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 semiconductor player Broadcom
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.
Broadcom has a P/E ratio of 29.5 and an EV/FCF ratio of 17.6 over the trailing 12 months. If we stretch and compare current valuations with the five-year averages for earnings and free cash flow, Broadcom has a P/E ratio of 56.0 and a five-year EV/FCF ratio of 21.7.
A one-year ratio under 10 for both metrics is ideal. For a five-year metric, under 20 is ideal.
Broadcom is 0 for 4 on hitting the ideal targets, but let's see how it compares against some competitors and NETGEAR
Marvell Technology Group
Source: Capital IQ, a division of Standard & Poor's.
Numerically, we've seen how Broadcom's valuation rates on both an absolute and a 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, Broadcom's net income margin has ranged from minus 1.7% to plus 15.8%. In that same time, the unlevered free cash flow margin has ranged from 15.7% to 20.8%.
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.
Also, over the past five years, Broadcom has tallied up four 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 while you should definitely take the analysts' prognostications with a grain of salt, they can still provide a useful starting point when compared with similar numbers from a company's closest rivals.
Let's start by seeing what this company has done over the past five years. In that time, Broadcom has put up past EPS growth rates of 37.4%. Meanwhile, Wall Street's analysts expect future growth rates of 19.6%.
Here's how Broadcom 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 Broadcom are trading, how consistent the company's 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 looking at a 29.5 P/E ratio.
By the numbers, Broadcom looks like a classic pay for tech growth situation -- i.e., high multiples and high past and expected future growth. If Broadcom's numbers are enticing, then Marvell's are more so. One a one-year basis, its earnings and cash flow multiples are reasonable to downright low. And its growth profile rivals Broadcom's.
If you find Broadcom's or Marvell's numbers compelling, don't stop. Tech stocks are notorious for promising high growth, only to disappoint investors. Understanding the technology each employs is critical. For one possible upside for Broadcom, read this.
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