It's a never-ending battle: Investors (and stock screeners, of course) are always looking for ways to identify companies that have good growth prospects—and can be picked up on the cheap.
The key to this exercise, of course, is a reliable valuation measure. When investors hear the word valuation in relation to a stock, the first thing that comes to mind is usually its price-to-earnings ratio. Fair enough, as that is probably the most widely known yardstick. But there are a number of other valuation tools in the analytical arsenal. We thought we'd spotlight another in this week's screen: price to cash flow.
Cash flow, as anyone who stayed awake during Principles of Accounting can tell you, is a company's net income plus depreciation, depletion, and amortization. A price-to-cash-flow ratio is used to compare a company's market value to its cash flow. In theory, the lower a stock's price/cash flow ratio is, the better value that stock is. We set our first filter to identify those outfits with a price-to-cash flow ratio between 0 and 10—below the median 10.3 for the Standard & Poor's 500-stock index.
Next, we took care of the "good growth prospects" part of the equation. We looked for those issues projected to increase earnings per share by more than 25% annually over the next five years, based on Wall Street analyst forecasts. The stocks on the list had to have positive earnings per share over the past 12 months.
We then looked in-house to another valuation measure. We used S&P's Fair Value Model, a proprietary quantitative stock ranking system. The model calculates a stock's weekly fair value—the price at which it should trade at current market levels—based on fundamental data such as corporate earnings and growth potential, price-to-book value, return on equity, and current yield relative to the S&P 500. Stocks are ranked from 5, indicating significant undervaluation, to 1, indicating significant overvaluation. We sifted for those issues ranked 4 or 5 under the model.
One final step: To make sure the names on our list were stable, liquid companies, we ensured each had a market capitalization above $1 billion and a stock price above $5.
The screen turned out a dozen names. The energy sector—and American depositary receipts of foreign companies—are well represented:
|Company||S&P Fair Value Rank|
|Advanced Semiconductor Engineering (ASX)||5|
|BHP Billiton (BHP)||4|
|CNOOC Ltd. (CEO)||4|
|Ensco International (ESV)||5|
|Fujifilm Holdings (FUJI)||5|
|Vimpel Communications (VIP)||5|
|Rowan Cos. (RDC)||5|
|Superior Energy Services (SPN)||5|
|Taiwan Semiconductor (TSM)||5|
|Wipro Ltd. (WIT)||4|