The Power of Earnings: Precision Castparts

Chartists, momentum investors and palm readers may disagree, but at The Motley Fool we know that a stock is worth only the cash flow its underlying business generates. But as investors, how do we know if we're buying those cash flows on the cheap or if we're paying too much for future expectations?

Try using the earnings power value (EPV), a quick way to calculate the value of a company's current earnings. Once we've crunched the numbers, we can then compare the EPV to a company's stock price to determine the value that investors are giving its earnings growth. Then you can make the call if it's worth paying up for that future growth.

If you're new to the EPV way, check out our primer here. Don't worry: You don't need a Ph.D. in finance -- just a few numbers you can easily find at Fool.com's quote pages. Let's take a quick look at the EPV for Precision Castparts (NYSE: PCP).

First: What it does
Precision Castparts specializes in designing and manufacturing high-end mechanical products for use in jet engines, gas turbines, and industrial machinery. More than half of its sales are tied to the aerospace industry, which has had a rough couple of years but is starting to show some signs of life.

Second: The value of today's earnings
Using our handy EPV primer from above and a 10% discount rate, we calculate the following for Precision Castparts:

Source: Capital IQ, a division of Standard & Poor's.
*Using fiscal 2010 data in place of trailing twelve months.

Third: Is it worth it?
I'm not surprised to see that growth accounts for about 40% of Precision Castpart's stock price. Over the past five years, Precision has been a growing machine, increasing revenues by 12% per year and operating profits by 25% per year. And the future looks bright, too. Analysts expect 12% growth this fiscal year and 17% growth next year as aerospace clients, like Boeing, start to take off.

Fourth: Precision's EPV vs. three others
Let's see how Precision stacks up against three other companies competing in the industrial and/or aerospace industries. Running these three companies through our EPV calculator (using the same 10% discount rate):

We can see that investors are not counting on much growth, if any, in Raytheon's or Spirit's current earnings. Are we getting any future growth for free? If so, then the stocks could be a good buying opportunity. But maybe there are some uncertain clouds on the horizon (like Spirit's big inventory buildups for Boeing's 787 Dreamliner). So it's time to dig deeper. Remember, EPV is a handy tool to see what price investors are putting on a company's future. It's just a starting point but a pretty good one. Give it a try and let us know which of the above stock looks best for market-beating returns by posting your opinion down below.

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