Relative valuation is one method of valuation that compares the stock/company valuation to similar competitors or as I did in the previous days post to the company’s historical valuation.
http://www.shadowstock.com/121910ReviewPost.html
But with the market more normalized or even stretched valuations the intrinsic value becomes more critical and useful in buying a business/stock at an opportunistic price. When I say intrinsic value as most of you know the valuation method is just a discount of the future cash flows. So a company is worth the present value of future cash flows the company can produce.
So for this post I’m focused on future free cash flow coupled with other important metrics to create a margin of safety.
Discount rates, estimated timing and amount of future cash flows are next to impossible to determine with 100% certainty. Modifying any of the inputs will dramatically change the valuation. This is why many value investors correctly in my opinion focus on the balance sheets as opposed to projecting future earnings.
So this is how I began my pool of stocks to mine for companies selling below intrinsic value.
Strong balance sheet and shareholder friendly capital structure; Enterprise value (Price + Total Debt) – Cash/Price <1.20 or specifically from 1.15(HWG) down to .42 (RIMG); Stable or reduced share count over the past few years, Reduction of total debt from 2007 compared to the TTM
Only companies with top line growth as measured by quarterly YOY revenue growth
Free Cash flow measures that justifies stock trading below the intrinsic value or PV of future FCF
At this point FCF was my focus. The future free cash flow measure helps justify the stocks trading below the intrinsic value or PV of future FCF.
These were some of the ideas that met all the above criteria along with additional metrics.
EVI: EnviroStar, Inc (1.06 to 1.20 days range on 12/17/10)
Current EBITDA+Average 4 year Capital Expenditures/EV= 24.262%
Average FCF over the past 3 years divided by the current enterprise value = 23.3193%
Average FCF over the past 5 years divided by the current enterprise value = 23.32%
HWG: Hallwood Group Inc. (26.47 to 26.50 days range on 12/17/10)
Current EBITDA+Average 4 year Capital Expenditures/EV= 41.35%
Average FCF over the past 3 years divided by the current enterprise value = 29.95%
Average FCF over the past 5 years divided by the current enterprise value = 17.12%
GPIC: Gaming Partners International Corporation (5.81 to 5.98 days range on 12/17/10)
Current EBITDA+Average 4 year Capital Expenditures/EV= 23.42%
Average FCF over the past 3 years divided by the current enterprise value = 16.50%
Average FCF over the past 5 years divided by the current enterprise value = 5.50%
TRCI: Technology Research Corp (3.57 to 3.60 days range on 12/17/10)
Current EBITDA+Average 4 year Capital Expenditures/EV= 20.38%
Average FCF over the past 3 years divided by the current enterprise value = 20.51%
Average FCF over the past 5 years divided by the current enterprise value = 15.39%
RIMG: Rimage Corporation (15.80to 16.11 days range on 12/17/10)
Current EBITDA+Average 4 year Capital Expenditures/EV= 14.13%
Average FCF over the past 3 years divided by the current enterprise value = 16.97%
Average FCF over the past 5 years divided by the current enterprise value = 20.06%
AHCI: Allied Healthcare International (2.54to 2.60 days range on 12/17/10)
Current EBITDA+Average 4 year Capital Expenditures/EV= 14.30%
Average FCF over the past 3 years divided by the current enterprise value = 9.05%
Average FCF over the past 5 years divided by the current enterprise value = 10.86%
Additional data on the above ideas
Click to view the stock quotes on the above ideas
