Numbers can lie -- but 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 electric utility Dynegy (NYSE: DYN) might be.

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

Then, we'll take things up a notch with a more advanced metric: enterprise value to unlevered free cash flow. This 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). Like 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.

Dynegy has a negative P/E ratio and an EV/FCF ratio of 26.8 over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, Dynegy still has a negative P/E ratio and a five-year EV/FCF ratio of 176.8.

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

Dynegy is 0 for 4 on hitting the ideal targets, but let's see how it compares against some competitors and industry mates. 

Company

1-Year P/E

1-Year EV/FCF

5-Year P/E

5-Year EV/FCF

Dynegy

NM

26.8

NM

176.8

Calpine (NYSE: CPN)

170.8

11.3

NM

17.5

Mirant (NYSE: MIR)

16.2

9.9

1.7

4.8

NRG Energy (NYSE: NRG)

9.2

7.6

7.3

12.4

Source: Capital IQ, a division of Standard & Poor's; NM = not meaningful.

Numerically, we've seen how Dynegy'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, Dynegy's net income margin has ranged from (27.7%) to 5.2%. In that same time frame, unlevered free cash flow margin has ranged from (12.5%) to 13.1%.

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.

Additionally, over the last five years, Dynegy has tallied up one year of positive earnings and two 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 while you should definitely take the analysts' prognostications with a grain of salt, they can still provide a useful starting point when compared to similar numbers from a company's closest rivals.

Let's start by seeing what this company's done over the past five years. In that time period, Dynegy has put up past EPS growth rates that aren't meaningful because negative earnings. Meanwhile, Wall Street's analysts expect future growth rates of 5.2%.

Among Dynegy's peers, only NRG Energy has a meaningful trailing five-year growth rate. But here's how Dynegy 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 Dynegy 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. We've gone well beyond simply looking at a negative P/E ratio.

Still, I'm not compelled to dig much beyond the numbers with Dynegy. The negative earnings and paltry future growth expectations aren't enticing. I'd rather dig further on Duke Energy (NYSE: DUK), which tops a list of popular dividend-paying utilities.

But if you find Dynegy's numbers compelling, don't stop. Continue your due diligence process until you're confident that the initial numbers aren't lying to you.

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Anand Chokkavelu doesn't own shares in any company mentioned. Duke Energy is a Motley Fool Income Investor selection. 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.