Investing 101: 6 Stocks Undervalued by Target Price and Levered Free Cash Flows

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Warren Buffett may best be known in the investment community for his success in value investing -- the concept of buying undervalued companies (or stocks) that eventually rise to their fair price, generating a profit. If you consider yourself a value investor, here are some ideas to get started.

Target price
In finding a proxy for fair value, one option is mean analyst target price. This is the price that analysts believe the stock will move to within the next year. Therefore, stocks trading at significant discounts to their target prices may be undervalued.

However because target price tends to be inflated due to analyst optimism, try using the lowest (most pessimistic) analyst target prices, and only of companies with sufficient analyst coverage of at least five ratings.

Levered free cash flow
Another way to find potentially undervalued stocks is by using the ratio levered free cash flow/enterprise value.

Levered free cash flow is the free cash flow after deducting interest payments on outstanding debt. Enterprise value is the sum of the firm's value from all ownership sources: market cap, outstanding debt, and preferred shares. Companies with high ratios of levered free cash flow/enterprise value may be undervalued by the market. 

Business section: Investing ideas
To illustrate these ideas, we ran a screen for stocks trading at the most significant discounts to even their most pessimistic (lowest) target prices. We also screened for those with the highest ratios of levered free cash flow/enterprise value, also indicating that they may be undervalued.

Do you think the market is undervaluing these names? Use this list as a starting point for your own analysis. (Click here to access free, interactive tools to analyze these ideas.)

1. ReachLocal (NAS: RLOC) : Provides a suite of online marketing and reporting solutions for the small and medium-sized businesses (SMBs) in North America and internationally. Of the 8 analysts that research this stock, the lowest target price stands at 10, which implies an upside of 21.07% from current levels around 8.26. Levered free cash flow at $19.83M vs. enterprise value at $146.21M (implies a LFCF/EV ratio at 13.56%).

2. Cliffs Natural Resources (NYS: CLF) : Produces iron ore pellets, lump and fines iron ore, and metallurgical coal products. Of the 16 analysts that research this stock, the lowest target price stands at 87, which implies an upside of 20.77% from current levels around 72.04. Levered free cash flow at $1.48B vs. enterprise value at $13.96B (implies a LFCF/EV ratio at 10.6%).

3. Spirit Airlines: Provides passenger airline service primarily to leisure travelers and travelers visiting friends and relatives. Of the 6 analysts that research this stock, the lowest target price stands at 18, which implies an upside of 17.80% from current levels around 15.28. Levered free cash flow at $111.36M vs. enterprise value at $713.05M (implies a LFCF/EV ratio at 15.62%).

4. Enersis (NYS: ENI) : Engages in the generation, transmission, and distribution of electricity in Chile, Argentina, Brazil, Colombia, and Peru. Of the 5 analysts that research this stock, the lowest target price stands at 21, which implies an upside of 17.65% from current levels around 17.85. Levered free cash flow at $1.98B vs. enterprise value at $17.31B (implies a LFCF/EV ratio at 11.44%).

5. Inergy (NAS: NRGY) : Engages in the retail marketing, sale, and distribution of propane to residential, commercial, industrial, and agricultural customers in the United States. Of the 6 analysts that research this stock, the lowest target price stands at 26, which implies an upside of 17.12% from current levels around 22.2. Levered free cash flow at $586.69M vs. enterprise value at $4.46B (implies a LFCF/EV ratio at 13.15%).

6. McKesson (NYS: MCK) : Offers medicines, pharmaceutical supplies, and information and care management products and services for the health care industry. Of the 16 analysts that research this stock, the lowest target price stands at 89, which implies an upside of 16.80% from current levels around 76.2. Levered free cash flow at $2.30B vs. enterprise value at $18.68B (implies a LFCF/EV ratio at 12.31%).

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.


Kapitall's Alexander Crawford does not own any of the shares mentioned above. Data sourced from Yahoo! Finance.

At the time this article was published Motley Fool newsletter services have recommended buying shares of McKesson and ReachLocal. 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.

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