Here's why MGM
In the daily noise machine of CNBC, analyst estimates, and quarterly announcements, investors are inundated with talking heads obsessing over earnings-per-share figures.
Earnings, or net income, is an accounting construction that is the basis for the price-to-earnings ratio, the most popular way of measuring how cheap or expensive a stock is.
But free cash flow -- the amount of cash a company earns on its operations minus what it spends on them -- is another, oftentimes more accurate measure of earnings, and it's one that can give you an advantage.
How MGM stacks up
If MGM 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 MGM consistently generates less free cash flow than net income, it may be less profitable and more expensive than it appears.
This graph compares MGM'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, MGM has a tendency to produce more free cash flow than net income. Notice how free cash flow (red) trailed both net income (blue) and operating earnings (green) in 2006 and 2007, when MGM was spending heavily on capital projects. MGM began to pare back capital expenditures in 2008, and significantly cut back in 2009 and 2010, causing free cash flow to rebound in line with operating cash flow.
This means that the standard price-to-earnings multiple investors use to judge companies may overstate its price tag.
Let's also examine MGM alongside a few of its peers for additional context:
|
Company |
Price-to-Earnings Ratio |
Adjusted Price-to-Free-Cash-Flow Ratio |
Adjusted Enterprise-Value-to-Cash-Flow Ratio |
|---|---|---|---|
|
MGM |
N/A |
3.2 |
12.0 |
|
Las Vegas Sands |
N/A |
N/A |
N/A |
|
Melco Crown |
N/A |
N/A |
N/A |
|
Wynn |
99.8 |
33.7 |
38.1 |
|
Penn National Gaming |
N/A |
24.3 |
42.5 |
*Of mid- and large-cap stocks.
MGM isn't alone among casinos that are having trouble generating reported profits these days. Like many of its competitors, MGM's price-to-earnings ratio is "N/A" because it has negative net income. It is, however, producing free cash flow.
It's not clear that we can count on MGM to continue producing these levels of cash flow – capital expenditures could pick up again, for example. Moreover, MGM's free cash flow multiple is considerably more expensive once we take debt into account in the third column. These reservations aside (seriously, no pun intended), MGM is probably cheaper than many investors realize.
