Written by Alexander Crawford
Do you consider yourself a value investor, always searching for underestimated stocks? For ideas on how to start your search, we ran a screen.
We began by looking at the 200 largest U.S.-traded stocks by market cap, referred to as mega-cap stocks, for those with high ratios of levered free cash flow/enterprise value.
Levered free cash flow is the free cash flow after deducting interest payments on outstanding debt. Enterprise value is the sum of the firm's value from all ownership sources: market cap, outstanding debt and preferred shares. The higher the ratio, the more undervalued the company appears.
We then searched on top of that for those that appear undervalued relative to their EPS trends. Based on the assumption that P/E is equal to a constant k, increases in EPS should be matched by proportionate increases in price. When they don't match up, a mispricing may have occurred. That is, when price does not rise as fast as earnings, the stock may be undervalued.
Of course, there is no reason to expect that P/E is equal to a constant k, this is just the assumption for the sake of the screen.
Interactive Chart: Press Play to compare changes in market cap over the last two years for the stocks mentioned below.
Business Section: Investing Ideas
Below is the final list of stocks from this screen. These mega-cap stocks appear undervalued by levered free cash flows, as well as their EPS trends.
Do you think these stocks should be trading higher? (Click here to access free, interactive tools to analyze these ideas.)
1. Cisco Systems, Inc. (Nasdaq:CSCO): Designs, manufactures, and sells Internet protocol (IP)-based networking and other products related to the communications and information technology industry worldwide. Market cap at $106.80B. Levered free cash flow at $9.39B vs. enterprise value at $76.16B (implies a LFCF/EV ratio at 12.33%). The EPS estimate for the company's current year increased from 1.77 to 1.83 over the last 30 days, an increase of 3.39%. This increase came during a time when the stock price changed by -3.67% (from 20.43 to 19.68 over the last 30 days).
2. Time Warner Inc. (NYSE:TWX): Operates as a media and entertainment company in the United States and internationally. Market cap at $35.08B. Levered free cash flow at $10.80B vs. enterprise value at $51.79B (implies a LFCF/EV ratio at 20.85%). The EPS estimate for the company's current year increased from 3.16 to 3.19 over the last 30 days, an increase of 0.95%. This increase came during a time when the stock price changed by -3.28% (from 38.11 to 36.86 over the last 30 days).
3. Dell Inc. (Nasdaq:DELL): Provides integrated technology solutions in the information technology (IT) industry worldwide. Market cap at $30.47B. Levered free cash flow at $3.83B vs. enterprise value at $25.04B (implies a LFCF/EV ratio at 15.3%). The EPS estimate for the company's current year increased from 2.02 to 2.13 over the last 30 days, an increase of 5.45%. This increase came during a time when the stock price changed by -4.65% (from 18.05 to 17.21 over the last 30 days).
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Disclosure: Kapitall's Alexander Crawford does not own any of the shares mentioned above. EPS and LFCF/EV data sourced from Yahoo! Finance.