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 Krispy Kreme (NYSE: KKD ) 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 -- 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.
Krispy Kreme has a P/E ratio of 27.8 and an EV/FCF ratio of 29.4 over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, Krispy Kreme has a P/E ratio of -45.2 and a five-year EV/FCF ratio of 34.0.
A positive one-year ratio under 10 for both metrics is ideal (at least in my opinion). For a five-year metric, under 20 is ideal.
Krispy Kreme is zero for four on hitting the ideal targets, but let's see how it compares against some competitors and industry mates.
|Einstein Noah Restaurant Group
Source: S&P Capital IQ; NM = not meaningful due to losses.
Numerically, we've seen how Krispy Kreme's 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, Krispy Kreme's net income margin has ranged from -13.9% to 5.4%. In that same time frame, unlevered free cash flow margin has ranged from 3.6% to 5.9%.
How do those figures compare with those of the company's peers? See for yourself:
Source: S&P Capital IQ; margin ranges are combined.
Additionally, over the last five years, Krispy Kreme has tallied up two years of positive earnings and five 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. Due to losses, though, Krispy Kreme's past EPS growth rate isn't meaningful. Neither is Einstein's:
Source: S&P Capital IQ; EPS growth shown.
Here's how Krispy Kreme measures up with regard to the growth analysts expect over the next five years:
Source: S&P Capital IQ; estimates for EPS growth.
The bottom line
The pile of numbers we've plowed through has shown us the price multiples shares of Krispy Kreme 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 27.8 P/E ratio, and we see that the further back in the five-year period you go on Krispy Kreme, generally, the worse the numbers are. This makes sense since Krispy Kreme is trying to turn around its operations. On that front, we see good trends in the profitability of earnings and free cash flows that may be worth looking into. That said, its profitability isn't robust enough to create low price multiples yet, and our CAPS community only rates it one star out of five.
Either way, these initial numbers are just a start. If you find Krispy Kreme's 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.
I wrote about a stock that's flying under the radar in our brand new free report: "The Stocks Only the Smartest Investors Are Buying." I invite you to take a free copy to find out the name of the company I believe Warren Buffett would be interested in if he could still invest in small companies.