It's no secret that Moneyball (both the book and the movie) is just as much a story about investing as it is a story about an underdog baseball team.
For those unfamiliar with this true story, general manager Billy Beane and the cash-strapped Oakland Athletics were able to compete successfully with the likes of the New York Yankees by questioning conventional wisdom and focusing on the right data. Using their methods, they were able to buy overlooked, quality players at bargain-basement salaries. This stats-based, thinking-smarter approach was termed "Moneyball."
In a similar story, we individual investors have fewer resources at our disposal than Wall Street does. We can't rely on an army of analysts and traders, flash-trade-enabled computers, or the safety net of billions of dollars of capital.
Fortunately, though, thanks to the beauty of our markets, we do have access to all the data we need to beat the market and Wall Street. Like the Moneyball folks, we have to think for ourselves and focus on the right data.
Let me give you an example of a Moneyball investing tool along with a few stocks that Wall Street is missing.
A Moneyball stat
Conventional wisdom used to be that a batter's worth could be measured by his batting average. Moneyball folks looked beyond batting average to stats like on-base percentage and slugging percentage. Now don't get me wrong. Batting average is good. The others were just better measures of a hitter's true value.
In investing, we focus a lot on earnings. We worry about companies beating or missing them. After all, it's the "E" in the P/E ratio. But Moneyball investors go beyond just earnings and look at free cash flow as well.
In their toolbelts alongside P/E is the EV/FCF ratio. EV/FCF 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). Notice that the measure not only substitutes free cash flow for earnings, but it also accounts for all of a company's commitments -- debt as well as equity.
Going where Wall Street doesn't
So now we've got an underappreciated tool to ferret out stocks that the market may be ignoring. We can also use Wall Street's size against it. It's just not cost-efficient for Wall Street to deploy analysts to cover every stock in the market. It gets the most bang for its buck on the largest, highest-volume stocks, such as Apple, McDonald's, and Exxon. Those are the ones their clients crave information on.
I think it's possible to beat Wall Street on the big companies, too, but the small companies allow us less competition.
While upwards of 50 analysts cover Apple, today I want to point to three companies that have very little analyst coverage (three or fewer analysts) and, while attractive on a P/E basis, are even more attractive on an EV/FCF basis...
3 Moneyball stocks Wall Street is missing
Biglari Holdings (NYS: BH)
Hillenbrand (NYS: HI)
United Online (NAS: UNTD)
Source: S&P Capital IQ.
These are some darn cheap valuations. Like the ballplayers in Moneyball, other investors don't seem to be beating down the door to snap them up. Beyond their smallness and their hidden Moneyball strength, each company has some offputting quirks akin to a Chad Bradford sidearm motion or Jeremy Brown chubbiness. Others are ignoring these stocks outright. Just considering these stocks puts us ahead of the stockpicking game.
Biglari Holdings is run by a young value investor (he's 34) who wants to be the next Warren Buffett. The core of the company's holdings is the restaurant concept Steak 'n Shake, which he turned from a struggler into a cash generator in short order. Buffett converted Berkshire Hathaway (NYS: BRK.B) from a textile mill into his investing vehicle. Biglari is hoping to do the same with Biglari Holdings. The drawbacks to investing in Biglari are his expensive hedge-fund-style compensation scheme (vs. Buffett's $100,000 salary), his ego (he renamed the company after himself), and his short (but impressive) track record. Those are some serious downsides to consider.
Meanwhile, Hillenbrand is primarily in the death business. It has a 50% market share of the casket market in North America and provides other funeral-related products as well. Boring and death-related doesn't make the headlines. But with high margins and returns on equity along with a 4% dividend yield, this is a company worth scouting out.
United Online isn't in the death business, but it's got some dying businesses. In a broadband-adopting market, it runs dial-up services NetZero and Juno. While your mom is jumping into Facebook or Google to keep in touch, it runs "online nostalgia services" Memory Lane and Classmates. Only the last segment has a good chance of being relevant in 10 years -- FTD, the online florist.
Beyond a dirt cheap valuation, here's why United Online is so interesting. The worst thing a company can do is grasp for growth through terrible acquisitions. See Hewlett-Packard (NYS: HPQ) and its $10 billion purchase of U.K. software company Autonomy for 10 times sales!. Arguably the best thing a company with limited growth prospects can do is pay you its excess cash as dividends. That's what rural landline telecom stocks Frontier (NYS: FTR) (12.7%) and Windstream (NAS: WIN) (8.7%) do. And that's what United Online is doing right now with its 7.1% dividend yield.
Are Biglari, Hillenbrand, and United Online guaranteed winners from here? Absolutely not. But Moneyball investing is about using statistics to our advantage and looking where others fail to look. These three stocks certainly fit the bill for further research. If you're looking for another stock that gets too little love, check out our free report: "5 Stocks The Motley Fool Owns -- And You Should, Too." In it is a stock that the market has been underestimating for years. Like United Online, it has been answering with huge dividend yields. Only this stock's been doing it for decades! Click here to read about that stock. The report's absolutely free.
At the time thisarticle was published Anand Chokkavelu owns shares of Frontier and Berkshire Hathaway. You can follow his thoughts on Twitter. The Motley Fool owns shares of Hillenbrand, Biglari Holdings, and Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Hillenbrand and Berkshire Hathaway. 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.
Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.