Numbers can lie -- yet they're the best first step in determining whether a stock is a buy. In this series, we use some carefully chosen metrics to size up a stock's true value based on the following clues:

  • The current price multiples.
  • The consistency of past earnings and cash flow.
  • How much growth we can expect.

Let's see what those numbers can tell us about how cheap Monsanto (NYSE: MON) might be.

The current price multiples
First, we'll look at most investors' favorite metric: the price-to-earnings ratio. It divides the company's share price by its earnings per share (EPS). The lower the P/E, the better.

Then we'll take things up a notch with a more advanced metric: enterprise value to unlevered free cash flow. This tool divides the company's enterprise value (basically, its market cap plus its debt, minus its cash) by its unlevered free cash flow (its free cash flow, adding back the interest payments on its debt). As with the P/E, the lower this number is, the better.

Analysts argue about which is more important -- earnings or cash flow. Who cares? A good buy ideally has low multiples on both.

Monsanto has a P/E ratio of 30.0 and an EV/FCF ratio of 60.7 over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, Monsanto has a P/E ratio of 25.9 and a five-year EV/FCF ratio of 31.9.

A one-year ratio less than 10 for both metrics is ideal. For a five-year metric, less than 20 is ideal.

Monsanto is 0-for-4 on hitting the ideal targets, but let's see how it stacks up against some of its competitors and industry mates. 

Company

1-Year P/E

1-Year EV/FCF

5-Year P/E

5-Year EV/FCF

Monsanto

30.0

60.7

25.9

31.9

DuPont (NYSE: DD)

12.2

13.2

15.6

16.8

Dow Chemical (NYSE: DOW)

13.7

30.4

13.6

24.6

3M (NYSE: MMM)

15.0

13.9

19.9

21.2

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

Numerically, we've seen how Monsanto's valuation rates on both an absolute and relative basis. Next, let's examine …

The consistency of past earnings and cash flow
An ideal company will be consistently strong in its earnings and cash-flow generation.

In the past five years, Monsanto's net income margin has ranged from 0.2% to 18.6%. In that same time frame, its unlevered-free cash-flow margin has ranged from 0.3% to 22.8%.

How do those figures compare with those of the company's peers? See for yourself.


Source: Capital IQ, a division of Standard & Poor's; margin ranges are combined.

In addition, over the past five years, Monsanto has tallied up five years of positive earnings and five years of positive free cash flow.

Next, let's figure out …

How much growth we can expect
Analysts tend to comically overstate their five-year growth estimates. If you accept them at face value, you will overpay for stocks. But even though you should definitely take the analysts' prognostications with a grain of salt, they can provide a useful starting point compared with similar numbers from a company's closest rivals.

Let's start by seeing what this company's done over the past five years. Monsanto has put up past EPS growth rates of 32.0% over that stretch, while Wall Street's analysts expect future growth rates of 12.5%.

Here's how Monsanto compares with its peers for trailing-five-year growth:


Source: Capital IQ, a division of Standard & Poor's; EPS growth shown.

And here's how it measures up with regard to the growth analysts expect over the next five years:


Source: Capital IQ, a division of Standard & Poor's; estimates for EPS growth.

The bottom line
The pile of numbers we've plowed through has shown us how cheap shares of Monsanto are trading, how consistent its performance has been, and what kind of growth profile it has -- both on an absolute and a relative basis.

The more consistent a company's performance has been and the more growth we can expect, the more we should be willing to pay. Monsanto has high multiples across the board, but it's had impressive trailing earnings growth. Analysts are still bullish on future growth despite increased competition. DuPont trades at lower multiples, but its growth, both past and prospective, isn't in Monsanto’s league.

We've gone well beyond looking at a 30.0 P/E ratio. Still, the numbers are just a start. If you find any of this data compelling, don't stop here. Continue your due-diligence process until you're confident that the initial numbers aren't lying to you.

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Anand Chokkavelu owns no shares in any company mentioned. 3M and Monsanto are Motley Fool Inside Value selections. Motley Fool Options has recommended a synthetic long position on Monsanto. 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.