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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 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 free cash flow isfree 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. 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.
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.
Enterprise Value/ Unlevered FCF
CAPS Rating (out of 5)
|Ford (NYSE: F )||8.1||24.4||****|
|Intel (Nasdaq: INTC )||15.2||19.9||*****|
|Johnson & Johnson (NYSE: JNJ )||14.9||17.5||*****|
|Hewlett-Packard (NYSE: HPQ )||8.5||15.8||***|
|Eli Lilly (NYSE: LLY )||9.5||16.9||****|
Sources: S&P Capital IQ, Motley Fool CAPS.
Let's say a few words about these companies.
Ford is one of the more remarkable turnaround stories of the last decade, but its stock is still clouded in a stigma of the American auto industry. Look under the hood, however, and you might be surprised. The automobile market may be healthier than you think, and is set up for what could be a strong rebound. As Motley Fool advisor Joe Magyer noted last year, collapsing auto sales during the Great Recession has created pent-up demand. "The good news is that new vehicle sales should snap back thanks to an economic recovery and pent-up demand," he wrote. "The average age of cars on U.S. roads is now a record 10.6 years, according to Polk, as a tough economy has forced drivers to grind out just a few more miles on their clunkers. As those vehicles get more and more expensive to fix and used-car prices hover near record highs, new vehicle demand will get pushed upward whether the economy comes along for the ride or not."
Five years ago, Intel earned $1.20 a share. Its stock price? About $25. Last year, Intel earned $2.30 a share. Its stock price? About $25.
Intel is among a handful of large-cap tech companies that have seen their business, earnings, and cash flow zoom ahead while their stocks languish. Trading at a multiple to earnings and cash flow that implies no earnings growth -- a highly unlikely prospect -- and throwing off a 3.3% dividend yield, Intel is one of my favorite companies for investors looking for good, high-quality blue chip investments to hold for the long run.
Johnson & Johnson
Few companies can boast a track record of rewarding shareholders as pristine as Johnson & Johnson's -- the company has paid a dividend every year since at least 1962, with 49 consecutive yearly increases -- but you would never know it looking at its stock price and valuation. Still spooked by recalls, investors have priced J&J shares at a value that would have been unthinkable in recent years. With a dividend yield of about twice what you can receive from 10-year Treasury bonds, plus another boost from several billion in annual share buybacks, J&J is a cheap stock that has three big things going in its favor: riding a boom in health-care spending, global diversity, and a time-tested business model that emphasizes decentralization of its business units.
You probably know the story: HP ran the gauntlet in recent years of misguided management and boneheaded business moves. Its former CEO doubled down on expensive acquisitions, squandered precious cash flow, and succeeded mightily in convincing Wall Street that HP couldn't care less about maximizing shareholder value.
But two important points need to be remembered here. First, former CEO Leo Apotheker is gone. Second, HP stock is almost comically cheap. If the company spent all of its annual free cash flow on share buybacks, it would repurchase itself entirely in about six years. HP may have some troubling days ahead of it, but its shares are priced for exactly that -- and more.
Eli Lilly is a smart choice for those looking for slow, stable, steady growth and consistent dividend income. You won't shoot the lights out with big pharma these days -- don't expect to get rich overnight -- but Eli Lilly and other large-cap pharmaceutical companies will continue to crank out cash flow for years to come. There's a difference between a dying company and a former high-growth company resigning into a period of boring-but-stable earnings. The latter is where I think a company like Eli Lilly is today. Patience will be rewarded.
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