Investors seeking great stocks often start by looking for robust top- and bottom-line growth. Unfortunately, that's also where many people stop looking. Respected fund manager Bill Nygren couldn't be happier about that unfortunate trait -- if only because it gives him an edge.
Nygren, who manages several Oakmark funds, thinks that investors give short shrift to the balance sheet and the statement of cash flows. He rightly points out that the market usually recognizes and amply rewards revenue growth. Look at Sirius XM Radio (Nasdaq: SIRI), with its five-year average annual revenue gain of 71%, or Chinese search engine specialist Baidu (Nasdaq: BIDU), with 90%. Sirius's trades for a forward price-to-earnings ratio of 68, and Baidu for 46.
These are not undiscovered gems. Many investors already like Sirius's dominant position in satellite radio, its strong sales of factory-installed units in cars, and its tax-loss carry-forwards, which will shield billions in future earnings from taxes. They also appreciate Baidu's potential, its accelerating revenue growth, and the vast untapped market that still awaits it. With so many people already clamoring for their shares, investing in these popular companies won't give you a huge margin of safety.
Look deeper
Nygren, like most successful value investors, seeks not just attractive companies, but also attractive prices. Thus, he looks at cash flow and other metrics that most other investors tend to ignore. After all, a company can boost its earnings significantly if its revenue contribution gets augmented by cash from investments.
When questioned this summer on why he was still holding Apple (Nasdaq: AAPL), Nygren pointed to its prodigious cash generation: "The company should amass $50 per share of cash by the end of next year, after earning more than $16 per share. Adjusting the price and the earnings for that cash, the business is being priced at about 13 times expected earnings." He also cited Apple's competitive advantages in design, customer support, and switching costs.
Nygren has favored DirecTV (Nasdaq: DTV) for similar reasons. In February, he said, "It is selling at a small price-to-cash flow premium to Comcast (Nasdaq: CMCSA), which we also like a lot." In addition, Nygren believes that DirectTV could make a tempting takeover target for traditional telecoms.
He also spoke highly of Medtronic (NYSE: MDT): "So we have here a very good cash-generating company with a strong balance sheet selling at a slight discount to the market multiple when we think it deserves to be selling at a significant premium." He also finds Medtronic appealing because its wares can help lower its customers' medical costs. Note that in all these cases, Nygren examines more than mere numbers when sizing up an investment. The more you know and like about a company, the better you're likely to do with it.
Great investors think alike
I was happy to notice that in 2009, Nygren bought into Precision Castparts (NYSE: PCP). Fool co-founder Tom Gardner had been impressed with the company's much-improved balance sheet, among other things, in recommending the stock in August 2008. Nygren may have been similarly impressed. And indeed, the stock has advanced some 35% since Tom recommended it.
Revenue growth is critical for any company. Without top-line growth, the bottom line is doomed. Still, it pays to look beyond revenue growth and the income statement when you're seeking standouts for your portfolio.
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Longtime Fool contributor Selena Maranjian owns shares of Apple and Medtronic. Baidu is a Motley Fool Rule Breakers selection. Apple and Precision Castparts are Motley Fool Stock Advisor recommendations. The Fool owns shares of Apple and Medtronic. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.
