Does Westport Innovations Look Like A Home Run Stock?

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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' ability to generate profits, and
  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 vary 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 owner greater value than a stagnant or declining business (duh!). However, many investors also 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 Westport Innovations (NAS: WPRT) and some of its closest peers.

Company

ROE (5-Year Avg.)

EBIT Margin (5-Year Avg.)

EBIT Growth (5-Year Avg.)

Total Debt / Equity (%)

Westport Innovations(59.0%)(19.8%)NM14.2%
Clean Energy Fuels (NAS: CLNE) (21.9%)(32.3%)NM21.6%
Cummins (NYS: CMI) 22.8%7.6%22.6%13.8%
Fuel Systems Solutions (NAS: FSYS) 13.9%12.3%83.6%3.2%

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

We have some polarized performances here. Westport and Clean Energy have yet to convert their promise into financial performance. On the other hand, Cummins and Fuel Systems look quite the opposite. Cummins and Fuel Systems generated respectable figures across the board, with Fuel Systems producing really prodigious growth. All these companies appear to have manageable debt burdens.

How cheap does Westport Innovations look?
To look at 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.

Company Name

EV / FCF

P / LTM Diluted EPS Before Extra Items

Westport Innovations(25.0)NM
Clean Energy Fuels(18.9)NM
Cummins19.811.4
Fuel Systems Solutions(9.0)43.5

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

We see the difference in performances here as well. The most established company here, Cummins, has the most alluring multiples on both a cash flow and earnings basis. Westport and Fuel Systems both registered negative operating cash flows over the last twelve months, which is not an encouraging sign. Clean Energy underwent massive capital expenditures over the last year, driving its free cash flow multiple into the red as well.

Overall, I don't love what I see here. Cummins demonstrated the best overall performance over the last five years, but it's also the most established firm out of these. The rest of the pack, in one way or another, looks like they're still trying to gain traction with their business models.

While Westport Innovations doesn't look like a winning stock on the surface, 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 page where our users come to share their ideas and chat about their favorite stocks or click HERE to add them to My Watchlist.

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At the time this article was published Andrew Tonner holds no position in any of the companies mentioned in this article.Motley Fool newsletter serviceshave recommended buying shares of Westport Innovations. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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