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 Textron (NYS: TXT) 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.
Textron has a P/E ratio of 16.4 and an EV/FCF ratio of 16.1 over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, Textron has a P/E ratio of 13.7 and a five-year EV/FCF ratio of 13.6.
A positive one-year ratio under 10 for both metrics is ideal (at least in my opinion). For a five-year metric, under 20 is ideal.
Textron has a mixed performance in hitting the ideal targets, but let's see how it compares against some competitors and industry mates.
General Electric (NYS: GE)
United Technologies (NYS: UTX)
Honeywell International (NYS: HON)
Source: S&P Capital IQ.
Numerically, we've seen how Textron'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, Textron's net income margin has ranged from -1.6% to 7%. In that same time frame, unlevered free cash flow margin has ranged from 3.1% to 11%.
How do those figures compare with those of the company's peers? See for yourself:
Source: S&P Capital IQ; margin ranges are combined.
Additionally, over the last five years, Textron has tallied up three 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 willoverpay 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, Textron has put up past EPS growth rates of -16.8%. Meanwhile, Wall Street's analysts expect future growth rates of 77%.
Here's how Textron compares to its peers for trailing five-year growth:
Source: S&P Capital IQ; EPS growth shown.
And here's how it measures up with regard to the growth analysts expect over the next five years:
Source: S&P Capital IQ; estimates for EPS growth.
The bottom line
The pile of numbers we've plowed through has shown us the price multiples shares of Textron 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 16.4 P/E ratio and although its five-year price multiples are pretty low, we do see some earnings fluctuations and negative recent growth. Considering the defense industry as a whole (to which Textron has goodly exposure), possible U.S. budget cuts could cripple individual players depending on what gets kept and what gets cut. Personally, though the threat is real, I think there are bargains in the industry. In fact, I've bought shares in a few defense contractors in my public real-money portfolio (to see it, click here). I don't have Textron in my portfolio, but fellow Fool Jim Mueller does. If you find Textron's numbers or story compelling, don't stop. Continue your due diligence process until you're confident one way or the other. As a start, add it to My Watchlist to find all of our Foolish analysis.
To see the stocks that I've researched beyond the initial numbers and bought in my public real-money portfolio, click here.
At the time thisarticle was published Anand Chokkaveludoesn't own shares in any company mentioned.The Motley Fool owns shares of Textron. 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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