12/05/2009

Discount to normalized earnings?

I attempted to find companies selling at a discount to normalized earnings by taking the average annualized prior 5 year free cash flow (04- 08) as a percentage of the the current enterprise value and then compare this yield to the yield using the prior 12 months of operating income as a percenge of the current enterprise. My goal was to select only those companies selling for a lower earnings yield using the current operating income/enterprise value versus the yield calculated by the average 5 year FCF/EV.

The thought was to locate companies where the current economics have temporarily depressed earnings when looking at the earnings capacity based on historical 5 year annualized FCF.

Additionally, companies were removed if they did not meet these metrics

-) Share count reduction: Select only companies with a trailing 12 month share count that was less than the average 5 year share count. This is a tough hurdle but can indicate a very shareholder friendly managment.

-) Strong financial position as measured by an enterprise value/market capitalization < .90; Another difficult goal only but wanted to only deal with cash rich companies. In a future post i will loosen this criteria.

-) Economic moat (High historical ROIC): Average 5 year Return on invested capital (ROIC) >25%; Companies with an annualized 5 year ROIC greater than an 25% clearly idicates a historical high economic moat.

Out of 4,320 stocks reviewed I came up with these 7 ideas

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