What are we looking for?
Companies with modest ratio of future growth value (FGV) to enterprise value (EV).
In the economic value added (EVA) framework, while growth can certainly fuel value generation, it is not a must-have. If the price is right, a company that channels its profits to shareholders with dividends and buybacks can yield returns comparable to those of high-growth firms, but without the valuation risk.
Additionally, reasonable valuations don’t necessarily conflict with growth opportunities. So, seeking out decent-quality companies can also unveil unexpected upsides for investors.
The screen
We screened for U.S. companies with a market capitalization greater than US$5-billion with:
- An FGV on EV ratio between minus 20 per cent and 20 per cent. This metric represents the speculative value attributed to a company, relative to its size. We use the most recent trailing 12 months net operating profit after tax (NOPAT) and assume the company will produce it forever without growth, and we discount it using the company’s cost of capital. This computation yields an intrinsic value, which we deduct from the EV resulting in the future growth value that we divide by the EV.
- A Stockpointer (SP) score greater than 70. The score mainly considers risk-adjusted return on capital, earnings per share (EPS) growth and free cash flow per share. The score varies between zero and 100. The higher the value, the better the company
- A ratio of five-year average free cash flow to capital greater than 5 per cent. We aim for companies with a proven history of generating free cash flow that can be distributed to investors.
- Positive one-quarter NOPAT and EPS growth.
For informational purposes, we have also included price-to-earnings (P/E) ratio, buyback yield, dividend yield, total yield and one-year price return.
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What we found
U.S. stocks with modest FGV on EV ratios.
SM Energy Co. SM-N is an independent oil and gas exploration and production company with operations in Midland Basin and South Texas. The company has the lowest FGV on EV metric of our screen standing at minus 13. The P/E ratio stands at 6.5, also the lowest of our screen, and provides a similar insight. However, the company barely meets our other criteria such as positive quarterly earnings and five-year average free cash flow to capital ratio at 5.1 per cent.
Kroger Co. KR-N manages grocery outlets, drugstores and fuel stations at supermarkets. Interestingly, our FGV/EV metric diverges significantly from the P/E ratio. While Kroger’s P/E ratio sits at 18.6, making it the second highest on our list, the FGV/EV ratio is notably low at minus 11.4 per cent, ranking as the second lowest. The company offers a below-average total yield of 2.1 per cent, compared to the list’s average of 4.2 per cent, but demonstrates robust quarterly earnings growth of 16.1 per cent.
Lockheed Martin Corp. LMT-N is an American aerospace, arms, defence, information security and technology provider. The company offers attractive attributes as it obtains the top position for total yield, at 8.7 per cent, and reaches the second position in terms of SP score, at 77, and free cash flow to capital, at 15.2 per cent.
Investors are advised to do further research before investing in any of the companies listed in the accompanying table.
Anthony Ménard, CFA, is vice-president of data management at Inovestor.
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