Kelly Brown is an investment analyst at Longview Asset Management Ltd. in Toronto.
What are we looking for?
U.S. companies that are on sale. I performed a similar screen earlier this month, with the results limited to Canadian companies.
Successful investors use several metrics to identify cheap stocks. The best known is the price-to-earnings, or P/E, ratio.
Today, I take a different tack and identify companies trading at a low multiple of their enterprise value (EV) to their earnings before interest and taxes (EBIT). Like the P/E ratio, EV/EBIT provides a good measure of value, but there are important differences between the two.
P/E compares the price of a stock with the company's earnings per share (EPS), net of interest and taxes. While this is simple, the result can be muddied by extraordinary items, and by tax regimes and levels of debt.
Looking at EV/EBIT levels the playing field between companies that take on debt and those that don't. EV is equal to the market value of a company's equity, plus all of its interest-bearing debt, less any excess cash. EBIT can be a good proxy for pretax unlevered free cash flow.
My colleague, Alvin Lau, and I used the S&P Capital IQ Screener to search for U.S. companies with an EV/EBIT multiple of less than 10. We excluded companies with a market capitalization lower than $400-million (U.S.). We excluded the financial sector as the value of financial companies is best measured by other metrics. To help protect against value traps, we required a minimum after-tax return on invested capital of 10 per cent and a five-year EPS growth rate of at least 5 per cent a year.
More about S&P Capital IQ
S&P Capital IQ offers tools for fundamental analysis of global securities as well as idea generation and work flow management. Its Web- and Excel-based platform provides access to information on companies, markets, transactions and people around the world.
What we found
Our screen produced 22 results. We selected the 15 with the lowest EV/EBIT multiples. As always, investors should perform their own research before purchasing any of these stocks.