The financial news, tips, and information site The Motley Fool says a “value trap” is “a stock that looks like a great deal but really isn’t.” GuruFocus Research and Yahoo Finance News reported last week (on 10.1o.2023) that: “Value-focused investors continually scout for stocks priced below their intrinsic value. One such stock that commands attention is Sun Communities Inc (NYSE:SUI). Currently priced at 115.11, the stock recorded a daily loss of 1.81% and a 3-month decrease of 11.73%. According to its GF Value, the fair valuation of the stock is $219.79.” “Despite its seemingly attractive valuation, certain risk factors associated with Sun Communities should not be overlooked.” What some would call a typo in the following is in the original: “Based on the [GuruFocus] analysis of Sun Communities’s financial health and its low Altman Z-Score, it appears that the company might be a potential value trap. Despite its seemingly attractive valuation, the risk factors associated with the company should not be ignored. Therefore, thorough due diligence is crucial for investors before making an investment decision.”
Given Sun Communities (SUI) high profile at the Manufactured Housing Institute (MHI) and in manufactured home connected investment circles, MHProNews decided to explore the GuruFocus report. What follows in Part I are the claims made by GuruFocus regarding Sun Communities in their words, claims, thoughts, and methodology. The GuruFocus insights are then framed in Part II with our more third-party information plus some of our own independent analysis.
Part I Per GuruFocus: “Understanding the Risks of a Possible Value Trap”
Understanding GF Value
The GF Value represents the current intrinsic value of a stock, derived from our exclusive method. The GF Value Line on our summary page provides an overview of the fair value at which the stock should be traded. It is calculated based on three factors:
- Historical multiples (PE Ratio, PS Ratio, PB Ratio, and Price-to-Free-Cash-Flow) that the stock has traded at.
- GuruFocus adjustment factor based on the company’s past returns and growth.
- Future estimates of the business performance.
We believe the GF Value Line is the fair value at which the stock should be traded. If the stock price is significantly above the GF Value Line, it is overvalued, and its future return is likely to be poor. Conversely, if it is significantly below the GF Value Line, its future return will likely be higher.”
Why Sun Communities (NYSE:SUI) Might Be a Value Trap
Despite its seemingly attractive valuation, certain risk factors associated with Sun Communities should not be overlooked. These risks are primarily reflected through its low Altman Z-score of 0.9. These indicators suggest that Sun Communities, despite its apparent undervaluation, might be a potential value trap. This complexity underscores the importance of thorough due diligence in investment decision-making.
Understanding the Altman Z-Score
Before delving into the details, let’s understand what the Altman Z-score entails. Invented by New York University Professor Edward I. Altman in 1968, the Z-Score is a financial model that predicts the probability of a company entering bankruptcy within a two-year time frame. The Altman Z-Score combines five different financial ratios, each weighted to create a final score. A score below 1.8 suggests a high likelihood of financial distress, while a score above 3 indicates a low risk.
A Snapshot of Sun Communities
Sun Communities is a residential REIT that focuses on owning manufactured housing, residential vehicle communities, and marinas. The company currently owns a portfolio of 671 properties, which includes 354 manufactured housing communities, 182 residential vehicle communities, and 135 marina properties. Sun targets owning properties that are desirable as second homes or vacation properties with nearly 50% of the portfolio located in either Florida or Michigan near major bodies of water.”
Dissecting Sun Communities’s Low Altman Z-Score
A dissection of Sun Communities’s Altman Z-score reveals Sun Communities’s financial health may be weak, suggesting possible financial distress:
Conclusion: Is Sun Communities a Value Trap?
Based on the analysis of Sun Communities’s financial health and its low Altman Z-Score, it appears that the company might be a potential value trap. Despite its seemingly attractive valuation, the risk factors associated with the company should not be ignored. Therefore, thorough due diligence is crucial for investors before making an investment decision.”
Part II – Additional Information Including MHProNews Analysis and Commentary
To tee up the analysis of the above, MHProNews asked Bing AI to define the Altman Z score method and to provide some additional context to the GuruFocus report on Sun Communities (SUI). The following was the specific inquiry, and Bing’s AI Chat search feature response. Note: what starts out rather technical is then followed by something more comfortable – so for those who aren’t ‘technically minded,’ don’t bail out. What follows is revealing on several levels that includes but arguably goes beyond Sun (SUI) and their corporate leadership.
> “GuruFocus recently published a report on Sun Communities saying it was a possible ‘value trap.’ GuruFocus mentioned Sun’s Altman Z-score as part of their analysis. Please provide some context for that metric?
The Altman Z-score is a formula that measures the financial health and bankruptcy risk of a company. It uses five financial ratios that can be calculated from the company’s annual report. The formula was developed by Professor Edward Altman in 1968 and has been widely used by investors and researchers to predict corporate defaults1.
The Altman Z-score formula is:
= ratio of working capital to total assets. Measures liquid assets in relation to the size of the company.
= ratio of retained earnings to total assets. Measures profitability that reflects the company’s age and earning power.
= ratio of earnings before interest and tax to total assets. Measures operating efficiency apart from tax and leveraging factors.
= ratio of market value of equity to book value of total liabilities. Adds market dimension that can show up security price fluctuation as a possible red flag.
= ratio of sales to total assets. Standard measure for total asset turnover (varies greatly from industry to industry).
The Altman Z-score can be interpreted as follows:
- A score below 1.8 means it’s likely the company is headed for bankruptcy.
- A score between 1.8 and 3 means the company is in the “grey zone” and its financial situation is uncertain.
- A score above 3 means the company is in good financial health and not likely to go bankrupt.
According to GuruFocus, Sun Communities has an Altman Z-score of 0.88 as of June 30, 2023, which indicates a high probability of bankruptcy2. However, the Altman Z-score was originally designed for manufacturing companies and may not be suitable for other types of businesses, such as real estate investment trusts (REITs). Therefore, one should use caution when applying the Altman Z-score to non-manufacturing companies and consider other factors as well.
If you want to learn more about the Altman Z-score, you can check out these articles:
- Altman Z-Score: What It Is, Formula, How to Interpret Results
- Altman’s Z-Score Model – Overview, Formula, Interpretation
- Altman Z Score – What Is It, Formula, Interpretation“
Next, note that despite GuruFocus’ seemingly favorable GF Value, which they seem to question themselves due to their application of the Altman-Z score. To compare and contrast what GuruFocus has said, here is what Yahoo Finance’s graphical summary indicated the common view from analysts was that Sun is “overvalued.” See the left side of the graphic that is boxed in orange under the heading “Fair Value” just under the financial summary on Sun Communities (SUI).
Note: to expand this image to a larger or full size, see the instructions
below the graphic below or click the image and follow the prompts.
below the graphic below or click the image and follow the prompts.
So, in a logical follow up, MHProNews asked Bing AI this question.
> “Bing, what is the latest on the allegations involving Brian Benderoff and Gary Shiffman, the later being the president and CEO of Sun Communities?”