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 Commercial Metals (NYS: CMC) , which is being eyed by billionaire investor Carl Icahn, might be. More on Icahn's offer after we look at the numbers.
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.
Commercial Metals has negative P/E and EV/FCF ratios over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, Commercial Metals has a P/E ratio of 29.8 and a five-year EV/FCF ratio of 38.5.
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.
Commercial Metals is zero for four on hitting the ideal targets, but let's see how it compares against some competitors and industry mates.
Nucor (NYS: NUE)
AK Steel Holding (NYS: AKS)
United States Steel (NYS: X)
Source: S&P Capital IQ; NM = not meaningful due to losses.
Numerically, we've seen how Commercial Metals' 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, Commercial Metals' net income margin has ranged from -3.3% to 4.3%. In that same time frame, unlevered free cash flow margin has ranged from -3.7% to 7.6%.
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, Commercial Metals has tallied up three years of positive earnings and two 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. Due to losses, the trailing growth rate for Commercial Metals isn't meaningful. Its peers, except Nucor, are in the same boat:
Source: S&P Capital IQ; EPS growth shown.
Meanwhile, 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 Commercial Metals 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 negative P/E ratio, and we see still-high but better five-year price multiples. Much depends on the future price of steel, but in the near term there's another factor for Commercial Metals specifically.
Shares jumped a couple weeks ago after Carl Icahn offered to buy the 90% of Commercial Metals he doesn't own for $15 a share. The shares sit within a dollar of that buyout price today, so there isn't much of a merger arbitrage opportunity left. To buy in today, you'd either have to believe that Ichan (or someone else) will ultimately offer more than $15 a share (management has rejected the offer as being too low, but Icahn says he'll go straight to the shareholders) or that Commercial Metals is worth more than current prices even without a buyout. On the dangerous side, shares could be headed for a tumble if Icahn's bid fails.
If you find Commercial Metals' 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 Chokkaveluowns shares of Nucor.Motley Fool newsletter serviceshave recommended buying shares of Nucor. 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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