Encompass Health is currently trading at $114.62 per share and has a Graham number of $45.05, which implies that it is 154.4% above its fair value. We calculate the Graham number as follows:
√(22.5 * 5 year average earnings per share * book value per share) = √(22.5 * 3.53 * 21.484) = 45.05
The Graham number is one of seven factors that Graham enumerates in Chapter 14 of The Intelligent Investor for determining whether a stock offers a margin of safety. Rather than use the Graham number by itself, its best to consider it alongside the following fundamental metrics:
Sales Revenue Should Be No Less Than $500 million
For Encompass Health, average sales revenue over the last 5 years has been $8.33 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 Encompass Health's current ratio by dividing its total current assets of $886.9 Million by its total current liabilities of $841.0 Million. 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. Encompass Health’s current liabilities are actually greater than its current assets, since its current ratio is only 1.0.
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. Encompass Health has much more liabilities than current assets because its long term debt to net current asset ratio is -0.8. We calculate Encompass Health’s debt to net current assets ratio by dividing its total long term of debt of $2.36 Billion by its current assets minus total liabilities of $3.69 Billion.
The Stock Should Have a Positive Level of Retained Earnings Over Several Years
Encompass Health had good record of retained earnings with an average of $-1254018750.0. 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
Encompass Health has offered a regular dividend since at least 2013. The company has returned an average dividend yield of 1.3% over the last five years.
A Minimum Increase of at Least One-third in Earnings per Share (EPS) Over the Past 10 Years
Encompass Health's earnings per share growth will be calculated using the average EPS of the years 2008, 2009, and 2010, and the average of the years 2022, 2023, and 2024. For the years starting in 2008, we have EPS values of $2.62, $0.77, and $7.16, which give us an average of $3.52. From 2022 to the present, we have EPS values of $2.70, $3.47, and $4.46, which average out to $3.54. The growth rate between the two averages is 0.57%, which falls short of Graham's 30% requirement while remaining positive.
Based on the above analysis, we can conclude that Encompass Health satisfies some of the criteria Benjamin Graham used for identifying for an undervalued stock because it is trading above its fair value and has:
- impressive sales revenue
- just enough current assets to cover current liabilities, as shown by its current ratio of 1.05
- much more liabilities than current assets because its long term debt to net current asset ratio is -0.8
- good record of retained earnings
- a solid record of dividends
- positive EPS growth