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There are a zillion ways to value a company. Price to earnings. Price to cash flow. Liquidation value. Price per eyeballs on website (big during the dot-com boom). Price to a number I completely made up (this one never gets old). Price to CEO's ego divided by lobbying activity as a percentage of revenue (this one doesn't get used enough).

Which one is best? Truth is, they're all limited and based on assumptions that could be horrendously wrong. No single metric, or even combination of metrics, holds everything you need to know.

The metric I'm using today is no different. But it's perhaps the most encompassing, and least susceptible to hidden complexities of a company's financial statements. The more I think about it, the more I feel it's one of the most important metrics an investor should use.

What is it? Unlevered cash flow to total enterprise value.

First, let's break apart what these words mean:

  • Unlevered cash flow: Free cash flow plus interest paid on outstanding debt.
  • Enterprise value: Market capitalization (share price times shares outstanding) plus total debt and minority interests, minus cash.

What does the ratio of these two statistics tell us? It tells us how much is being earned for all providers of capital -- both stockholders and bondholders.

I know what you're thinking: You invest in common stock, so why should you care about bondholders? Ask Lehman Brothers investors why. The answer is that bondholders stand in front of stockholders. When a company earns money, it has to take care of its bondholders before you, the common shareholder, gets one penny. Focusing solely on profits in relation to equity, then, can be misleading -- like getting excited about a sale, but being the 100th person in line at a store that could close any second. That's the danger of leverage.

Enterprise value, on the other hand, provides a more encompassing view. By bringing debt capital into the situation, we see real earnings in relation to the company's entire capital structure, not just the part you may be interested in. Put another way, combining enterprise value and unlevered free cash flow shows a company's full earnings power in relation to everyone who has a stake in that company. It's like getting excited about a sale and standing right at the cash register.

Using this metric, here are six companies I found that look attractive:


Enterprise Value / TTM Unlevered Free Cash Flow

5-Year Average

UnitedHealth (NYSE: UNH  )



Dell (Nasdaq: DELL  )



Raytheon (NYSE: RTN  )



Pfizer (NYSE: PFE  )



Gap (NYSE: GPS  )



International Paper (NYSE: IP  )



Source: Capital IQ, a division of Standard and Poor's.
*One skewing outlier year removed from average calculations.
TTM = trailing 12 months.

Are there caveats to this table? Oh yes. One, a company can boost reported cash flow by slashing capital expenditures. That helps in the short run, but can leave a company prone to needing to catch up in the future. Second, comparing one company's metric with another's might not be meaningful because of differences in capital structures. Third, I had to cherry-pick parts of this table because companies can report huge unlevered cash flow thanks to changes in net working capital. Ford (NYSE: F  ) was one such example.

The two examples I really like are UnitedHealth and Pfizer. Not only do the two look cheap compared with multiyear averages, but we know why they're cheap: political uncertainty on health-care reform.

Now, if you're from the camp that thinks Obamacare will incinerate the health-care industry as we know it, I offer you a tissue and a Glenn Beck T-shirt. But if you're like me, noticing that (a) proposed legislation isn't terribly detrimental to many health-care companies, and (b) the odds of proposed legislation actually passing appear to be waning, then these valuations might look really good.

More importantly, these stocks are pricing in pending health-care reform, so expected reform that doesn't happen is just icing on the cake for investors. It's the kind of "heads I win, tails I don't lose that much" scenario value investors look for.

What do you think? Share your thoughts in the comments section below.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Pfizer and UnitedHealth Group are Motley Fool Inside Value selections. Ford Motor and UnitedHealth Group are Motley Fool Stock Advisor recommendations. The Fool owns shares of UnitedHealth Group, and has a disclosure policy.

Read/Post Comments (25) | Recommend This Article (100)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 26, 2010, at 4:15 PM, spawn44 wrote:

    I read your article twice on how to value a business. I never say the word future potential mentioned once. You keep your six companies with unlevered cash flow I'll take Ford shares over the next two to three years.

  • Report this Comment On January 26, 2010, at 4:39 PM, BioBat wrote:

    Frankly, it's not all about cash flow. For the size of Pfizer, they're drug pipeline absolutely sucks. The majority of their drugs in Phase 3 are rehashed drugs with already existent safety concerns but offering new and improved formulations and indications.

    Sure they can buy out small pharma companies with hot drug pipelines but even if they do, that's still a long way off from having a viable new FDA approved blockbuster drug.

  • Report this Comment On January 26, 2010, at 5:23 PM, Joemit wrote:

    BioBat stole my thoughts on PFE's drug pipeline and stated his comments better tahn I could have anyway.

    JNJ has followed the metric of buying companies with drugs ready for market and has kept its dividend intact. BMY has fewer drugs in development than NVS but I think both have more to offer than PFE.

    Long - BMY, UNH, JNJ, NVS

  • Report this Comment On January 26, 2010, at 6:08 PM, 102971 wrote:

    The only two of your six stocks that look attractive to me are Dell & United Health, You can keep Pfizer and I wouldn't touch Gap with a barge pole.

  • Report this Comment On January 26, 2010, at 7:30 PM, yragca wrote:

    I imagine implicit in BioBat's comment regarding PFE was the understanding that Lipitor, about 25% of revenue, expires in 2011 (though fights over extention could expand a little). so the lack of pipeline is huge.

  • Report this Comment On January 26, 2010, at 11:21 PM, SwampBull wrote:

    Four reasons this was worth the read:

    1) Clear explanation of terms used (Unlevered Cash Flow and Enterprise Value)

    2) Strong support of underlying reasoning

    3) Strong use of fundamentals and value investing philosophies sans patronization (well, unless you were a Lehman investor)

    4) No subscription pitch or titular bait-and-switch

    So, in a nutshell, nicely done Morgan! 1 rec from the Swamp.

  • Report this Comment On January 26, 2010, at 11:30 PM, goalie37 wrote:

    Definitely one rec. And as a fundamental analysis geek, thank you for the Enterprise Value. I don't know why I never heard that metric, but it's perfect.

  • Report this Comment On January 26, 2010, at 11:54 PM, goalie37 wrote:

    So by calculating enterprise value, we would find that companies with lower amounts of debt are "cheaper". Just one more advantage of low debt.

  • Report this Comment On January 27, 2010, at 7:01 AM, horacekgl wrote:

    OMG. Are we back to GAP, PFE and Dell again? I would offer that some stocks are great on paper, but just never pan out in reality -- and these appear to be a bunch of them. Writers for MF have ridden the GAP bandwagon so long that they must be saddlesore. Some day they will be right, just not yet. Working in the paper industry, your pick of IP also seems odd. UNH seems to be everyone's darling, but I'm not real excited yet (I'm not done picking the dividend paying part of my portfolio). Maybe we are over analyzing a tad? Plenty of time to analyze as the stock market is very likely to take a dip before going higher.

  • Report this Comment On January 29, 2010, at 2:15 PM, birder1500 wrote:

    This leaves me cold. Nothing here interests me at all. Why did I bother signing up anyway?

  • Report this Comment On January 29, 2010, at 3:40 PM, mikecart1 wrote:

    "Using this metric, here are six companies I found that look attractive"

    Let's hope you are better at judging girl's beauty LOL.

  • Report this Comment On January 29, 2010, at 4:07 PM, RxDan1 wrote:

    One area that the Motley-Fool brothers have to work on is a kind of ethics for their recommendations. For example:

    1. Raytheon: Obviously this is military (which we don't need much more of) and is extremely cyclical.

    2. UnitedHealthCare: One of the largest and most dispicable companys around in terms of policies on pre-existing conditions, caps and outright lies to the American people. Huge funder of anti-health care reform at virtually all levels. Look what the CEO makes, 3.2 milliion. There has also been that 12 million dollar class-action law suit from 37 states over dispicable claims processing and administration. And another one, 286 million or more from backdating stockoptions which will undoubtedly cut into revenue. We could goOn at length. They are a tea-party favorite

    3. International Paper: they are fine if they are not cutting any environmental corners which, truthfully, I have not looked up.

    4. Dell: Correct me if I am wrong but I thought that their phone support has dropped somewhat dramatically per Consumer Reports. Have they lost market share or are they cutting costs?

    Try to make your recommendations a little more ethical. Also, each company you recommend should be graded on some kind of EPA or earth-friendly criteria.

  • Report this Comment On January 29, 2010, at 4:33 PM, cmfhousel wrote:


    Please note: I'm not one of the Gardner brothers. Also, ethical investing is part of an individual philosophy. It's unreasonable to suggest stock recommendations should be forced to conform to a moral standard some may or may not agree with.

    To quote fellow Fool Joe Magyer, "I'm a stock picker looking to deliver winning investments ideas. I'm not your Dad, spiritual advisor, or life coach."

  • Report this Comment On January 29, 2010, at 4:58 PM, Silvertip7 wrote:

    The article's message is excellent and clear. EV/Unlevered free cash flow should definitely be one valuation metric in any investor's toolbox. One thing I would point out - this "multiple" should reflect a few things; (i) the market's expectation of future unlevered free cash flow growth, (ii) the market's vote on the respective company's balance sheet and (iii) riskiness of the business model. And I emphasize FUTURE here - where are all these going? I have never been a fan of using the "historic" multiples because businesses change over time and growth rates shift. Is a particular company going through a cyclical or secular business model shift? PFE (hate to point this out yet again) is a great example. it trades at a lower multiple vs 5 year avg given weak pipeline and regulatory risk. As an individual investor - you have to ask yourself, is the market right about this or over-penalizing the Company? You can make wonderful money if you are correct and bet against the crowd, especially when the market is overly focused on the short term. If you are right - the multiple should expand over time, provided fundamental improvement materializes. If you are wrong, it's just another value trap.

  • Report this Comment On January 29, 2010, at 11:47 PM, kalepatrick wrote:


    1) I work for a military contractor similar to Ratheon, and frankly I think you are very misinformed. Perhaps you didn't know that the majority of of products that corporations like mine produce have little to do with killing people(I assume this is what you mean by military contractors lacking ethics). For example, cyber security is a large portion of defense spending now a days, and that doesn't harm anyone. Nor do infrared counter measures(using lasers to defeat guidance systems on missiles). You were also most likely too busy hugging trees to realize that the defense industry is responsible for an uncountable number of technological innovations(ever heard of the internet?)

    2) If you wanted to dig into any company I am sure you can find a plethora of "unethical" practices, from using non-biodegradeable chemicals to clean there bathrooms, to cutting down a tree to make room for a parking lot. I hate to be the person to tell this to you, but thats life buddy, get over it. We are all here to learn and hopefully make some money in the process.

    3) Perhaps your time could be better spent(not to mention more fulfilling) campaigning for insects rights, or hanging out with members of PETA. If you want to save mother earth perhaps you should invest in alternative energies: wind turbines, solar panels, or biomass.

    4) I do have to conceed an agreement with you that DELL is a terrible company.

    Look, you are wasting everyones time by complaining about ethics and the enviroment. Please keep your left wing uberliberal ideals to yourself and let us continue to try to learn, discuss, and invest.

  • Report this Comment On January 30, 2010, at 1:34 AM, RaulChapin wrote:

    RxDan1: Thanks for your point of view, I did not find that it was unreasonable to suggest that ethics should play a part of recomending something. Now what those ethics should be is another topic of discussion :-)


    From the quote used by Morgan Housel:

    To quote fellow Fool Joe Magyer, "I'm a stock picker looking to deliver winning investments ideas. I'm not your Dad, spiritual advisor, or life coach."

    All readers should be aware than this quote implies that Morgan and Joe would have absolutely no moral or ethical problem with suggesting you invest in a Crystal Meth producing lab as long as it had a very good prospect of making money and it found a way to be listed in a stock market. Any horrendous practice, as long as it had not yet caused the company's profitability to be affected would be willingly disregarded. Further more, inferred from the reaction to RxDan1 suggestion, it is entirely possible that even if Morgan knew that his target audience for suggestions would not willingly invest in such a company he would feel no obligation to disclose information that would otherwise discourage the investment...

  • Report this Comment On January 30, 2010, at 9:42 AM, cmfhousel wrote:

    Oh please, how did you make the jump from International Paper to crystal meth lab?

  • Report this Comment On January 30, 2010, at 11:43 AM, stevegofcp wrote:

    Dell is a 1990s technology company with a 1990s management team. They have dropped from 1st place in PC shipments to 3rd place, soon to be in 4th place behind Lenovo.

  • Report this Comment On January 30, 2010, at 6:18 PM, jbnow wrote:

    Please provide some suggestions for the following

    What readily available stock screening web url provides the ability to screen to make this analysis or get close to the analysis upon which I can do the rest with a spreadsheet by hand.

    For example, what criteria on stock screen should i chose to find similar companies.

    if not then what screening tool?

  • Report this Comment On January 30, 2010, at 6:37 PM, jbnow wrote:

    Also, the other day at work... a colleague and I were arguing the following point. I put forth the argument that all Information Technology (IT) infrastructure economic activity far exceeded all agricultural infrastructure economic activity. For example, we were talking about weirs and damns used to monitor the flow of water into irrigation canals.*

    My central question is which infrastructure has more economic activity IT or Agriculture. And I'm not talking about the downstream effects of the infrastructure, just the infrastructure alone. Why was I curious about this? Because many of critically important water supply damns and canals in existence today were built many, many years ago. In some cases about a hundred years ago. At that time they represented significant single focus economic activity relative to all other economic activity. (Think what it took to build the Transcontinental rail road in the 1860s not that the railroad was an agricultural infrastructure investment, but I just don't have better example.)

    We are making huge investments in information age economy but still the old agricultural infrastructure is critical. So I was curious about their relative size? Anyone fair to take a guess at it in terms of nearest billion dollar?


    Something our company is very involved in (oh and by the way we are a company that makes technology to improve the understanding of earths climate, we manufacture sensors, yet these sensors are also used for military applications. However, the bulk of our sensors are used for resource management (although an argument could be made that the use of military is a means of resource management, then all of our sensor are used for resource management.) But that's a side topic.

  • Report this Comment On January 31, 2010, at 9:09 AM, deemre wrote:

    Dell has developed a horrible reputation among many IT savvy folks as Dell's lap tops experience significant operational failures. The same IT analysts state that Dell is manufacturing its laptops off shore, not in Texas, and is experiencing quality issues. I have no personal expertise, except a really poor Dell laptop that we abandoned after several months. Product quality is a core business value as Toyota is learning, and if Dell is experiencing wide spread quality issues, its long term reputation, and business will suffer.'I would be interested in feed back concerning the above.


  • Report this Comment On February 01, 2010, at 11:24 AM, runningwalk wrote:

    As a 25 year veteran RN, MSN/MHA, I think you are dead wrong not to be worried about OBAMACARE. I've researched universal healthcare extensively. It doesn't work in Europe, Canada or in the states that have tried it. The impact such a system would have on healthcare stocks would be catastrophic. I'm basing my opinion on research, not politics. But hey, what do I know?

  • Report this Comment On February 01, 2010, at 11:19 PM, alwaysintrouble wrote:

    runningwalk, please explain "It doesn't work..." in specific terms.

  • Report this Comment On February 04, 2010, at 10:40 PM, RaulChapin wrote:

    How to jump from international paper to a meth lab... it was an exageration, however when you say that all you are is a "stock picker looking to deliver winning investments ideas" it leaves room to believe that you pay no attention to the ethical or moral value of the business behind such ideas as long as it will deliver gains to the investor.

    I just meant to show that you are more than a stock picker, at one point your ethics or morals will get in the way of pure profit which is in my eyes fine... the saying is just useful to get you away from explaining why you do not consider the ethical or moral objections of your readers to be valid enough to ignore the profit potential...

  • Report this Comment On February 04, 2010, at 10:42 PM, RaulChapin wrote:

    sorry, i said "your readers" should have said "some of your readers" as exemplified by RxDan1

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