Here's why Windstream (Nasdaq: WIN) might be cheaper than you think.

In the daily noise machine of CNBC, analyst estimates, and quarterly announcements, investors are inundated with talking heads obsessing over earnings-per-share figures.

This is the primary metric we use to mark corporate progress. Earnings, or net income, are also the basis for the price-to-earnings ratio, the most popular way of measuring how cheap or expensive a stock is.

Free cash flow -- the amount of cash a company earns on its operations minus what it spends on them -- is another, oftentimes more accurate metric that can help you identify cheap stocks. That means investors like us who peek at free cash flow can gain a significant advantage in the market.

How Windstream stacks up
If Windstream tends to generate more free cash flow than net income, there's a good chance earnings-per-share figures understate its profitability and overstate its price tag. Conversely, if Windstream consistently generates less free cash flow than net income, it may be less profitable and more expensive than it appears.

This graph compares Windstream's historical net income to free cash flow. (I omitted various gains and charges such as tax deferrals, restructurings, and benefits related to stock options.)



Source: Capital IQ, a division of Standard & Poor's, and author's calculations.

As you can see, Windstream has a tendency to produce more free cash flow than net income, largely because of capital expenditures coming in lower than depreciation and amortization charges from previous purchases.

This means that the standard price-to-earnings multiple investors use to judge companies may overstate its price tag.

Let's examine Windstream alongside some of its peers for additional context:

Company

Price-to-Earnings Ratio

Adjusted Price-to-Free-Cash-Flow Ratio

Adjusted Enterprise-Value-to-Free-Cash-Flow Ratio

Windstream

17.3

8.6

19.3

Verizon (NYSE: VZ)

116.8

N/A

N/A

CenturyLink (NYSE: CTL)

N/A

N/A

N/A

Qwest Communications (NYSE: Q)

N/A

3.2

1.6

Frontier Communications (NYSE: FTR)

18.1

9.3

27.3

MetroPCS Communications (NYSE: PCS)

12.5

8.7

14.7

Level 3 Communications (Nasdaq: LVLT)

59.8

40.8

48.7

Median

17.7

8.7

18.8

It's not unusual for Windstream's peers to generate more free cash flow than earnings, which translates into low free-cash-flow multiples. (CenturyLink, which is both earnings- and free-cash-flow negative is the lone exception.) Windstream's multiples are about in line with its peers.

The disparity between Windstream's price-to-earnings and price-to-free-cash-flow ratios is jarring. If we decide to include Windstream's debt, however, the multiple expands considerably in the third column.

While a free-cash-flow multiple that takes debt into account shows Windstream as more expensive than a traditional price-to-earnings multiple, one that excludes debt shows Windstream to be considerably cheaper. Depending on which you prefer, Windstream may be much cheaper than many investors realize.

Ilan Moscovitz doesn't own shares of any company mentioned. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.