5 Companies You Can Buy Today

There are many ways to value a company. Price to earnings. Price to cash flow. Liquidation value. Price per eyeballs on website. 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? They're all limited and reliant on assumptions. No single metric holds everything you need to know.

The metric I'm using today is no different. But it's perhaps the most encompassing, and the 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 useful metrics out there.

What is it? Enterprise value over unlevered free cash flow.

Enterprise value is market capitalization (share price times shares outstanding) plus total debt and minority interests, minus cash. Unlevered cash flow is free cash flow with interest paid on outstanding debt added back in.

The ratio of these two statistics provides a valuation metric that takes into consideration all providers of capital -- both stockholders and bondholders.

But you invest in common stock, so why should you care about bondholders? Ask Lehman Brothers investors why. When a company earns money, it has to take care of bondholders before you, the common shareholder, get a dime. Focusing solely on profits in relation to equity can be dangerously misleading. And it often is.

Enterprise value 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. If you owned the entire business, this is the metric you'd naturally gravitate toward.

Using this metric, here are five companies I found that look attractive.

Company

Enterprise Value/ Unlevered FCF

5-Year Average

 

CAPS Rating (out of 5)

Johnson & Johnson (NYSE: JNJ  ) 15.8 21.6 *****
Kraft Foods (NYSE: KFT  ) 15.6 21.3 ****
IBM (NYSE: IBM  ) 14.7 16.4 ****
Costco (Nasdaq: COST  ) 16.4 23.1 ****
Wal-Mart (NYSE: WMT  ) 15.1 35.7 ***

Source: Capital IQ, a division of Standard & Poor's.

Johnson & Johnson
Remember the 1993 oh-dear-there's-a-syringe-in-my-Pepsi debacle? Most people don't. Investors don't. The market doesn't. But it was a big deal at the time, and Pepsi (NYSE: PEP  ) shares fell more than 15%. It didn't matter whether the syringes were a hoax (and they were). A bad reputation for a company that relies on brand-name recognition is terrifying for investors.

But time heals. Customers forget. Investors who bought when others were running reaped rewards. I can't help but think a similar opportunity is brewing at Johnson & Johnson today. Sure, the company really did screw up, recalling millions of pills and other drugs. But short-term PR nightmares fade, and investors can pick up shares of J&J today at a seriously attractive valuation. Dare to look past the noise.

Kraft
Food is a commodity's commodity. It's hard to make good profits on something others can easily copy. But Kraft does. How? It has strong brands, and it markets the heck out of them. Very few companies can do that effectively, which makes Kraft all the more valuable. Altria (NYSE: MO  ) spun off its majority stake in the company a few years back, partly because its slow-growing cigarette business was clouding Kraft's faster-growing food business. Truth be told, Kraft's growth isn't stunning. But this is a solid company trading at an attractive valuation and throwing off a 3.6% dividend yield. Conservative investors looking for stability could do worse.

IBM
Bill Miller declared IBM the most remarkably mispriced name in the market earlier this year. Last week, he said the company has "an absolutely unequal record in capital allocation." He wasn't kidding about either. IBM trades at 11 times forward earnings, making it one of a number of today's ridiculously cheap tech stocks. As for allocating capital, the returns speak for themselves:

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

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

Note that this chart starts during the dot-com bubble in 2000, when valuations were insane. This is a grossly unfair starting point. Yet shares still delivered a 70% cumulative return over the decade. That's when you know management is doing something right.

Costco
I ask myself why I don't own Costco shares every time I enter one of its warehouses. The business model is simply awe-inspiring: Sell products so cheaply that you hardly make a dime off retail margins. Make all your profit by getting customers to pay very reasonable yearly membership dues. Get customers to renew yearly memberships in droves. Rinse, repeat. The result is a company that is as beneficial to customers as it is profitable to shareholders. Charlie Munger recently said Costco "does more for civilization than the Rockefeller Foundation." Shares might not look terribly cheap relative to others, but you can't overstate how strong this company's moat is. It deserves a high multiple.

Wal-Mart
Wal-Mart, on the other hand, also has a solid moat (thanks to sheer size and scalability), yet shares trade like it's an average-at-best company. Some of this is no doubt due to past performance: Wal-Mart shares have flatlined over the past decade. Investors, it's safe to say, have all but given up. But the reason shares have gone nowhere is not because Wal-Mart is stalling. The company grew EPS by roughly 12% per year over the past decade. The poor shareholder returns were entirely due to past valuations. In 2000, shares traded at more than 45 times earnings. That guaranteed disappointment. Bad returns occur when investors buy in at too high valuations. That isn't the case today.

Looking for other great stock ideas? Check out the Motley Fool's free report, "13 High-Yielding Stocks to Buy Today." Just click here to grab your copy.

Fool contributor Morgan Housel owns shares of Johnson & Johnson and Altria. Costco Wholesale and Wal-Mart Stores are Motley Fool Inside Value recommendations. Costco Wholesale is a Motley Fool Stock Advisor selection. Johnson & Johnson and PepsiCo are Motley Fool Income Investor recommendations. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson. Motley Fool Options has recommended a diagonal call position on PepsiCo. The Fool owns shares of Altria Group, Costco Wholesale, International Business Machines, Johnson & Johnson, and Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (52)

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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 October 25, 2010, at 5:49 PM, PeyDaFool wrote:

    "I ask myself why I don't own Costco shares every time I enter one of its warehouses."

    I was just there yesterday morning in Seattle and confessed this same exact words to my buddy as we were walking out. With the potential for international expansion, the awesome business model and amazing management, I agree it deserves a higher multiple.

    Great article, Morgan.

  • Report this Comment On October 26, 2010, at 1:05 PM, ScottRichard wrote:

    Absolutely great company for members...

    However, you have to go back 15 years to see a period of rapid appreciation in its stock price. Add in a fairly low dividend and this one may be more appreciated by its members than its investors.

  • Report this Comment On October 26, 2010, at 2:50 PM, PeyDaFool wrote:

    ScottRichard,

    You may be partially correct about the lack of "rapid appreciation" (except the fact for shares had a 2:1 split just ten years ago and investors have seen a nice progression of dividend increases), but COST is still outperforming SPY by about 60% over the last ten years and their current ROE is 12.00 while their ROI is 10.0. Moreover, past performance does not necessarily predict future performance so this isn't even a fair analysis.

    I think it's fair to say you're not giving their performance history enough credit.

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