When Market Leaders are in the Value Bin

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

As a value investor I rejoice when good companies become cheap, and I can buy more cash flow for my dollar. It’s like finding a good science fiction movie for $0.99.

When I look for companies I look for qualities such as a huge cash and marketable securities position relative to stockholders' equity.  Companies that have total Debt to Equity of less than 85% and Long Term Debt to Equity of less than 50% are preferable. It’s also a plus for the Return on Equity to be above 12%. In companies that pay a dividend, the dividend to free cash flow ratio needs to be below 40% with a free cash flow yield above the yield of the 10-year treasury. I also look for companies that grow their free cash flow and revenue at a pretty decent rate. Based on my review of annual reports from 2000-2011, here are four companies that fit the above criteria: Microsoft (NASDAQ: MSFT), Apple (NASDAQ: AAPL), eBay (NASDAQ: EBAY), and Intel (NASDAQ: INTC).

Microsoft (MSFT)

Revenue Growth
(2000-2011)

10.659%

Free Cash Flow Growth
(2000-2011)

8.000%

Cash+Short Investments+Equity and Other Investments

$68,997

Cash + Short Term Investments/ Stockholders' Equity

86.70%

Total Debt Equity<85% (mrq)(1)

71.88%

Total Long Term Debt/Equity<50%(2)
(mrq)

33.76%

Free Cash Flow Per Share
Year End 2011(3)

$2.867

Free Cash Flow Yield >1.70%
(as of Market Close 05/18/12)(4)

9.8%

Net Income Growth
(2000-2011)
(As of Year End 2011)

8.5170%

Return On Equity
(As of Year End 2011)

40.55%

Dividend to Free Cash Flow<40%
(mrq)

21.14%

Dividend to Operating Cash Flow
(mrq)

19.65%

Dividends to Cash+Short Term Investments (mrq)

7.91%

Dividend to Net Income
(mrq)
(Payout Ratio)

26.94%

Source: SEC Filings

Microsoft, in my opinion, is one of the better companies I reviewed. With more than $68 billion in cash and liquid investments on its balance sheet, it is in a good position to boost dividends, invest in future product development, and keep going during a major downturn. As of close on May 21, Microsoft had a free cash flow yield of 9.6%. That is way above the 10-year treasury yield of around 1.7%. Its debt is also way below my threshold for rejection.

Microsoft also has growth potential with its Windows 8 platform that is under development. According to the Windows 8 consumer preview, it’s going to have an improved touch experience, mobile broadband features such as data metering, and a cloud feature called Skydrive; all created to run on ARM-based tablets. According to their online pamphlet, this new platform is designed with businesses in mind, which is smart because the business division was the highest percentage of Microsoft’s 2011 revenue.

I do have some concerns for Microsoft’s future. There is currently softening demand for its video game consoles. I am also concerned that the market won’t respond to the Windows 8 operating system. Apple has a strong foothold in the touch interface tablet market. However, with such a good liquid position on Microsoft’s balance sheet, they can take these products back to the drawing board, if necessary, and still boost dividends.

Apple (AAPL)

Revenue Growth
(2000-2011)

26.745%

Free Cash Flow Growth
(2000-2011)

40.29%

Cash+Short Investments+Equity and Other Investments

$110,176

Cash + Short Term Investments/ Stockholders' Equity

27.84%

Total Debt Equity<85% (1)(mrq)

47.26%

Total Long Term Debt/Equity<50%(2)(mrq)

16%

Free Cash Flow Per Share(3)
Year End 2011

$32.11

Free Cash Flow Yield >1.70%
(as of Market Close 05/18/12)(4)

6.10%

Net Income Growth
(2000-2011)
(As of Year End 2011)

37.411%

Return On Equity
(As of Year End 2011)

33.83%

Dividend to Free Cash Flow<40%
(mrq) Rough Estimate!

17%(5)

Dividend to Operating Cash Flow
(mrq) Rough Estimate!

17%(5)

Dividends to Cash+Short Term Investments (mrq) Rough Estimate!

4.5%(5)

Dividend to Net Income
(mrq) (Payout Ratio)
Rough Estimate

7.5%(5)

Source:  Sec Filings

Apple appears to have the best liquid position. It has cash and investments balance of $110 billion with the cash and short-term investments comprising 27.84% of the equity base. As of this writing Apple has seen a 12.84% drop from its 52-week high. The company has seen a 66% increase in its revenue versus the same six month time period ending March 31 last year. The biggest drivers are iPad and iPhone sales and related products and services. I just bought an iPad and the most interesting thing about this tablet is that it has the size and feel of a book. The portability of this device is amazing. While it hasn’t replaced my laptop computer, if you want to surf the web, read or check email on the go, an iPhone or iPad is the thing to have. The potential for these devices is great.

I am concerned about whether the innovation will continue without Steve Jobs. Competition from Microsoft and other non-Apple devices could also cut in to their market share. My general concern when investing in tech companies is obsolescence and the fading of trends. I think of how Gateway and Dell used to be on top and now Apple is all the rage. How long will Apple stay on top? Will the trend of tablet computing take hold or will it be replaced by something new and more interesting? Even so, the liquid position of this company should allow it to invest in new innovation and return increasing value to shareholders in the form of future increased dividend payouts.

eBay (EBAY)

 Revenue Growth
(2000-2011)

34.938%

Free Cash Flow Growth
(2000-2011)

41.587%

Cash+Short Investments+Equity and Other Investments

$8732

Cash + Short Term Investments/ Stockholders' Equity

31.38%

Total Debt Equity<85% (mrq)(1)

50.77%

Total Long Term Debt/Equity<50%(2)
(mrq)

13.54%

Free Cash Flow Per Share(3)
Year End 2011

$1.76

Free Cash Flow Yield >1.70%(4)
(as of Market Close 05/18/12)

4.6%

Net Income Growth
(2000-2011)
(As of Year End 2011)

46.531%

Return On Equity
(As of Year End 2011)

18.01%

Source:  Sec Filings

eBay is best known for allowing people to advertise and sell their goods online, making it easier for people to clean out their closet for a little cash, without setting up a yard sale. eBay also has PayPal, which comprised 35% of eBay’s revenue in 2011. PayPal has become a convenient and safe way for people to transmit funds back and forth on the internet. Convenience and a well-recognized brand name have become the driving force behind eBay’s success and will drive it forward in my opinion. Think about this: “PayPal” rolls off the tongue better than “Google Checkout.”

My primary concern about this company is that they like to make a lot of acquisitions. In 2011, eBay made a little over $3 billion in acquisitions. As a result, goodwill stands at 45.11% as of the most recent quarter. This goodwill could be impaired and written down at a future date.

The stock price of this company has experienced a run up in the past month, but I think it still has good price potential and it would be worthwhile to put on your watch list for future price corrections.

Intel (INTC)

Revenue Growth
(2000-2011)

4.372%

Free Cash Flow Growth
(2000-2011)

4.701%

Cash+Short Investments+Equity and Other Investments

$8,732

Cash + Short Term Investments/ Stockholders' Equity

20.19%

Total Debt Equity<85% (mrq)(1)

53.59%

Total Long Term Debt/Equity<50%(2)(mrq)

28.05%

Free Cash Flow Per Share(3)
Year End 2011

$1.885

Free Cash Flow Yield >1.70%(4)
(as of Market Close 05/18/12)

7.2%

Net Income Growth
(2000-2011)
(As of Year End 2011)

1.888%

Return On Equity
(As of Year End 2011)

28.19%

Dividend to Free Cash Flow<40%
(mrq)

-52450%

Dividend to Operating Cash Flow
(mrq)

35.3%

Dividends to Cash+Short Term Investments (mrq)

11.11%

Dividend to Net Income
(mrq) (Payout Ratio)

38.31%

Source:  Sec Documents

Intel is at the bottom of my list based on fundamentals. Revenue and free cash flow growth were variable at 4.372% and 4.701%, respectively. Dividends to free cash flow based on 2011 figures are 40.46%, which is barely in my range of tolerance for payout to cash flow. Free cash flow in the most recent quarter was -52450% because of negative cash flow during the quarter. Free cash flow yield is a decent 7.2% based on 2011 figures. 

Intel is a well recognized leader in the PC chip market. People still need PCs because, in my opinion, a tablet just can’t do everything that a laptop or a desktop can. *Disclaimer* I have a personal preference for the chip and I own the stock myself. Even so, mobile computing is on the rise, but Intel can’t seem to get a foothold in that business. They also seem to be deviating from their core competency by buying McAfee, a virus protection program, and creating computer notebooks of their own. Intel has experienced a rough quarter because of delays in its hard drive supply. 

However, as Ben Graham would say, this company may make a good “cigar butt.” It has a well-recognized brand with a decent liquid position and possible low and steady growth could mean future increases in dividends. 

A value investor is always on the lookout for good companies that become cheap. All four of these market leaders are poised for great price appreciation. Mr. Market may recognize the potential of some companies sooner than others, so patience is warranted.

Footnotes:

  1. I take the total debt (Short Term+Long Term Debt) for the previous year and divide it by the previous year’s Stockholders' Equity.
  2. I take the Total Long Term Debt (not just notes and bonds payable) for the previous year and divide by the previous year’s Stockholders' Equity.
  3. I take the Operating Cash Flow and subtract the capital expenditures and add back equipment disposals to arrive at Free Cash flow.  I divide that figure by the diluted weighted shares outstanding to arrive at free cash per share
  4. I take free cash flow per share and divide it by the market price per share and multiply by 100.
  5. Estimated based on equivalent time last year.  I know the increase in cash flow will be great so these figures will probably be half.


stockdissector has positions in Intel and Microsoft mentioned above.  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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