billion, so in the context of the Graham analysis the stock has impressive sales revenue. Originally the threshold was $100 million, but since the book was published in the 1970s it's necessary to adjust the figure for inflation.
Current Assets Should Be at Least Twice Current Liabilities
We calculate NextEra Energy's current ratio by dividing its total current assets of $15.36 Billion by its total current liabilities of $27.96 Billion. Current assets refer to company assets that can be transferred into cash within one year, such as accounts receivable, inventory, and liquid financial instruments. Current liabilities, on the other hand, refer to those that will come due within one year. NextEra Energy’s current liabilities are actually greater than its current assets, since its current ratio is only 0.6.
The Company’s Long-term Debt Should Not Exceed its Net Current Assets
This means that its ratio of debt to net current assets should be 1 or less. Since NextEra Energy’s debt ratio is -0.2, the company has much more liabilities than current assets because its long term debt to net current asset ratio is -0.2. We calculate NextEra Energy’s debt to net current assets ratio by dividing its total long term of debt of $23.61 Billion by its current assets minus total liabilities of $118.47 Billion.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years
NextEra Energy had good record of retained earnings with an average of $17.83 Billion. Retained earnings are the sum of the current and previous reporting periods' net asset amounts, minus all dividend payments. It's a similar metric to free cash flow, with the difference that retained earnings are accounted for on an accrual basis.
There Should Be a Record of Uninterrupted Dividend Payments Over the Last 20 Years
Shareholders of NextEra Energy have received regular dividends since 2007. The company has returned an average dividend yield of 2.2% over the last five years.
A Minimum Increase of at Least One-third in Earnings per Share (EPS) Over the Past 10 Years
We are going to compare NextEra Energy's earnings per share averages from the two 'bookends' of the 17 year period for which we have data. The first bookend comprises the years 2007, 2008, and 2009, whose EPS values of $3.27, $4.07, and $0.85 average out to $2.73. Next we look at the years 2021, 2022, and 2023, whose values of $1.81, $2.10, and $3.60 average out to $2.50. The growth rate between the two averages does not meet Graham's standard since it is -8.42%.
Based on the above analysis, we can conclude that NextEra Energy meets most of Benjamin Graham's criteria for an undervalued stock because it is trading above its fair value and has:
- impressive sales revenue
- not enough current assets to cover current liabilities because its current ratio is 0.55
- much more liabilities than current assets because its long term debt to net current asset ratio is -0.2
- good record of retained earnings
- a solid record of dividends
- positive EPS growth
