You have to spend money to make money, or so goes the old adage. Running a business today takes serious capital - no longer can you fake it with just ingenuity and creativity. However, that doesn't mean a business can't spend efficiently. In fact, those are the businesses to look for when investing: companies that know how to spend their hard-earned dollars, squeezing out every penny.

A calculation I use to examine similar businesses and their ability to handle cash is a derivative of both free cash flow and return on equity. Take the most recent trailing twelve months figure for EBITDA (Earnings before interest, taxes, depreciation and amortization), and subtract the most recent annual capital expenditures (CAPEX) and then divide that number into shareholder equity. It looks like this:

Shareholder Equity (Annual)

This calculation simultaneously allows me to understand how much a company spends to make each dollar of EBITDA and the return it provides shareholders. It's not terribly scientific, but when used with similar businesses, it's quite effective at pointing out the efficient ones. I'll look at two industries and some of the major competitors within them. (For more check out Examples of Capital Expenditure and A Clear Look At EBITDA.)

Textile - Apparel Clothing Industry
Company EBITDA (TTM) CAPEX (Annual) Shareholder Equity CAPEX per $1 EBITDA Return (%)
VF Corp. (NYSE:VFC) $1.14B $113.86M $3.65B $0.10 28.11
Lululemon (Nasdaq:LULU) $58.47M $29.68M $112.03M $0.51 25.70
Ralph Lauren (NYSE:RL) $821M $184M $2.40B $0.22 26.50
Columbia Sportswear (Nasdaq:COLM) $221.17M $34.29M $956.85M $0.16 19.53
True Religion Apparel (Nasdaq:TRLG) $53.11M $8.77M $103.73M $0.17 42.75

Textile Breakdown
Jim Cramer always speaks highly of VF Corp. and why not? VF Corp. spends less than a dime to make a buck and yet its modified return on equity is almost 30%. Polo Ralph Lauren, on the other hand, spends 22 cents to make a dollar in EBITDA while producing a return on equity slightly less than VF. Considering VF Corp. pays a $2.23 dividend, I don't think there's any question the better stock of the two.

Lululemon is the new kid on the block and the "it" company according to some, like Dana Telsey, one-time analyst and now full-time retail consultant for the Telsey Advisory Group. Telsey believes it has room to grow its store base, unlike many out there like the Gap (NYSE:GPS), etc. This may be true, but there are firms out there spending less to make more than the yoga specialist. True Religion, once only selling wholesale to places like Nordstrom (NYSE:JWN) and Saks (NYSE:SKS), now has 25 stores and anticipates 10 more opening in 2008. With revenue and net income up 47.4% and 34.7% respectively in the first quarter, ended May 8, 2008, and spending 17 cents to generate a dollar in EBITDA earnings, the premium jean maker, along with VF Corp. are my picks in this group. (Look into the numbers, read Core Earnings Measure UP.)

Personal Products Industry
Company EBITDA (TTM) CAPEX (Annual) Shareholder Equity CAPEX per $1 EBITDA Return (%)
Estee Lauder(NYSE:EL) $1.02B $312.10M $1.56B $0.31 45.38
Alberto-Culver(Nasdaq:ACV) $197.1M $59.86M $1.09B $0.30 12.59
Bare Escentuals(Nasdaq:BARE) $184.22M $25.99M $-104.5M $0.14 N/A
United Guardian(NYSE:UG) $4.64M $0.53M $15.40M $0.11 26.69
Physicians Formula(Nasdaq:FACE) $20.20M $2.46M $78.09M $0.12 22.72

Personal Care Breakdown
Immediately, the first thing that jumps out at me is the negative shareholder equity of Bare Escentuals. How could the company have negative equity and be doing so well? It turns out that Bare Escentuals paid a special dividend to shareholders in June 2006 for $340.4 million when it recapitalized the business. It subsequently went public on September 28, 2006. Estee Lauder's modified return on equity is excellent, clearly the best of the bunch. Despite a slowdown in the U.S., it managed to increase sales 11.2% and operating income 2.9% in the first quarter of 2008. It projects full-year EPS between $2.34 and $2.40. MAC, Bobbi Brown, Clinique, Aramis are some of the top brands beyond the grand dame that started it all in 1946.

Alberto-Culver also has some great brands like VO5, Tresemme and Nexus; however, by any metric, it's more expensive than Estee Lauder. United Guardian appears to be a company not worth a second look. Its revenues vacillate between $11 and $12 million annually from the sale of cosmetic ingredients. Interestingly, operating earnings increased 20% over the last four years to $4.44 million, enabling the company to increase the yearly dividend to 54 cents a share, producing a dividend yield slightly less than 5%. As for Physicians Formula, it is rolling out a new line of Organic make-up that will help grow company sales. Its management expects sales to increase between 10% and 12% in 2008 to $125 million with EPS between 65-69 cents per share. If it meets both of these objectives, it should grow its share of the masstige market beyond the current 8%. In the personal products area I favor Estee Lauder for its stable of brands and Bare Essentuals for its innovation in mineral makeup. (For more on valuations, see Fundamental Analysis: Introduction.)

Bottom Line
Companies that spend wisely usually do well financially because they understand how hard it was to earn the money in the first place. I want to own these types of companies.

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  2. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  5. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  6. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  7. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  8. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  9. Professionals

    Tips for Helping Clients Though Market Corrections

    When the stock market sees a steep drop, clients are bound to get anxious. Here are some tips for talking them off the ledge.
  10. Stock Analysis

    The Safest Stocks You Can Invest in Right Now

    These stocks are likely to hold up better than others in a bear market, but there's a twist.
  1. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  2. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  3. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  4. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  5. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
  6. Impact investing

  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!