Written by Danny Guttridge
Are you on a search for potentially undervalued companies? One method of identification is the application of PEG and P/FCF ratios, which are commonly used determinants of value.
It's also important that investors not only look to see if a company is growing, but where that growth is coming from. Basically, is that growth sustainable? A common way for determining growth quality is the DuPont formula.
Not sure what these all mean? Keep reading to more details. A list of stocks meeting these criteria is below.
The PEG ratio is short for Price/Earnings to Growth ratio.
PEG = (P/E)/(Annual EPS Growth)
The higher the earnings growth, the lower the PEG ratio. So a company that looks overvalued because of its relatively high P/E might look like a better investment if you take into account its high earnings growth.
In general, a stock with a high PEG ratio is considered expensive or overvalued, while a stock with a low PEG ratio is considered cheap or undervalued.
Free cash flow is the amount of cash generated by a company in one year after subtracting short-term and long-term investments in the company, expenses, and taxes. It is the cash flow available to both debt and stock investors.
The ratio of stock price divided by free cash flow per share (P/FCF) is often used to compare the value of companies. As a general rule, P/FCF under five (or price is less than five times free cash flow per share) is considered "undervalued," which means the stock may be trading at too low of a price and may rise in the future to properly reflect the free cash flow generated by the firm.
Return on equity (ROE) is a widely used profitability measure. The higher the ROE the more profitable the company appears, but this profitability can come from many sources - some better than others.
In the 1920s, the DuPont Corporation developed a useful equation that breaks down ROE into three components.
ROE = Net Profit Margin x Asset Efficiency x Financial Leverage
Net profit margin reflects cost structure, asset efficiency reflects productivity, and financial leverage is use of debt. Increases in any of the three can contribute to increased ROE.
In general, an encouraging DuPont breakdown implies one or more of the following:
- Improving Net Profit Margin, i.e. higher Net Income/ Revenues
- Improving Asset Efficiency, i.e. higher Sales/Assets
- Decreasing Financial Leverage ratio, i.e. lower Assets/Equity
In other words, it is preferable for ROE to rise because of higher net profit margins or asset efficiency. Increasing financial leverage, which would increase ROE, is not always a positive development for a company.
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Business Section: Investing Ideas
Now that you have a basic understanding of the terms, below is a list involving the above criteria. These names have a PEG below one and a P/FCF under 15, with encouraging DuPont trends. Do you think these names are worth looking further into? (Click here to access free, interactive tools to analyze these ideas.)
1. CF Industries Holdings, Inc. (NYSE:CF): Through its subsidiary, CF Industries, Inc., manufactures and distributes nitrogen and phosphate fertilizer products, serving agricultural and industrial customers worldwide. Market cap at $13.13B, most recent closing price at $199.92. PEG at 0.73, P/FCF at 7.35. MRQ net profit margin at 25.54% vs. 16.18% y/y. MRQ sales/assets at 0.191 vs. 0.141 y/y. MRQ assets/equity at 1.974 vs. 2.161 y/y.
2. Universal Health Services Inc. (NYSE:UHS): Operates acute care hospitals, behavioral health centers, surgical hospitals, ambulatory surgery centers, and radiation oncology centers. Market cap at $4.1B, most recent closing price at $42.15. PEG at 0.62, P/FCF at 14.25. MRQ net profit margin at 7.05% vs. 6.5% y/y. MRQ sales/assets at 0.235 vs. 0.231 y/y. MRQ assets/equity at 3.207 vs. 3.635 y/y.
3. Protective Life Corp. (NYSE:PL): And its subsidiaries engage in the production, distribution, and administration of insurance and investment products in the United States. Market cap at $2.62B, most recent closing price at $28.91. PEG at 0.91, P/FCF at 4.67. MRQ net profit margin at 10.13% vs. 9.94% y/y. MRQ sales/assets at 0.017 vs. 0.017 y/y. MRQ assets/equity at 12.542 vs. 14.278 y/y.
4. Community Health Systems, Inc. (NYSE:CYH): Provides healthcare services through the operation of hospitals in the United States. Market cap at $2.27B, most recent closing price at $24.53. PEG at 0.71, P/FCF at 4.59. MRQ net profit margin at 1.99% vs. 1.83% y/y. MRQ sales/assets at 0.239 vs. 0.228 y/y. MRQ assets/equity at 6.363 vs. 6.368 y/y.
5. Symetra Financial Corporation (NYSE:SYA): Operates as a financial services company in the life insurance industry in the United States. Market cap at $1.44B, most recent closing price at $12.01. PEG at 0.86, P/FCF at 1.58. MRQ net profit margin at 13.89% vs. 10.89% y/y. MRQ sales/assets at 0.019 vs. 0.019 y/y. MRQ assets/equity at 9.048 vs. 10.869 y/y.
6. Portfolio Recovery Associates Inc. (Nasdaq:PRAA): Provides outsourced receivables management and related services in the U.S. Market cap at $1.15B, most recent closing price at $66.96. PEG at 0.80, P/FCF at 7.03. MRQ net profit margin at 22.52% vs. 20.49% y/y. MRQ sales/assets at 0.11 vs. 0.101 y/y. MRQ assets/equity at 1.799 vs. 2.03 y/y.
7. Nacco Industries Inc. (NYSE:NC): Engages in lift trucks, small appliances, specialty retail, and mining businesses primarily in the Americas, Europe, and the Asia-Pacific. Market cap at $948.07M, most recent closing price at $111.95. PEG at 0.27, P/FCF at 9.29. MRQ net profit margin at 5.72% vs. 4.43% y/y. MRQ sales/assets at 0.528 vs. 0.522 y/y. MRQ assets/equity at 3.126 vs. 3.707 y/y.
8. TPC Group Inc (Nasdaq:TPCG): Produces specialized lines of chemical products to chemical and petroleum based companies worldwide. Market cap at $663.32M, most recent closing price at $41.91. PEG at 0.64, P/FCF at 10.0. MRQ net profit margin at 2.97% vs. 2.05% y/y. MRQ sales/assets at 0.571 vs. 0.565 y/y. MRQ assets/equity at 3.454 vs. 3.641 y/y.
9. Advance America, Cash Advance Centers Inc.: Provides cash advance services in the United States, the United Kingdom, and Canada. Market cap at $657.93M, most recent closing price at $10.50. PEG at 0.64, P/FCF at 4.17. MRQ net profit margin at 14.54% vs. 9.83% y/y. MRQ sales/assets at 0.375 vs. 0.371 y/y. MRQ assets/equity at 1.684 vs. 1.836 y/y.
10. HFF, Inc. (NYSE:HF): Provides commercial real estate and capital markets services to the commercial real estate industry in the United States. Market cap at $562.14M, most recent closing price at $15.44. PEG at 0.94, P/FCF at 7.97. MRQ net profit margin at 16.67% vs. 8.75% y/y. MRQ sales/assets at 0.159 vs. 0.147 y/y. MRQ assets/equity at 3.772 vs. 3.904 y/y.
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Disclosure: Kapitall's Danny Guttridge does not own any of the shares mentioned above.