What do I think of I, Robot? I loved it. Loved it when it was a collection of short stories by science fiction legend Isaac Asimov. Loved it when it came out as a feature film starring Will Smith a couple years ago.
Oh. You meant, "What do I think of iRobot (Nasdaq: IRBT ) , the stock?" Well, that's a different story.
As of this writing, the little Roomba-maker's shares are changing hands for about $28 a stub. Although that's a 25% discount from what shareholders had to pay just three months ago, I still say that iRobot's not cheap enough. I've arrived at this conclusion by two paths. Let's do the "easy math" solution first.
Eyeballing a value
There are something like 10,000 stocks trading on the public markets at any given hour. A Fool simply doesn't have time to run exact valuations on each of them in search of bargains. To weed out the riffraff, I employ a shortcut described in this column: the "seven steps."
Basically, they boil down to seeking out companies with positive free cash flow (FCF), priced at a low multiple to that free cash flow after netting out the firm's cash and long-term debt (enterprise value, or "EV"), and growing at a rate (G) in excess of the quotient of EV/FCF.
More simply, I look for firms where the EV/FCF/G ratio is less than 1.0. A stock that passes this test is a probable bargain. A stock that fails the test is ... well, not.
With $650 million in market cap, $76 million in cash, and an enterprise value of just $574 million, iRobot doesn't look too expensive. It's certainly growing fast enough, with profits projected to grow by 35% annually over the next five years. Unfortunately, iRobot fails the "seven steps" test because it has no positive free cash flow at all. Although the firm reports positive "accounting profits" under generally accepted accounting principles (GAAP), its "cash profits," or free cash flow, are negative. Even if you substitute the firm's accounting profits for real cash profits, the formula would still look as bad as this:
$574 million / $2.6 million / 35 = 6.3. That means the firm looks about five times overvalued.
Now for the hard part
Based solely on the above calculation, I looked at iRobot after its 25% haircut and decided the stock was still much too richly priced for me.
But before taking this position public, I decided to give the firm one more chance and run its numbers through the Fool's own discounted cash flow calculator. (Feel free to click that link and follow along with the math.)
I chose a 12% discount rate, demanding only a very slight premium to the 10.5% return that investors have historically been able to secure via a simple index fund. Because iRobot has no free cash flow, I ran the numbers based on the firm's $2.6 million in trailing-12-month accounting profits instead.
In my first calculation, I inputted the analysts' expected rate of 35% growth over the next five years, and then 20% per year for the five years following, before dropping the growth rate down to average GDP growth -- 3% from there to infinity. Result: iRobot's expected future profits, discounted back to present value, are worth about $7 a share today. Even with $3.25 per share in cash, that still makes the firm look overvalued by more than 170%.
Waiter? Reality check, please.
In fact, at $28 per share, the market is assuming that iRobot will beat analyst estimates and grow its profits by nearly 50%. Each year. Every year. For the next 10 years. Sorry, folks, but that's simply not credible.
iRobot may be a "cool" company, and if Hollywood has taught us anything -- in I, Robot, Alien, and the various Terminator flicks -- it's that robots are the future. But if it's taught us anything else, it's that robots aren't necessarily our friends. At this price, neither is iRobot's stock.
Think you're done with the Duel? You're not! Go back and read the other three arguments, and then vote for a winner.
Fool contributorRich Smith has no position, short or long, in iRobot, but the stock is a recommendation ofMotley Fool Rule Breakers. The Fool'sdisclosure policy obeys Asimov's Laws.