An Old Buffett Favorite Rises From The Ashes

Madison Avenue Partners may not be a renowned investment manager but managing $457 million is nothing to sneeze at all the same. What makes the money manager interesting is the big stake they took in a single firm.

Although the assets under management at Madison are not huge relative to titans like Buffett, the percentage committed to a little-known firm, called Graham Holdings (NYSE:GHC), is massive. Specifically, the investment team allocated 17.1% of their portfolio to this one firm, but why?

What You Don’t Know About Graham Holdings

Graham Holdings is perhaps best known for once housing The Washington Post but its tenure stretches all the way back to 1877 when the Post was first distributed. These days it’s much more than a firm publishing a single newspaper.

Although media was a strategic focus for over a century, management did veer away from that as a core business model and it established a presence in other sectors, such as education via Kaplan.

It also entered the healthcare space, an area believed to be more impervious to the swings of economic fortune. The goal of these expansions was to stabilize revenues that had been under pressure from the decline in the newspaper industry, and as you’ll discover the approach has been very successful.

Kaplan in particular has been a key asset for the firm because the constant stream of test-takers ensures exam preparation services are always in demand. Everything from university preparation and professional training to english language education is supported.

Furthermore, Kaplan has embraced the digital revolution with more online learning offerings and its constant improvement and technological innovations have helped it ride the wave that once hurt the firm, meaning the trend towards more attention online once hurt the offline newspaper business. 

In healthcare, Graham Holdings took a big stake in Residential Healthcare Group, with the intent to make a splash in an area where consistent demand leads to more stable revenues. Tailwinds for such a play include an aging population and increased health awareness.

Yet these forays have not deterred Graham Holdings from maintaining a media exposure as it has done with its television broadcasting assets, including several TV stations. These contribute substantially to the company’s revenue and show the resilience of broadcast media at a time when digital offerings continually encroach on viewers’ attention.

Beyond these businesses, Graham Holdings also invests in real estate, ranging from industrial to commercial properties. While these assets are more sensitive to economic ups and downs, they add a different dimension to support revenue streams.

The commercial real estate side of the business can thrive during boom times while industrial properties are more likely to offer stability due to the more steady nature of warehousing and manufacturing facilities.

Given the breadth of businesses under the umbrella corporation, how strong is the company overall? 

Is Graham Holdings Stock a Buy?

Graham Holdings stock is a Sell according to the one analyst who covers the stock and has a $635 per share price target on it.

That poses a conundrum between why Madison Avenue Partners has taken such a large stake when the single analyst assesses fair value to be meaningfully lower than the current share price.

To uncover the apparent disconnect a cash flows analysis is helpful. On a 5-year time horizon, a DCF forecast reveals fair value to sit meaningfully higher at $1,048 per share, suggesting 55.9% upside.

The notable difference between price and fair value on a cash flows basis likely explains why the investment manager took such a large stake and may even explain why management has followed through with a share repurchase scheme to the tune of 500,000 shares.

Clearly, the top brass expect no changes in the stream of earnings that have been flowing and indeed net income is forecast to rise this year.

Yet valuation isn’t the only reason to like this former media darling.

Graham Holdings Dividend Is Modest But Stable

In addition to a compelling valuation argument, Graham Holdings pays a dividend of almost 1.0% which should be in no jeopardy on account of the strong profitability over the past twelve months that is forecast to continue in addition to the very low payout ratio of 19.8%, or $6.60 per share. Better yet, it’s been on a 7-year growth streak.

While the dividend is modest, stability is paramount. And looking through the financials, there is no evidence of risk to shareholders. Over the past twenty quarters, each and every one has been reported with positive earnings before interest and taxes. So too have revenues been climbing on a year-over-year basis for ten quarters straight.

Graham Holdings Financials Look Good

Beyond the income statement, the balance sheet looks to be in a good place too with cash levels outstripping long-term debt.

In addition, levered free cash flows have largely been positive over the past 5 years with just a handful of quarters reported in the red.

All in all, the financials are very solid and appear to be growing in strength with each passing quarter. For a $3.0 billion company generating revenues of $4.3 billion, it’s clear that Graham Holdings is not trading at premium prices by any means. The price-to-sales ratio comes in at 0.7x while the price-to-earnings ratio is 19.5x.

The bottom line is Graham Holdings is an attractive valuation play at this time with significant upside potential. While it’s not a high-flying technology stock that will attract the attention of Cathie Wood’s team at ARK Invest, it is a slow and steady earner that pays a modest dividend, has strong cash flows, a predictable revenue stream and should reward shareholders over the long haul.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.