You'd better sit down for this, Fools, because I may be about to eat my own words -- and maybe a helping of crow to boot. (Let's hope that seven years have improved the taste).
Seven years ago, I put an article in this space explaining the simple reason I won't buy ExxonMobil stock. Granted, I never actually used the word "never" in the article -- but that was the clear implication. After running the numbers and comparing Exxon's reported net income to the actual free cash flow it was generating from its oil business, I had concluded:
"It costs a lot of money to build the infrastructure needed to take oil out of the ground [but] the cash profit they earn [from these investments simply] isn't nearly as rich as is represented on their income statements."
My conclusion: ExxonMobil (XOM -2.78%) was not as cheap as it looked -- never had been, and never would be. And therefore, the stock should not be bought. So imagine my surprise when I ran my usual end-of-year value stock screener specifically looking for cheap stocks generating high free cash flow -- and ExxonMobil popped up at the top of the list.
Old tools, new tricks
To recap, I first developed this stock screener to uncover hidden gems in the rubble of the 2008 Financial Crisis -- beaten-down stocks that were nonetheless generating significant free cash flow, projected to grow that cash flow quickly, carrying modest debt, and selling for bargain prices. I called this tool my make-me-rich screener, and over the past 15 years it's actually worked pretty well to uncover great stock bargains, but usually among small-cap stocks.
My question today is: Could a gigantic dividend stock like ExxonMobil stock be a value stock in disguise?
Let's examine the evidence.
Past and present
Over the span from 2000 through 2019, ExxonMobil reported a staggering $532.4 billion in net profit. Not revenue. Profit.
Actual free cash flow for the period, however, was more modest $369.6 billion -- still a tidy sum, but about 30% less real free cash flow than the company reported as its net income. Basically, for every $1 the company said it earned over this 20-year period, it actually generated less than $0.70 in real cash profit.
Or put another way, investors who bought Exxon stock during this time period, based on its low P/E ratio, were actually paying 44% more than they thought they were, based on the value of the company's free cash flow. This, in a nutshell, is why I've declined to buy ExxonMobil stock in the past.
But what about the present?
Well, when COVID hit, shaking up economies and economics around the globe, Exxon seemed to flip the script -- maybe only temporarily, but maybe not temporarily. From 2020 through 2022, and into the first quarter of 2023, Exxon generated a lot more free cash flow ($102.7 billion) than it reported in net income ($67.7 billion). Granted, the full 2023 results aren't in just yet, but through the three quarters that have been reported, free cash flow at net income are now roughly even -- $26 billion to $28.4 billion.
Now, that's still a difference of about 8.5%. But it's a much smaller difference than we've seen with Exxon stock historically, and this suggests Exxon's apparent P/E may now finally better reflect its real ability to generate cash. In fact, if we run-rate out what Exxon's been earning through the end of this year, the company could end up with total annual free cash flow of $34.7 billion in 2023, implying a price-to-free cash flow ratio of only 11.5 -- not too far off from the company's 10.7 P/E ratio.
Valuing ExxonMobil stock
For one of the world's top oil companies, I have to say that seems an attractive price. It gets even more attractive when you consider that ExxonMobil has been using its free cash flow to (1) pay down debt (long-term debt has fallen more than $10 billion over the past three years) and (2) continue growing its dividend payout. Exxon has, in fact, raised its dividend amount every single year for the past 41 years straight, and it currently pays a 3.8% dividend yield -- more than twice the average payout of the S&P 500.
By my calculations, Exxon's dividends justify about one third of its stock price today. And if Exxon can continue growing its earnings by at least 7% annually in the future, the stock could be not just fairly priced -- but actually cheap.
When you consider that, over the past five years, S&P Global Market Intelligence data shows that Exxon has averaged income growth of more than 12%... well, I'd say the chances that Exxon stock will outperform the market from this point on look pretty darned good.
