There are many ways to value a company. Price to earnings. Price to cash flow. Liquidation value. Price per eyeballs on website. Price to a number I completely made up (this one never gets old). Price to CEO's ego divided by lobbying activity as a percentage of revenue (this one doesn't get used enough).
Which one is best? They're all limited and reliant on assumptions. No single metric holds everything you need to know.
The metric I'm using today is no different. But it's perhaps the most encompassing, and least susceptible to hidden complexities of a company's financial statements. The more I think about it, the more I feel it's one of the most useful metrics out there.
What is it? Enterprise value over unlevered free cash flow.
Enterprise valueis market capitalization (share price times shares outstanding) plus total debt and minority interests, minus cash.
Unlevered cash flowis free cash flow with interest paid on outstanding debt added back in.
The ratio of these two statistics provides a valuation metric that takes into consideration all providers of capital -- both stockholders and bondholders.
But you invest in common stock, so why should you care about bondholders? Ask Lehman Brothers investors why. When a company earns money, it has to take care of bondholders before you, the common shareholder, get a dime. Focusing solely on profits in relation to equity can be dangerously misleading.
Enterprise value provides a more encompassing view. By bringing debt capital into the situation, we see real earnings in relation to the company's entire capital structure. If you owned the entire business, this is the metric you'd naturally gravitate toward.
Using this metric, here are five companies I found that look attractive.
Enterprise Value / Unlevered FCF
Ford (NYSE: F)
ConAgra (NYSE: CAG)
Visa (NYSE: V)
Clorox (NYSE: CLX)
Paychex (Nasdaq: PAYX)
Source: S&P Capital IQ. N/A = not applicable due to no available data. ^Average since 2008.
Let's say a few words about these companies.
Ford's turnaround over the past three years has been nothing short of extraordinary. Likened to the walking dead in 2008, the company reported third-quarter earnings of $1.6 billion last week. If I had to make a list of the most impressive CEOs of the past decade, Ford boss Alan Mulally would unquestionably make the cut.
And there's still plenty of room for optimism in the auto industry for long-term investors. Consider what auto analyst Adam Jonas noted earlier this year, as quoted by Bloomberg: "The average car on the road is more than 10 years old and sales have run below the auto scrappage rate for two years."
Put simply, the same forces that pained the auto industry for the past several years -- falling sales as consumers squeeze life out of their old vehicles -- have planted the seeds for strong rebound driven by pent-up demand. It's a cyclical industry, and the past few years were undoubtedly near a low point of the cycle.
ConAgra won't win any awards for innovation or explosive growth, but it's a relatively stable franchise that produces steady earnings. As I've shown before, ConAgra's consistent dividends over time have been an incredible boon for shareholders, fueling cumulative returns of over 28,000% since the 1970s.
Sometimes the best returns come from boring companies that churn out consistent results purchased at a good price and held for a long period of time. For patient investors, that's how I'd describe ConAgra's opportunity today.
I've always loved Visa. Along with rival MasterCard (NYSE: MA) , it's enjoying incredible growth driven by a global shift from cash to plastic, and growing ranks of middle-class consumers in developing markets. Both companies' prospects are bright.
But I've been turned off by Visa's stock in the past because I considered it overvalued, especially as U.S. consumers deleveraged. I now think those worries were overblown -- in the past year alone, Visa's payment volume grew a staggering 17%. You can justify current valuations with that kind of growth. International growth has been so strong, and the impact of deleveraging U.S. consumers so weak, that I consider Visa is a good buy at these prices.
Here are two numbers to think about: 3.6% and 2.3%.
What are they? Clorox's dividend yield, and the yield on 10-year Treasury bonds, respectively.
In a normal economy, those numbers would likely be flipped -- stocks provide the opportunity for growth, and therefore normally trade at higher valuations (and thus offer lower yields) than Treasury bonds. But today's market is permeated by so much fear and distaste for risk that people are willing to stuff their money into bonds while shunning high-quality companies like Clorox. That won't last forever; take advantage of it while it's here.
Paychex's bottom line is inextricably tied to the state of America' jobs market. That market has been dismal for three years now. And yet Paychex's earnings have held up remarkably well -- earnings per share are now actually higher than 2007 levels.
How? Consider: the U.S. jobs market has notched private-sector payroll growth for 21 months in a row. The biggest impediment to overall jobs growth has been declines in government employment, not in the private sector, where Paychex does its business. Paychex may be the equivalent of a baby thrown out with the bathwater, portrayed as a company that should be struggling as employment languishes, but actually doing far better than people think.
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