I'm reading a book by Norm Brodsky and Bo Burlingham called The Knack: How Street-Smart Entrepreneurs Learn to Handle Whatever Comes Up, a how-not-to-mess-up guide to entrepreneurship that anyone considering going into business should read. Brodsky has started eight successful companies over the years and he, along with co-author Burlingham, have helped small business people since 1995 with their monthly Street Smarts articles in Inc. Magazine. One of the main points Brodsky makes in the book is that entrepreneurs should value their businesses based on EBITDA - at a number between 5x and 10x earnings - rather than on sales. While he's talking about private companies, investors can apply the rule to public companies, too. And, thus, begins my hunt for deep value.
IN PICTURES: 8 Tips For Starting Your Own Business
In step one of my screening process, I searched for companies that: 1) have an EBITDA margin greater than 10%, 2) operate in the consumer goods sector, 3) have a price-to-sales ratio (P/S ratio) of less than 1, 4) a market cap greater than $500 million, 5)average daily volume of one million shares traded and 6) a return on assets of at least 5%. Second, I used the P/S ratio in addition to EBITDA because with public companies, sales figures are much harder to manipulate than earnings. (This measure may have its benefits, but it can also present earnings through rose-colored glasses. Learn more in A Clear Look At EBITDA.)
By using these parameters, I hope to eliminate some of the riff-raff. The first screen produced a list of 31 companies. And, in step two, I ratcheted up the value play by taking the top five companies in terms of return on assets that have entity values (Market Cap + Total Debt - Cash and/or Short-Term Investments) less than 5x EBITDA. Finally, multiplying EV/EBITDA by P/S produced the totals. In this instance, lower is better.
|Company||Market Cap||Entity Value/
|Corn Products International
|Packaging Corporation of America
And The Winner Is...
Not so fast! Normally I'd simply pick the best stock and then make a case for it. In this situation, however, I'll produce the winner through a process of elimination. All five are down between 50% and 75% from their 52-week highs. Each clearly has issues. At this point, none are slam-dunk choices.
The first stock to be eliminated is apparel company Phillips-Van Heusen. In late March, it issued first quarter earnings per share (EPS) guidance between 40 and 50 cents (excluding one-time items). Although the EPS number isn't bad, it is well off analyst estimates of 60 cents. Taken in combination with the news that retail sales declined 1.1% in March, much worse than the 0.3% drop expected, it makes little sense right now to take a risk on the owner of Calvin Klein.
The next to go is Packaging Corporation of America. Longbow Research analyst Joshua Zaret, who covers paper producers like Packaging Corporation of America, predicted at the end of March that 2009 will be a horrible year for cardboard exports due to a strong dollar and weak economy. Zaret said, "The industry has been turned on its head since September." So the paper company's out.
On April 7, Corn Products International appointed Ilene Gordon its new CEO, replacing long-time chief executive Samuel C. Scott III, who is retiring. While Corn Products International is a good company, it's going to take the former Alcan Packaging executive some time to get comfortable in her new post. Check back in six months on this one.
Down to just two companies, both Owens-Illinois and SPX Corp. have similar valuations so the decision isn't easy. Nevertheless, Owens-Illinois is the last to go.
Making the Case For SPX
I chose SPX Corp over Owens-Illinois for two reasons. First, the Charlotte-based industrial products company has 54 cents in EBITDA earnings for every dollar of debt, which compares favorably with Owens-Illinois' 46 cents per dollar in debt. Second, SPX's price-to-book ratio is 1.09, compared to 2.79 for Owens-Illinois. Despite the fact that SPX cut 2009 full-year EPS guidance to the $4.40 to $4.80 per share range, down from $5.40 and $5.80 per share, its stock is blessed with deep value right now! (Learn more about value investing in Stock-Picking Strategies: Value Investing.)
EntrepreneurshipLearn how to make a successful pitch to investors. Regardless of your industry, size or market, there are some questions all investors need to have answered.
EntrepreneurshipLearn how these multibillionaires built their fortunes to stand out from the crowd of the countless ultra-rich who call Los Angeles home.
Stock AnalysisA summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
Investing BasicsThe reality TV shows "Restaurant Impossible" and "Kitchen Disasters" offer lessons not just for restaurateurs, but for all business owners.
Options & FuturesInvesting during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
EntrepreneurshipLearn about some of the most successful crowdfunding campaigns on Indiegogo, which raised millions of dollars for everything from electric bikes to beehives.
Investing BasicsHeld onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
EntrepreneurshipFind out which factors you should weigh when searching for income-producing real estate.
Wealth ManagementDiscover how the richest "Sharks" on the hit TV show amassed their vast fortunes, and learn how much they have to offer eager entrepreneurs.
EntrepreneurshipDiscover a number of different options available to support small business growth, including crowdfunding campaigns and shopping locally.
When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
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 >>
A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
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 >>
The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>