Six Flavors Of Value
Of the six Quadrix category scores used to derive the Overall score, Value has worked best.
Stocks with a Value score above 80 have outperformed peers by a wider margin than any other Quadrix category score since 1992. Of the Value score’s 20 factors, the six listed below are the most effective for identifying winning stocks.
Enterprise value/EBITDA ratio. This metric measures the relative value of the business, not just the stock. Enterprise value (stock-market value plus outstanding debt plus preferred stock minus cash) approximates how much it would cost to acquire the company. For the denominator, trailing 12-month earnings before interest, taxes, depreciation, and amortization (EBITDA) strips out noncash and financing charges, capturing a more basic measure of earning power.
Price/cash flow. Cash flow, as defined for this ratio, equals net income plus depreciation and other noncash charges.
Price/free cash flow. Free cash flow is operating cash flow minus dividends and capital spending after taking into account the change in working capital. Free cash flow shows how much cash companies have to grow dividends, buy back shares, or make acquisitions.
Price/earnings ratio. Critics note that this popular ratio can be distorted by accounting conventions that skew reported profits, but it has proved to be reliable for identifying stocks that outperform.
Price/sales ratio. While comparisons of share price to per-share sales can unduly reward low-margin companies, the price/sales ratio has a good track record.
Price/sales to five-year median. This metric compares the current
price/sales ratio to historical levels.
To identify the across-the-board values listed in the table below, we ranked stocks based on these six factors and screened for monitored stocks in the top 20% based on a six-factor composite rank. We also required stocks to earn Value scores of at least 80 and Overall scores of at least 60. Three intriguing options are profiled below:
British drugmaker AstraZeneca ($50; AZN) scores in the top 25% for three of the six key value factors, including a rank of 88 for the highly effective enterprise value/EBITDA ratio. The six-factor composite rank is 89. Shares trade at eight times trailing earnings, a 38% discount to the five-year average. Based on its P/E, AstraZeneca is the cheapest among drug companies with market capitalizations greater than $50 billion.
In the opening weeks of 2010, the stock has gained 6.7%, versus the S&P 500 Index’s 2.1% decline. That surge was tested when AstraZeneca reported December-quarter results Jan. 28, the day after this issue went to press. Wall Street projected 22% higher per-share profits for the quarter, implying 26% growth for the year. Revenue was expected to be up 8% for the quarter. AstraZeneca has topped the consensus in each of the past four quarters by at least 6%. AstraZeneca is also one of Quadrix’s steadiest stocks. Its Overall rank, currently 98, has remained above 80 for 24 consecutive months. AstraZeneca is a Buy and a Long-Term Buy.
Around Feb. 3, Comcast ($16; CMCSa) is expected to report flat December-quarter profits, which would be a departure from recent trends. Comcast has grown per-share profits at least 10% in eight consecutive quarters. The consensus calls for growth to resume in the March quarter, with profits up 7%.
Free cash flow jumped 23% in the first nine months of 2009, while operating cash flow has risen in 10 of the last 12 quarters. Comcast redistributes some of that cash in the form of a quarterly dividend, raised 40% in December to $0.0945 per share. A planned $3.6 billion stock buyback could cut the share count by about 7% over the next three years.
Comcast trades at just five times operating cash flow, a discount to nearly all large-cap cable and broadcasting stocks. Moreover, at 13 times trailing earnings, Comcast shares linger 49% below the three-year average P/E ratio. Earning a six-factor composite rank of 93, Comcast is a Focus List Buy and a Long-Term Buy.
Shares of Travelers ($50; TRV) jumped when the insurer reported operating income of $2.12 per share in the December quarter, up 34% and $0.63 above the consensus. Revenue surged 11% to $6.46 billion, easily topping Wall Street’s target of $5.26 billion. Retention rates remained high, and the effect of renewal rate changes on premiums was positive in all three business segments. Travelers issued a 2010 profit guidance range with a high end of $5.55 per share, a penny below the consensus at the time of the announcement.
The Forecasts monitors 130 stocks that earned a profit in the last 12 months. Just three of those companies carry a lower P/E ratio than Travelers. The stock trades at less than nine times trailing earnings, 16% below its five-year average valuation. Travelers earns a Value score of 94 and a six-factor composite score of 91. The stock is a Buy and a Long-Term Buy.