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 we can expect
Let's see what those numbers can tell us about how cheap fabless semiconductor maker Conexant Systems
The current price multiples
First, we'll look at most investors' favorite metric: the P/E ratio. It 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. Who cares? A good buy ideally has low multiples on both.
Conexant Systems has a P/E ratio of 3.1 and an EV/FCF ratio of 10.0 over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, Conexant Systems has negative P/E and EV/FCF ratios.
A one-year ratio under 10 for both metrics is ideal. For a five-year metric, under 20 is ideal.
Conexant Systems has a mixed performance in hitting the ideal targets, but let's see how it compares against some competitors and industry mates.
Integrated Device Technology
Marvell Technology Group
Source: Capital IQ, a division of Standard & Poor's; NM = not meaningful.
Numerically, we've seen how Conexant Systems' valuation rates on both an absolute and a relative basis. Next, let's examine ...
The 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, Conexant Systems' net income margin has ranged from minus 137.6% to 18.8%. In that same time frame, unlevered free cash flow margin has ranged from minus 6.5% to 10.6%.
How do those figures compare with those of the company's peers? See for yourself:
Source: Capital IQ, a division of Standard & Poor's; margin ranges are combined.
Also, over the past five years, Conexant Systems has tallied up one year of positive earnings and three years of positive free cash flow.
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 can still 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, Conexant Systems has put up past EPS growth rates that aren't meaningful. This is because it had negative earnings five years ago. Meanwhile, Wall Street's analysts expect future growth rates of 20%.
Here's how Conexant Systems compares with its peers for trailing five-year growth:
Source: Capital IQ, a division of Standard & Poor's; EPS growth shown.
And here's how it measures up with regard to the growth analysts expect over the next five years (there aren't analyst estimates available for Integrated Device Technology):
Source: Capital IQ, a division of Standard & Poor's; estimates for EPS growth.
The bottom line
The pile of numbers we've plowed through has shown us how cheap shares of Conexant Systems are trading, how consistent its performance has been, 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.
Conexant hasn't been consistent, but its one-year P/E ratio of just 3.1 is eye-popping. So is its expected growth of 20%. For a semiconductor company, the numbers can be deceiving. Technologies change and can either make a quick winner or a quick loser. Also the company's P/E ratio is partially inflated by gains it booked from selling some discontinued assets.
If you find Conexant Systems' numbers or technology compelling, don't stop. Continue your due diligence process until you're confident that the initial numbers aren't lying to you.
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Anand Chokkavelu doesn't own shares in any company mentioned. The Fool owns shares of Marvell Technology Group. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Fool has a disclosure policy.