This is as Close as it Gets to a Sure Thing
Ted is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investors usually make decisions more complicated than they need to be. The easiest way to be successful in the long run is to only buy into the 'obvious' situations. Obvious situations involve companies with durable competitive advantages trading at a high free cash flow yield. By high yield, I mean above 10%; great companies should not yield 10%, they should trade closer to 6% in most years. Luckily for the astute investor, these companies do sometimes trade at high free cash flow yields, as is currently the case for Omnicom (NYSE: OMC).
Omnicom has a tremendous moat in the advertising industry; it owns three of the finest advertising agencies in the world. When a client gets upset with one of its agencies, Omnicom can directly switch it to another of its world-class agencies. This advantage, along with its size, contributes to its steady free cash flow margins.
Omnicom has much more predictable free cash flow than Lamar Advertising (NASDAQ: LAMR) and Interpublic Group (NYSE: IPG). This makes sense because Lamar and Interpublic do not have the same moat that Omnicom has.
But the value of the moat really shows itself in Omnicom's return on invested capital. It regularly earns over 15% before tax on its investments, while Lamar and Interpublic struggle to breach double digits. That means that although Omnicom is a much larger competitor than the other two, it is compounding its wealth at a higher rate.
Superior Competitive Position
It would be unreasonable to project past operating results into the future if Omnicom did not have a superior position in its industry. But, with three independent global agency networks under its umbrella, the company appears to have a distinct advantage over its competitors. Since each network maintains its own clients and compete with one another in the same markets, unhappy customers can simply switch to one of the other two agencies and Omnicom will keep their business.
Omnicom also has an advantage over smaller rivals because it can provide clients with the full breadth of marketing and advertising services. This is also a key source of growth; more and more clients want to deal with only one agency, so Omnicom is able to cross-sell its products to existing customers.
Stock is Cheap
With that said, it is unclear why Omnicom trades at a discount to Lamar and Intperpublic. After 'normalizing' free cash flow (by taking the average free cash flow margin over the last 10 years and multiplying it by the last four quarters of revenue), Omnicom trades at just 9x normal free cash flow while Lamar trades at 15.7x and Interpublic trades at 15.9x.
At 9.1x free cash flow, Omnicom is yielding 11.01%. That is, the stock should return an annualized 11.01% to shareholders assuming Omnicom does not grow or shrink. However, over the course of the market cycle, Omnicom deserves to trade at about 15x free cash flow. At 15x the normalized free cash flow figure, the company is worth $83.42 per share. At a current price of $50.53 per share, Omnicom looks like a no-brainer.
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