AgFeed May Be Cheaper Than You Think

Here's why AgFeed (Nasdaq: FEED) may be cheaper than you think.

In the daily noise machine of CNBC, analyst estimates, and quarterly announcements, investors are inundated with talking heads obsessing over earnings-per-share figures.

This is the primary metric we use to mark corporate progress. Earnings, or net income, are also the basis for the price-to-earnings ratio, the most popular way of measuring how cheap or expensive a stock is.

Unfortunately, "earnings" figures don't always give you the full picture.

Let me explain
Reported earnings are an accounting construction that may or may not accurately reflect a company's true earnings power. Free cash flow -- the amount of cash a company earns on its operations minus what it spends on them -- is another, oftentimes more accurate metric that can help you identify cheap stocks.

Better still, it's one that other investors frequently overlook. That means investors like us who peek at free cash flow can gain a significant advantage in the market.

There are a number of reasons why net income may understate a company's true profitability. Considering this overlooked-but-critical metric can give you an advantage over other investors.

How AgFeed stacks up
If AgFeed tends to generate more free cash flow than net income, there's a good chance earnings-per-share figures understate its profitability and overstate its price tag. Conversely, if AgFeed consistently generates less free cash flow than net income, it may be less profitable and more expensive than it appears.

This graph compares AgFeed's historical net income to free cash flow. (I omitted various gains and charges such as tax deferrals, restructurings, and benefits related to stock options.)

Source: Capital IQ (a division of Standard & Poor's) and author's calculations.

As you can see, AgFeed has a tendency to produce less free cash flow than net income.

This means that the standard price-to-earnings multiple investors use to judge companies may actually understate its price tag. The culprits, in AgFeed's case, are capital expenditures, rising inventories, and ballooning accounts receivables. The company is not only ramping up its operations, but also extending better and better credit to its customers or failing to collect the bills.

Let's examine AgFeed alongside some of its larger American peers for additional context:

*Of mid- and large-cap domestic stocks.

AgFeed seems pricier than some of its American counterparts, though that's partly because investors expect high growth. But they should also keep an eye on rising inventories and accounts receivable and make sure AgFeed can turn a strong profit on its capital investments.