Is Baker Hughes' Stock Cheap?

Numbers can lie -- but they're the best first step in determining whether a stock is a buy. In this series, we use some carefully chosen metrics to size up a stock's true value based on the following clues:

  • The current price multiples.
  • The consistency of past earnings and cash flow.
  • How much growth we can expect.

Let's see what those numbers can tell us about how expensive or cheap Baker Hughes (NYSE: BHI  ) might be.

The current price multiples
First, we'll look at most investors' favorite metric: the P/E ratio. It divides the company's share price by its earnings per share (EPS) -- the lower, the better.

Then, we'll take things up a notch with a more advanced metric: enterprise value to unlevered free cash flow. This divides the company's enterprise value (basically, its market cap plus its debt, minus its cash) by its unlevered free cash flow (its free cash flow, adding back the interest payments on its debt). Like the P/E, the lower this number is, the better.

Analysts argue about which is more important -- earnings or cash flow. Who cares? A good buy ideally has low multiples on both.

Baker Hughes has a P/E ratio of 27.5 and a negative EV/FCF ratio over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, Baker Hughes has a P/E ratio of 21.4 and a negative five-year EV/FCF ratio.

A positive one-year ratio under 10 for both metrics is ideal. For a five-year metric, less than 20 is ideal.

Baker Hughes is zero for four on hitting the ideal targets, but let's see how it compares against some competitors and industry mates. 

Company

1-Year P/E

1-Year EV/FCF

5-Year P/E

5-Year EV/FCF

Baker Hughes 27.5 NM 21.4 NM
Halliburton (NYSE: HAL  ) 19.6 158.1 19.0 35.9
Schlumberger Limited (NYSE: SLB  ) 24.2 50.8 25.0 37.9
Weatherford International (NYSE: WFT  ) 674.1 178.2 20.2 NM

Source: Capital IQ, a division of Standard & Poor's; NM = not meaningful.

Numerically, we've seen how Baker Hughes' valuation rates on both an absolute and relative basis. Next, let's examine ...

The consistency of past earnings and cash flow
An ideal company will be consistently strong in its earnings and cash flow generation.

In the past five years, Baker Hughes' net income margin has ranged from 3.7% to 26%. In that same time frame, unlevered free cash flow margin has ranged from -4.7% to 5.7%.

How do those figures compare with those of the company's peers? See for yourself:

Source: Capital IQ, a division of Standard & Poor's; margin ranges are combined.

Additionally, over the last five years, Baker Hughes has tallied up five years of positive earnings and three years of positive free cash flow.

Next, let's figure out ...

How much growth we can expect
Analysts tend to comically overstate their five-year growth estimates. If you accept them at face value, you will overpay for stocks. But while you should definitely take the analysts' prognostications with a grain of salt, they can still provide a useful starting point when compared to similar numbers from a company's closest rivals.

Let's start by seeing what this company's done over the past five years. In that time period, Baker Hughes has put up past EPS growth rates of -3.3%. Meanwhile, Wall Street's analysts expect future growth rates of 19.6%.

Here's how Baker Hughes compares to its peers for trailing five-year growth:

Source: Capital IQ, a division of Standard & Poor's; EPS growth shown.

And here's how it measures up with regard to the growth analysts expect over the next five years:

Source: Capital IQ, a division of Standard & Poor's; estimates for EPS growth.

The bottom line
The pile of numbers we've plowed through has shown us the price multiples shares of Baker Hughes are trading at, the volatility of its operational performance, and what kind of growth profile it has -- both on an absolute and a relative basis.

The more consistent a company's performance has been and the more growth we can expect, the more we should be willing to pay. We've gone well beyond looking at a 27.5 P/E ratio and we see some negative free cash flows that lead to EV/FCF ratios that aren't meaningful. For these elevated price multiples, we get slightly negative recent growth and some analyst expectations for future growth. But these initial numbers are just a start. If you find Baker Hughes' numbers or story compelling, don't stop. Continue your due diligence process until you're confident one way or the other. As a start, add it to My Watchlist to find all of our Foolish analysis.

To see the stocks that I've researched beyond the initial numbers and bought in my public real-money portfolio, click here.

Anand Chokkavelu owns shares of Halliburton. The Motley Fool owns shares of Schlumberger. 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 (0) | Recommend This Article (1)

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.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1512801, ~/Articles/ArticleHandler.aspx, 9/17/2014 11:56:46 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement