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 can be expected.
Let's see what those numbers can tell us about how expensive or cheap Archer Daniels Midland
The current price multiples
First, we'll look at most investors' favorite metric: the P/E ratio, which 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. But who cares? A good buy ideally has low multiples on both.
ADM has a P/E ratio of 9.0 and a negative EV/FCF ratio over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, ADM has a P/E ratio of 10.0 and a negative five-year EV/FCF ratio.
A positive one-year ratio under 10 for both metrics is ideal (at least in my opinion). For a five-year metric, under 20 is ideal.
ADM has a mixed performance in hitting the ideal targets, but let's see how it compares against some competitors and industry mates.
|Archer Daniels Midland||9.0||NM||10.0||NM|
|Corn Products International||10.8||134.3||19.5||42.7|
Source: S&P Capital IQ; NM = Not meaningful due to losses.
Numerically, we've seen how ADM's valuation rates on both an absolute and relative basis. Next, let's examine …
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, ADM's net income margin has ranged from 1.8% to 4.6%. In that same time frame, unlevered free cash flow margin has ranged from -4.3% to 1.6%.
How do those figures compare with those of the company's peers? See for yourself:
Source: S&P Capital IQ; margin ranges are combined.
Additionally, over the last five years, ADM has tallied up positive earnings every year and positive free cash flow two of those years.
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 still can 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, ADM has put up past EPS growth rates of 7.1%. Meanwhile, Wall Street's analysts expect future growth rates of 9.2%.
Here's how ADM compares to its peers for trailing five-year growth:
Source: S&P Capital IQ; EPS growth shown.
And here's how it measures up with regard to the growth analysts expect over the next five years:
Source: S&P Capital IQ; estimates for EPS growth.
The bottom line
The pile of numbers we've plowed through has shown us the price multiples at which shares of Archer Daniels Midland are trading, the volatility of its operational performance, 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 9.0 P/E ratio and can see that its five-year P/E ratio is even cheaper given the longer time frame.
Its EV/FCF ratios aren't meaningful due to negative free cash flow. This negative free cash flow is due to large spending on capital expenditures, which will be a good use of funds if it results in profitable growth in the future.
On the margin and growth side, we see low but consistently positive earnings margins and low but positive growth.
Our CAPS community rates it four stars out of five, and the initial numbers make Archer Daniel Midland look interesting for further research, but all this is just a start. If you find Archer Daniels Midland's numbers or story compelling, don't stop. Continue your due diligence process until you're confident one way or the other. As a start, add it to your Watchlist to find all of our Foolish analysis.
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Anand Chokkavelu doesn't own shares in any company mentioned. 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.