As investors, we always want our investments to generate a healthy return. However, investors often forget that returns stem from two, not one, extremely important factors:

  1. the business's ability to generate profits and
  2. the price you pay for one share of those profits.

This idea of price versus returns provides the bedrock for the school of investing known as value investing. In this series, I'll examine a specific business from both a quality and pricing standpoint. Hopefully, in doing so, we can get a better sense of its potential as an investment right now.

Where should we start to find value?
As we all know, the quality of businesses vary widely. A company that has the ability to grow its bottom line faster (or much faster) than the market, especially with any consistency, gives its owner greater value than a stagnant or declining business (duh!). However, many investors also fail to understand that any business becomes a buy at a low enough price. Figuring out this price-to-value equation drives all intelligent investment research.

In order to do so today, I selected several metrics that will evaluate returns, profitability, growth, and leverage. These make for some of the most important aspects to consider when researching a potential investment.

  • Return on equity divides net income by shareholder's equity, highlighting the return a company generates for its equity base.
  • The EBIT (short for earnings before interest and taxes) margin provides a rough measurement of the percent of cash a company keeps from its operations. I prefer using EBIT to other measurements because it focuses more exclusively on the performance of a company's core business. Stripping out interest and taxes makes these figures less susceptible to dubious accounting distortions.
  • The EBIT growth rate demonstrates whether a company can expand its business.
  • Finally, the debt-to-equity ratio reveals how much leverage a company employs to fund its operations. Some companies have a track record of wisely managing high debt levels, generally speaking though, the lower the better for this figure. I chose to use five-year averages to help smooth away one-year irregularities that can easily distort regular business results.  

Keeping that in mind, let's take a look at Ameren Corp. (NYSE: AEE) and some of its closest peers.

Company

Return on Equity (5-year avg.)

EBIT Margin (5-year avg.)

EBIT Growth (5-year avg.)

Total Debt / Equity

Ameren

7.48%

19.00%

3.52%

96.60%

Entergy (NYSE: ETR)

14.07%

18.48%

4.60%

135.86%

Exelon (NYSE: EXC)

22.25%

27.13%

4.38%

97.34%

NextEra Energy (NYSE: NEE)

13.71%

16.93%

18.97%

146.43%

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

Ameren generates a below-average return on its equity and growth of its operating earnings. However, it enjoys relatively reasonably strong operating margins. It has the most conservative capital structure out of the group.

Entergy generates almost twice the return on its equity as Amaren while also suffering from weak growth. Its EBIT margin seems healthy. It has a reasonably leveraged capital structure, although you typically see this capital intensive industry such as utilities.

Exelon produces far and away the strongest ROE and operating margins out of the companies listed here, while lacking a strong growth component. Its capital structure seems safe.

NextEra separates itself from the group by having the only true growth element. It generates average returns and healthy margins, like Entergy. It has the highest debt load out of the companies mentioned here.

How cheap does Ameren look?
To look at pricing, I chose to look at two important multiples, price to earnings and enterprise value to free cash flow. Similar to a P/E ratio, enterprise value (essentially debt, preferred stock, and equity holders combined minus cash) to unlevered free cash flow conveys how expensive the entire company is versus the cash it can generate. This gives investors another measurement of cheapness when analyzing a stock. For both metrics, the lower the multiple, the better.

Let's check this performance against the price we'll need to pay to get our hands on some of the company's stock.

Company

Enterprise Value / FCF

P / LTM Diluted EPS Before Extra Items

Ameren

14.88

65.50

Entergy

23.91

9.60

Exelon

NM

11.14

NextEra Energy

NM

14.19

Source: Capital IQ, a Standard & Poor's company; NM = not meaningful, denoting a negative figure.

In terms of pricing, these companies all look priced either fairly or perhaps maybe even expensively. You do start to see some possibly tempting metrics on the earnings multiple side, though.

Given the decent performances seen above, one of these companies looks to offer an attractive enough risk-reward proposition to perform a more detailed analysis.

While Ameren stock doesn't look like a stock for your portfolio right now, the search doesn't end here. In order to really get to know a company, you need to keep digging. If any of the companies mentioned here today piques your interest, further examining a company's quality of earnings, management track record, or analyst estimates all make for great ways to further your search. You can also stop by The Motley Fool's CAPS page where our users come to share their ideas and chat about their favorite stocks or click here to add them to My Watchlist.

Andrew Tonner holds no position in any of the companies mentioned in this article. The Motley Fool owns shares of NextEra Energy. Motley Fool newsletter services have recommended buying shares of and creating a covered strangle position in Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.