Can You Make Paper with These Stocks?

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Many investors completely ignore certain segments of the market because the industry isn't all that exciting. I can imagine even analysts of paper product stocks probably need a little bit of caffeine to make it through the company presentations. But what’s not boring is finding a good value stock that pays a good dividend and has earnings growth.

That’s why I recently ran a screen on The Motley Fool CAPS Screener looking for companies in the “consumer non-durable" segment. My thought process was that, as the economy slowly recovers, any company related to packaging and paper should see improved results. There were only a few companies that met my requirements: International Paper (NYSE: IP), Packaging Corp. of America (NYSE: PKG), and Sealed Air (NYSE: SEE)

All three of these companies compete in the boring business of selling paper, corrugated paper, sealed packaging, and related businesses. Each of these companies pays a dividend yield of at least 2.5%, and they are all expected to enjoy earnings growth of between 6% and 11% over the next few years. Let's take a look at the relative valuation of these three companies.

<table> <tbody> <tr> <td> <p><strong>Name</strong></p> </td> <td> <p><strong>P/E on '12 Earnings</strong></p> </td> <td> <p><strong>Growth Expected</strong></p> </td> <td> <p><strong>PEG</strong></p> </td> </tr> <tr> <td> <p>International Paper</p> </td> <td> <p>14.77</p> </td> <td> <p>6.00%</p> </td> <td> <p>2.46</p> </td> </tr> <tr> <td> <p>Packaging Corp. of America</p> </td> <td> <p>17.65</p> </td> <td> <p>10.66%</p> </td> <td> <p>1.66</p> </td> </tr> <tr> <td> <p>Sealed Air Corp.</p> </td> <td> <p>16.52</p> </td> <td> <p>7.00%</p> </td> <td> <p>2.36 </p> </td> </tr> </tbody> </table>

I've read multiple articles in the past where a company's P/E ratio is compared to a set standard. For instance, some people only look for companies that have a P/E ratio of less than 15. The problem with a set number is that it ignores the company's growth rate. Looking at the PEG ratio makes much more sense, as it gives investors a comparison of the company's P/E ratio versus its growth rate. While Packaging Corp. has the highest P/E ratio, the company's growth rate is also the highest. Using the PEG ratio, Packaging Corp. looks like the best value. While there isn't much of a difference between International Paper and Sealed Air, Sealed Air gets second place with a slightly lower PEG ratio. (Packaging Corp. - 3, Sealed Air – 2, International Paper – 1)

Earnings growth is certainly essential, but for many investors cash flow is just as important. Looking at a company's cash flow tells us how much money it has for growing the business, buying back shares, and paying dividends. Since not all companies are the same size, comparing free cash flow to each $1 of sales levels the playing field. When it comes to cash flow efficiency, Packaging Corp. is the clear leader. This company generated $0.11 of free cash flow per $1 of sales in their most recent quarter. This was more than double the free cash flow generation of International Paper’s $0.05. Investors in Sealed Air should be a bit concerned, as the company is currently showing negative free cash flow. (Packaging Corp. - 3, International Paper – 2, Sealed Air – 1)

One of the primary reasons investors would investigate these companies is their dividend payments. Both International Paper and Packaging Corp. pay yields that are almost identical at about 2.85%. In addition, both companies have nearly the same payout ratio. International Paper has a 30.48% free cash flow payout ratio and Packaging Corp. paid out 30.56% of its free cash flow. Meanwhile, while Sealed Air pays the highest dividend yield of 3.2%, its negative cash flow effectively eliminates the company from this competition. (International Paper – 3, Packaging Corp. - 3, Sealed Air – 1)

Last but not least, we should look at each company's balance sheet to determine which one could withstand future challenges. To compare businesses of different sizes, I use the debt-to-equity ratio. By this measure, Packaging Corp. is the clear leader at 0.88. Sealed Air just barely comes in second at 1.72, and International Paper shows the weakest balance sheet with a 1.89 debt-to-equity ratio. (Packaging Corp. - 3, Sealed Air – 2, International Paper – 1)

In the final tally Packaging Corp. scores a perfect 12, International Paper taking home silver with a 7, and Sealed Air brings up the rear with a 6. With a clean sweep, Packaging Corp. is clearly the best value. The company is expected to report better than 10% earnings growth and pays an almost 3% yield. This means investors could expect 13% or better total returns.

Investors considering International Paper, should keep an eye on the company's relatively high debt ratio versus similar companies. As far as Sealed Air is concerned, investors should be very careful. The stock already sells for more than twice its expected growth rate, yet shows negative free cash flow. If Sealed Air continues its negative free cash flow, the dividend could be cut or eliminated. This would leave investors with a potentially overvalued stock paying either no dividend or a reduced payout. Given the three choices available, Packaging Corp. looks like a no-brainer to help investors wrap up profits.

MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Sealed Air. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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