Valuation analysis for ACE Limited (NYSE:ACE)

November 10, 2014, 12:15 pm ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

Given the current state of the stock market it is important for us to determine fair valuation for the stocks that we own so that we can determine whether or not these stocks are likely to fall materially if the market itself begins to turn down.

ACE Limited (NYSE:ACE) is a company who has experienced solid growth recently, but the growth rate, according to our EPS growth observations, has begun to come down and analysts expect the growth rate to come down even more than it already has.  This is a concern for investors who are interested in growth, and a concern for investors who are interested in capital preservation if valuation is a concern to them.

Specifically, our observation of EPS growth excludes onetime events to focus on earnings from operations, and we observe trailing 12 month data when we compare earnings growth over time to define yearly EPS growth accordingly.  Our current observations tell us that ACE Limited is currently growing at a rate slightly above 4%, after coming down from growth rates that exceeded 20% a few quarters ago.

Furthermore, forward estimates by analysts suggest that forward growth will actually be negative and the company is likely to earn less next year than it will this year.  That means that the trajectory of the growth rate chart will continue down and become negative again like it was in calendar 2013.

This brings valuation into question because although the PE multiple is only 11.5 times earnings, much lower than the market itself, the stock still trades with a peg ratio of 2.8 and that is rich by definition.  In addition, looking back, we can see that the PE multiple was much closer to 8 times earnings a few years ago, suggesting that ACE could experience multiple contraction if earnings don't continue at their current pace.

Technical take:

According to our real time trading report for ACE Limited the stock is very close to longer term resistance and upside potential looks limited as a result.  On a technical basis we would therefore be selling this stock and short Sellers could even take advantage of a position established near resistance, from resistance to support, using resistance as risk control respectively.

Summary:

On a fundamental basis, given current growth rates, ACE Limited looks rich.  However, growth rates are expected to decline and actually turn negative going forward according to analyst estimates, so the rich looking valuation that exist today will likely look even more stretched as earnings growth subsides, if analysts are correct.  In addition, the stock is testing longer term resistance and based on our observations that is not only a sell signal but also a short signal so long as resistance levels remain intact.  We would not be buyers; we would instead sell the stock, and expect downside pressure accordingly.

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