Does United Parcel Service Deserve a Spot in Your Portfolio?

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.
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 varies 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 owners greater value than a stagnant or declining business (duh!). However, many investors 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 United Parcel Service (NYSE: UPS) and some of its closest peers.

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

We see the men separated from the boys pretty blatantly here, with UPS and Expeditors International substantially outstripping the competition. Both exhibit strong historical returns and healthy margins. Expeditors bests UPS with greater growth and less leverage. It looks pretty appealing from a performance perspective. YRC Worldwide, literally on death's doorstep, shows nothing but red in all four aspects examined here. However, this makes up only one portion of the price/value equation.

How cheap does United Parcel Service look?
To examine 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.

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

On the pricing front, YRC again looks like a total wash, and investors should keep well away from its shares. Both UPS and FedEx look somewhat attractive relative to their earnings, but too pricey from a cash flow perspective. Conversely, Expeditors International's cash flow multiple looks more appealing than P/E, although neither appears obviously cheap on an absolute basis.

In assessing the overall value proposition, only UPS and Expeditors International look like possible candidates for your portfolio. FedEx looks too expensive, and YRC doesn't even deserve consideration from the average investor. That being said, with concerns over the strength of the global economy growing, right now might be a better time to remain on the sidelines than to buy aggressively. However, as the market declines, some of these stocks could make for very appealing long-term buys.

While United Parcel Service 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 community, where our users come to share their ideas and chat about their favorite stocks or click here to add the stocks in this article to My Watchlist.