The stocks covered in this article are currently undervalued based on their price to free cash flow ratios. A company with a price to free cash flow ratio of approximately 15 is considered to be undervalued. Additionally, the price to free cash flow ratio is one of the most important factors to consider when evaluating stocks. The income statement can be manipulated to show a profit while a company still has negative cash flow from operations. Cash flow is the lifeblood of a company. If the company does not obtain cash flow in one way or another it cannot remain as a going concern.
These five companies are trading at or less than 15 times free cash flow. LSI Corporation (LSI) has the highest ratio at 17 times free cash flow while Xerox Corp. (XRX) has the lowest at 6.79 times free cash flow. Each time you consider starting a position in a stock, you should prudently scrutinize its free cash flow information.
Additionally, the five stocks are trading at or below $10. Stocks trading for $10 or less tend to be more volatile with frequent, larger percentage moves in the stock price. This provides the opportunity for greater returns (or losses) relative to the market or more bang for your buck so to say.
Finally, these are U.S. S&P 500 stocks with market caps of $3 billion or greater that are trading on average 30% below their 52 week highs and have 22% upside potential based on current consensus mean price targets. The question is, is it really time to buy?
In the following sections, we will perform a review of the fundamental and technical state of each company. Additionally, we will discern if any up or downside potential exists based on sector, industry or company specific catalysts. The following table depicts summary statistics and Wednesday's performance for the stocks.
Boston Scientific Corporation (BSX)
BSX is trading for 7.76 times free cash flow. The company is trading 13% below its 52 week high and has 12% potential upside based on the analysts' consensus mean target price of $6.25 for the company. BSX was trading Wednesday for $5.57, up slightly for the day.
BSX has some strong fundamentals. BSX has a price to book ratio of 1.12 and an EPS growth rate of 141% for this year. BSX has a forward PE ratio of 12.91. The company trades for approximately one times sales.
Technically, the stock has been stuck in a trading range between $5 and $6 for the past few months. The stock is trading above the 2% above the 50-day sma which is positive.
Boston Scientific was upgraded by JMP Securities (JMP) from market perform to outperform with a price target of $9. JMP believes the company should experience strong growth during the next several years. BSX has had a series of positive catalysts recently with new product in the pipeline that should increase revenues in 2013.
BSX's business model generates solid free cash flow, reliable revenue and controllable capital expenditure requirements. I believe BSX is a buying opportunity at this level.
LSI is trading for 17 times free cash flow. The company is trading 26% below its 52 week high and has 23% potential upside based on the analysts' consensus mean target price of $8.39 for the company. LSI was trading Wednesday for $6.87, up over 2% for the day.
LSI has several fundamental positives. The stock has a projected EPS growth rate for next five years of 18%. LSI has a rock-solid balance sheet with a significant percentage of market cap in cash. LSI has a PEG ratio of 1.17. The forward P/E ratio is 10.04
Technically, the stock is at the apex of a descending triangle. This is known as the break out position. The stock has been in a short-term downtrend since September and broken through the 200-day sma. Currently, LSI is trading 7% below its 200-day sma yet just above support at the 50-day sma. The day 50-day sma should provide support for the stock. I like the stock here, yet would wait for the stock to break out one way or the other prior to starting a position to reduce risk.
Micron Technology Inc. (MU)
Micron is trading for 14.81 times free cash flow. The company is trading 33% below its 52 week high and 46% potential upside based on the consensus mean target price of $9.04 for the company. Micron was trading Wednesday for $6.18, up over 2% for the day.
Fundamentally, Micron has some positives. Micron's forward P/E is 9.74. Micron is expecting EPS to be up significantly next year according to Finviz.com. Micron is trading for approximately 80% of book value and 75% of sales. Micron insider ownership has increased by 45% over the past six months.
Technically, Micron is in a long-term downtrend. Nevertheless, the stock has been in a short term uptrend since the beginning of November. The stock broke through major resistance at the 50-day sma and kept on going.
According to a recent Goldman note, they see Micron moving higher based on an improving supply/demand balance. Goldman doesn't see NAND flash memory vendors making "meaningful capacity additions" through mid-2013, even though many have all cut supply lately. In the meantime, demand growth is steady and could see upside if cheaper solid-state drives are rapidly adopted. Micron should benefit from this more favorable supply/demand balance. I believe the risk/reward is favorable for the longs here. The stock is a buy here.
MetroPCS Communications, Inc. (PCS)
MetroPCS is trading for 10.27 times free cash flow. The company is trading 31% below its 52 week high and 22% below the analysts' consensus mean target price of $12.23 for the company. MetroPCS was trading Wednesday at $10.10, up over 1% for the day.
MetroPCS has several fundamental positives. The company is trading for slightly above book value, has a PEG ratio of .46 and has a forward PE of $12.95. MetroPCS has an EPS growth rate of 14.53% for next five years.
MetroPCS Chief Executive Officer Roger Linquist said recently the company's stock is undervalued as investors focus too much on its pending merger with Deutsche Telekom AG's T-Mobile USA unit. Speaking to investors at the UBS Global Media and Communications Conference in New York Wednesday he stated,
"The stock has declined 26 percent since the T- Mobile deal was announced, is "absolutely" not trading at its fair value."
MetroPCS is a Texas-based company with strategically placed spectrum licenses. The company is set up for massive expansion. MetroPCS stock offers a compelling buying opportunity at this price. If you bought the stock based on my initial recommendation on May 22nd you would be up over 60%. I still like the stock here.
Xerox is trading for 6.78 time free cash flow. The company is trading 19% below its 52-week high and has 7% upside potential based on the consensus mean target price of $7.50 for the company. Xerox was trading Wednesday for $6.97, down slightly for the day.
Fundamentally, Xerox is solid. The company has a forward P/E of 6.28. The company is trading for 71% of book value and has a PEG ratio of 1.93. Xerox's EPS growth rate was over 100% this year. The company pays a dividend with a yield of 2.44%. Xerox insider ownership has increased by 58.96% over the past six months.
Technically, the stock looks like it may have put in a bottom. The stock has been on a roll since the company's annual conference on November 13th. The stock has posted higher highs and higher lows since that date.
Xerox predicted its services business will expand to two-thirds of revenue by 2017 from about half this year, mitigating waning demand for paper documents, and announced a dividend increase in 2013. Chief Executive Officer Ursula Burns stated,
"We'll be able to have a low-growth business shifting to a high-growth business as we get more of our revenue from services. On balance, we're making progress, not fast enough. I'm not patient."
Xerox is trying to transform itself from a printer sales company to a service company where the margins are much higher. I believe Xerox has the wherewithal to pull off the turnaround. The risk reward is favorable for long trades at this level.
The Bottom Line
The risk/reward ratio for these undervalued stocks looks favorable for long trades at the time. We are talking about investing in these stocks for the long haul. If you attempt to trade stocks in this volatile market you will surely get yourself into trouble.
Use the sell offs to layer in to your favorite stocks at a discount. If you choose to start a position in any stock, I suggest layering in a quarter at a time on a weekly basis at a minimum to reduce risk. Set a 5% trailing stop loss to minimize losses even further if you wish.
Additional disclosure: This is not an endorsement to buy or sell securities. Investing in securities carries with it very high risks. The information contained within this article for informational purposes only and is subject to change at any time. Do your own due diligence and consult with a licensed professional before making any investment.