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 expensive or cheap PetSmart (Nasdaq: PETM) might be.

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 -- 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.

PetSmart has a P/E ratio of 21.7 and an EV/FCF ratio of 14.5 over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, PetSmart has a P/E ratio of 23.1 and a five-year EV/FCF ratio of 23.5.

A one-year ratio under 10 for both metrics is ideal. For a five-year metric, under 20 is ideal.

PetSmart is zero for four on hitting the ideal targets, but let's see how it compares against some other retailers that specialize and fight against the big-box retailers. 

Company

1-Year P/E

1-Year EV/FCF

5-Year P/E

5-Year EV/FCF

PetSmart

21.7

14.5

23.1

23.5

Best Buy (NYSE: BBY)

9.4

10.2

10.4

12.6

AutoZone (NYSE: AZO)

14.9

12.7

17.5

17.5

RadioShack (NYSE: RSH)

8.1

7.4

10.1

6.2

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

Numerically, we've seen how PetSmart's valuation rates on both an absolute and 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, PetSmart's net income margin has ranged from 3.8% to 5.8%. In that same time frame, unlevered free cash flow margin has ranged from 1.1% to 7.8%.

How do those figures compare with those of the company's peers? See for yourself:

Petmmarginranges

Source: Capital IQ, a division of Standard & Poor's; margin ranges are combined.

Additionally, over the last five years, PetSmart has tallied up five years of positive earnings and five 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 period, PetSmart has put up past EPS growth rates of 9.4%. Meanwhile, Wall Street's analysts expect future growth rates of 13.9%.

Here's how PetSmart compares to its peers for trailing five-year growth:

Petmtrailing

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:

Petm

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 the price multiples shares of PetSmart are trading at, 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 21.7 P/E ratio, and while its price multiples aren't as attractive as those of its peers, its profitability has been consistent and its growth has been solid. If you find PetSmart's numbers or story compelling, don't stop. Continue your due diligence process until you're confident that the initial numbers aren't lying to you.

Interested in reading more about any of these stocks? Add them to My Watchlist to find all of our Foolish analysis. And for more stock ideas, check out this recent article: "The Only Stocks You'll Need to Retire."

Anand Chokkavelu doesn't own shares in any company mentioned. Best Buy is a Motley Fool Inside Value recommendation. Best Buy and PetSmart are Motley Fool Stock Advisor selections. The Fool owns shares of Best Buy. 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.