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 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 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 and equity can be 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.

Company

Enterprise Value/Unlevered FCF

5-Year Average

 

CAPS Rating (out of 5)

Google (Nasdaq: GOOG  ) 18.1 35.2 ****
Johnson & Johnson (NYSE: JNJ  ) 19.8 21.9 *****
Procter & Gamble (NYSE: PG  ) 24.6 28.4 *****
UnitedHealth Group (NYSE: UNH  ) 6.9 10.2 *****
Colgate-Palmolive (NYSE: CL  ) 22.8 24.4 *****

Source: S&P Capital IQ.

Let's say a few words about these companies.

Three years ago, Warren Buffett and Charlie Munger had some flattering words for Google. "Google has a huge new moat. In fact I've probably never seen such a wide moat." Munger said. "I don't know how to take it away from them," Buffett said. "Their moat is filled with sharks!" Munger added.

Here's a good example: After trying to make inroads in the online ad business, Microsoft just wrote down almost the entire value of its 2007 purchase of aQuantive. The Daily Beast summed it up well: "Microsoft's $6.2 Billion Writedown Shows It's Losing War With Google."

I still like Microsoft because it's good at what it does. But advertising and search isn't it. That's Google's turf. And today you can buy Google at literally the lowest price-to-cash-flow ratio ever. Take advantage of that while it lasts.

Johnson & Johnson is one of the best-performing stocks over the last several decades. But it's having a rough go of it lately. Recalls, management blunders, more recalls, competition from generics... and on and on. Yes, growth has slowed. Yes, it might stay slow for a while. But valuation more than compensates for that. The stock currently provides a 3.6% dividend yield, and trades for 12 times next year's earnings -- below the market average. It's a good company at a good price.

Procter & Gamble is a similar story. One of the world's greatest collections of brands has hit a slowdown. That's hit shareholder returns -- P&G shares haven't budged in two years. But most of the company's missteps appear to be tied to poor execution by management. My guess: Within a year or two the company will have a new CEO, and the market will come to appreciate its value anew.

Everything important you need to know about UnitedHealth Group comes down to the Affordable Care Act, also known as Obamacare. Most health insurance companies currently trade at depressed valuations, likely because the market hates uncertainty -- something that still exists even after the Supreme Court ruled Obamacare constitutional.

But what are the two most likely outcomes here? One is that Obamacare remains law, in which case insurers will face a raft of costly new rules, but also a flood of new customers essentially mandated to buy their product. The other is that Obamacare is repealed -- likely under a Romney administration -- in which case those costly new rules would go away. Neither outcome seems particularly bad for insurers.

Past performance is no guarantee of future returns, but I can't help but point out how successful Colgate-Palmolive has been over the last 30 years. The toothpaste and soap company has produced average returns of nearly 17% a year since 1980, compared with 11% for the broader market. That's the power of two forces: A strong brand, and simple products that aren't pushed to extinction by new technology. Combine that with a pretty reasonable valuation, and Colgate-Palmolive should be a great company to own for years to come.

For a couple more ideas, check out the Motley Fool's special report: "The 3 Dow Stocks Dividend Investors Need." It's free. Just click here.

Fool contributor Morgan Housel owns shares of Microsoft, Johnson & Johnson, and Procter & Gamble. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Johnson & Johnson, Microsoft, and Google. Motley Fool newsletter services have recommended buying shares of Procter & Gamble, Microsoft, Google, Johnson & Johnson, and UnitedHealth Group. Motley Fool newsletter services have also recommended creating a bull call spread position in Microsoft, a diagonal call position in UnitedHealth Group, and a diagonal call position in Johnson & Johnson. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (11) | Recommend This Article (34)

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.

  • Report this Comment On July 06, 2012, at 8:58 PM, MrSinnister wrote:

    When will Discovery Labs (DSCO) finally get some love from Motts? I mean they have 2 FDA approved products that go into distribution in the 4Q, with the FDA approval coming in March. They only have 43 million outstanding shares, with a current market cap of 125M which nearly multiplies with every 10 cent increase. They are going to distribute a drug for Respiratory Distress Syndrome for infants in the US and European markets, and they have TREMENDOUS upside, already up 60 percent on the year. Add to that two more drugs awaiting approval, Aeroserf, that is in a collaboration with Batelle to get streamlined and fine-tuned and Surfaxin LS, a liquid version of their already FDA-approved drug Surfaxin. How this stock stays in the 2 range is amazingly shortsighted.

  • Report this Comment On July 06, 2012, at 11:32 PM, MrSinnister wrote:

    Value of Surf LS + Afectair: 275million

    Shares O/S: 43mil

    Tell me why we can't see $40+/share with DSCO. Note that my sell target is below this, but I expect the stock to soar once it gains momentum. Imagine that liquid surfaxin penetrates the market quickly and gets great reviews by practicing docs (which it should). Surf LS will be even better. And Aerosurf even better after that.

    Facts:

    1. one approved device

    2. one approved drug

    3. $40 million in cash

    4. no debts

    5. no preferred stocks

    6. no impending warrants (outside of the 5yr 5M at 2.80)

    8. exclusive rights

    9. excellent pipeline

    10. Newly partnered (Batelle for R&D)

    11. MAA approval soon

    12. New device new drug launch soon

    13. Mkt Cap 128 million ???

    At 3 times sales, this is already $400 million firm, and that is $10 PPS. DSCO === Hidden Gem.

  • Report this Comment On July 07, 2012, at 8:21 AM, GW1000 wrote:

    I will check out DSCO. I was already familiar with and own four of the five stocks detailed in the article, so there was nothing for me to learn with those. I do not plan on selling these four, but you have got my attention on checking out DSCO as a potential new investment. Vertex Pharmaceutical in another possibility. VRTX reached profitibility recently with the successful launch of two drugs and has a good pipeline also. MrSinnister, what is your opinion of VRTX?

  • Report this Comment On July 07, 2012, at 8:30 AM, GW1000 wrote:

    DSCO is interesting but still speculative in my opinion. I will check into it as a speculative holding. VRTX could quickly skyrocket with upcoming earnings reports. QCOR is another interesting biotech company that has reached profitibility. DSCO may be the next. Do not put all of your eggs in one basket however, there are a lot of baskets out there!

  • Report this Comment On July 07, 2012, at 3:11 PM, lngtrmcptlgns wrote:

    Morgan,

    is there a site you recommend for finding reliable "EV/unlevered FCF" information?

    Thanks so much for your insights!

    After scouring various sources of investing guidance for years you are at the top of my list.

    Also would you recommend holding Google in a taxable account vs a retirement account (since it pays no dividend)?

  • Report this Comment On July 07, 2012, at 7:07 PM, MrSinnister wrote:

    @GMaster I see VRTX in the same place as DSCO, being pinned to the 35-50 range when it would easily shoot past 80 as Piper so eloquently put it. I 2 drugs with recent FDA approval but the PPS hasn't really moved. VRTX seems to be throwing their extra cash into short-term investments, so we also have to see in the coming year how that plays out. Still, their are in specialized markets, so it shouldn't take much to get a decent market penetration as they continue both clearing trials and expanding their reach through sales, exposure, and hospital penetration/connection. Yes, I'm definitely looking to try to play a few calls in this one by month's end.

    Thanks for the reply AND THE TIP!!

  • Report this Comment On July 07, 2012, at 7:42 PM, MrSinnister wrote:

    Yea, VRTX looks like a play I will definitely buy some calls into. They seem to be putting their extra cash into short-term investments, so we'll have to see how those play out (will they be repaid?, were they ownership claims?). They have 2 FDA drugs already out and a pipeline ready to sell them, as they prepare two more with one about to enter Phase 3.

    I mention this b/c FDA approval for their first two, Incivek and Kalydeco were approved w/in a year and the stock has not received a pop at all from them, even though they are no longer drowning in debt. I expect VRTX to breakout soon, although I hope it is not late this month so I'd have a chance to buy in heavier and reap the jump, although there are many others that are banking on this jump from the price of the calls.

    The short interest is 8M and probably more by now which is why VRTX is dropping right now, in anticipation of a rare earnings miss, but I just don't see that happening. I follow Piper in projecting 80+ here. Thanks for your response, and the tip! Forgive if a dup messages comes as I don't know after 30 mins if first one went through, and I didn't want to be seen as a selfish, one-trick(stock) pony.

  • Report this Comment On July 07, 2012, at 9:18 PM, GW1000 wrote:

    What do you think about Questcor (QCOR)?

  • Report this Comment On July 09, 2012, at 1:22 AM, MrSinnister wrote:

    QCOR looks VERY VERY good. Trading currently at 9x earnings, that could easily both increase to 12x and have 80-90 pps due to the fact that they use their profits to buy back shares which is taking less and less from cash flow. The short interest is over 25 percent w/10 days to cover, hopefully to pile on to keep the price down until next earnings when I"m going in HEAVY.

    They haven't missed since distribution since distribution of Acthar and H.P. Acthar, that are all-in-one nerve injections with a very expandable market base. As they get more experience, i feel they will get more in-depth with neurological pharmaceutics and widen their profit base even more. Again, w/the low o/s, their philosophy of buying back with extra cash and actually increasing revenues by at least 25 percent, every quarter, QCOR can easily touch 100 and when it starts moving (volume amazingly low), it will move fast and big.

    Thanks for yet ANOTHER tip.

  • Report this Comment On August 23, 2012, at 12:23 AM, MHedgeFundTrader wrote:

    While in Zermatt, Switzerland recently, I took the opportunity to undergo my annual physical. Over the years, I have discovered that American doctors are so paranoid about getting sued that I can never get a straight answer about anything, so I do all of my physicals abroad.

    I like visiting Dr. Christian because he is cut from the same cloth as I. He is a small wiry guy without an ounce of fat, and keeps his hair tied behind in a ponytail. Nothing like treating your patients through example. He has served as the team doctor on several Himalayan expeditions, reaching the incredible altitude of 25,000 feet without oxygen. He includes Mount McKinley and Aconcagua on his resume.

    He gave me the good news: I had blood pressure of 110/70 and a resting pulse rate of 50. This was at an altitude of 5,500 feet, which always elevates one’s blood pressure. The bottom line was that I had the heart of a teenaged Olympic athlete. He told me that whatever I was doing, to keep on doing it. I said that would be strapping on a 60 pound backpack and climbing the 1,500 foot mountain in my backyard every night after work. He answered that would explain everything.

    Dr. Christian usually allocates extra time for patients my age to deliver them bad news. That was unnecessary in my case. So we killed time trading notes on our favorite climbs.

    I also grilled him on the state of the Swiss medical system. He complained that it was going downhill, but was nowhere near as bad as in the US, where his brother practices medicine. Everyone here gets medical care after paying a small premium. His liability insurance was only $3,000 a year, compared to $100,000 in the US. The only malpractice suits in Switzerland are brought by Americans, and they always lose.

    The main reason medical costs were so low is that the people of Switzerland were so much healthier. Walking around the streets here, most people look like they are triathletes. And they do this despite smoking like chimneys. Maybe they are related?

    Life expectancy in Switzerland is 82.2 compared to only 78.2 in the US. And the quality of life at old age is much better. Obesity is rampant at home, but rare in the Alps. Diabetes is unusual in Switzerland, but epidemic in the US. Over 400,000 Americans undergo kidney dialysis in the US, while the treatment is almost unheard of in Europe. This is why the US is spending 12% of GDP on health care, on its way to 17%, while Switzerland is flat lining at 8%, with an older population.

    I thanked Dr. Christian for his advice. The total bill? $200. I headed to the local pharmacy to get a one year supply of my anti-cholesterol drug, which I can buy 90% cheaper than at home. That allows me to keep my total health care costs under $500 a year.

    I then celebrated my good fortune by stepping across the street for a bratwurst and a beer, which my American doctor once banned me from. There, I planned my coming assault on the Matterhorn.

    The Mad Hedge Fund Trader .

  • Report this Comment On August 23, 2012, at 1:33 AM, yonkmember wrote:

    On a EV/FCF basis, I like MSFT and AAPL

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