Which Trash Hauler Has Treasure for Your Portfolio?

Welcome to "Stock Smackdown," where two of your favorite stocks go head to head in a battle for superiority. They'll each be judged on a series of objective merits, including valuation, earnings quality, and dividend quality. We'll also take a look ahead at some more subjective measures -- Wall Street's analysts will get their say, but so will The Motley Fool's top market minds.

The winner will be the stock that racks up the most points at the end of their competition. Let's go to ringside and meet our two combatants, Waste Management (NYSE: WM) and Veolia Environnement (NYSE: VE).

In this corner...
This is one battle that proves the value of keeping people's environments clean. Waste Management is America's biggest trash hauler, while Veolia dominates European waste and water management. Both stocks have been in a bit of a funk lately. Waste Management's most recent quarterly earnings weren't particularly appealing, and labor-related problems threaten to undermine its second-half profitability. Veolia's reeled under Europe's weakness, and its diversified holdings are becoming gradually less so as it struggles to reduce a heavy debt burden. Waste Management's also working on converting more of its trash into useful energy, thus reducing the inherently polluting nature of its core business and making it an appealing stock to more socially conscious investors.

Veolia abandoned its American trash-hauling business to Waste Management and Republic Services (NYSE: RSG), but still offers this essential service in its home markets. The company also retains a focus on water services overseas that makes it one of the few solid international water utilities you can buy. A tighter focus on water services could make Veolia's stock a sleeper hit -- American Water Works (NYSE: AWK) has doubled in the past five years as Veolia's diversified its way into the dumps. Waste Management, Republic, and American Water Works all looked less costly on a P/E basis than Veolia this spring, and that gap's only gotten wider as Veolia's become unprofitable. Efforts to tighten up its operations might make Veolia a good turnaround play, but those plans take time to enact.

Will trash bring treasure to your portfolio, or will Veolia's water services provide sweet liquidity once it recovers? Let's dig into the numbers to find out.

Valuation battle
We use many different numbers and ratios when talking about the value of a stock. The price-to-earnings ratio is the standard, so we'll check each company's current P/E and five-year historical average P/E. We'll also use price to free cash flow today. Earnings can be gamed with a number of different accounting tricks, but free cash flow is harder to manipulate, making it a favored metric here at the Fool.

In each case, the difference between a stock's current ratio and its five-year average ratio will be more important than the numbers themselves. Stocks trading significantly lower than their average ratios may have more room to return to that middle ground.

For the tiebreaker, we'll check one less-used financial metric: the debt-to-equity ratio. A company with little or no debt is usually in better shape than one leveraged to its eyeballs.

Source: Wolfram Alpha and YCharts. Winners in bold. NM = not material due to negative results.

It looks like Waste Management takes this round with a lower level of debt to equity. How will it fare in the next round?

Earnings quality battle
A company can be cheaply valued without being a good value. To balance out our valuation fight, let's look at a few key earnings statistics for each company. We'll look at gross and net margins, a five-year annualized rate of earnings growth, and consecutive years of both positive earnings and earnings growth since 1992, two decades ago. A company with no momentum today is less likely to become a superstar later -- it has happened before, but not often.

Sources: Yahoo! Finance and Wolfram Alpha. Winners in bold.

A clean sweep for Waste Management! Both companies have slumped, but Veolia's fallen much further, and its key ratios all look rather weak.

Dividend battle
A growing company is great, but one that pays you back is even better. Let's see how strong and stable each company's dividends really are. We'll examine yield and two payout ratios, both the standard net income-based ratio and the free cash flow payout ratios. We'll also examine each company's five-year annualized dividend growth rate, and each company's current streak of uninterrupted payments.

Those payout ratios are important, particularly the free cash flow payout ratio. Companies that pay out more than they take in can rarely sustain such practices for long.

Sources: Morningstar and Dividata. Winners in bold. NM = not material due to negative results. *Waste Management occasionally paid $0.01 dividends from 1998-2003.

Poor Veolia's dividend doesn't look particularly sustainable right now. Waste Management's history of dividend growth leads it to a decisive victory. What do the pros (and some average joes) think about each company's future?

Battle for the future
Looking at the past is well and good, but let's go further. How do the world's most engaged market participants view these companies? Let's see what Wall Street's analysts expect from these companies, and what our Motley Fool CAPS community thinks.

Sources: Yahoo! Finance, Motley Fool CAPS. CAPS rating = out of five stars.

Well, that's a little awkward. Neither company is getting any love from the analysts lately, but those on Veolia's case have at least deigned to award it some comeback potential. Our CAPS players are overwhelmingly in favor of Waste Management beating the indexes in the years ahead. It's a split decision, but Waste Management's got the overall battle in the bag.

The results are decisive: Waste Management picks up the win! Its dividend is sustainable, and its business ought to hold up better than Veolia's through any economic weakness. For more great dividend ideas, take a look at the Fool's latest free report, "The 3 Dow Stocks Dividend Investors Need." It's available for a limited time, so claim your free information now.