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.

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