12 Above Average Performing U.S. Growth Firms At Bargain To Reasonable Valuation Multiples

by: Eklund Research

This article summarizes a "value investing" type screen using Financial Times' free-to-use (membership required) stock screener. I have singled out a quick list of U.S. growth firms with market capitalizations exceeding 100 million USD and metrics that could support potential valuation upside. These firms are from a variety of different industries, but all share having above average business performance over the past 5-year period, including the financial crisis. In addition, their shares are currently being offered at bargain to reasonable valuation multiples in the markets.

The list itself has limited shelf life, since stock market valuations and fundamentals are ever changing. With that said, the methodology discussed can be reapplied indefinitely (that is until the day equity markets become perfectly rational weighing machines).

Not being specialized in U.S. stocks myself, I encourage all interested readers to further research the discussed firms and/or to use the comment field below to share a few insights when it comes to the long-term fundamentals of any of these firms. Going forward, I may publish some more in-depth research if interesting cases can be found here.

The article starts out with a brief background on stock screens and valuation multiples, and then I present the stock list from the screen. Following the list is a more thorough discussion on my choice of screening criteria and a shorter general note on value investing concludes.

A Simple Screen: The Short Version

A simple yet powerful tool that could be used at an early stage when looking for prospective investment candidates is stock screens. Screening an up-to-date database can provide the value investor with firms that 1) have certain historical business performance metrics and 2) that trade at some specific stock market valuation (in relation to the firm's historical or expected future business performance).

Valuation multiples can be employed as more or less standalone value investing strategies, there is empirical research that shows how mechanically buying the lowest valuation segments (quantile) of market has systematically outperformed buying the market average (index) as well as buying the segments with the highest valuation in the market. Many Seeking Alpha readers are already familiar with the topic so I will not go into an academic discussion here.

The intention of the screen employed in this article is basically to find firms that 1) are growing their revenues 2) at good profitability and 3) that generate attractive returns on capital.

The firms' current stock market valuation multiples should, at the same time, be below somewhat conservative threshold levels, regardless of the level of business outperformance. This means there will be no relaxation in valuation allowed for cutting-edge technology firms or hype industries, despite high double digit, or even triple digit, short-term historical annual growth. That sort of growth is generally not sustainable, projections are more prone to estimation uncertainty, and the author is definitely not competent in evaluating these sorts of businesses from an investing perspective.

In addition, this simple screen will not deal with the distressed or unprofitable firms that sometimes can be singled out as future gems; success in such turnaround plays are usually driven more by in-depth-knowledge and timing. Firms currently in a growth-less "cigar butt" stage, or worse, and quite a few high quality businesses with opaque accounting issues will also fall outside the screen.

To crudely stratify into screening categories, we introduce two firm groups; "Growth Firms" and "High Growth Firms," as defined in the section following the stock list. Any firms qualifying for the latter category are excluded from the former.

Findings: Candidates for Further Research as of June 1, 2013

The screen on June 1, 2013, singled out 12 U.S. candidate growth firms. The firms are presented in somewhat arbitrary groups of three at the time, so consider each individual firm as a potential investment research candidate without comparison to the others. My brief comments focus on the screen findings mainly.

Group 1: Ross Stores (NASDAQ:ROST), Fossil Group (NASDAQ:FOSL) and Ingredion (NYSE:INGR)

Starting out with a group of more or less consumer-oriented firms, we have the discount retailer Ross Stores, the fashion accessories company Fossil Group and Ingredion, a food ingredients supplier.

ROST seems to have prospered post-financial crisis, with respectable growth at increasing profitability. A ROE of almost twice ROA with a current net cash position suggests an efficient operational model when it comes to capital. Current valuation seems very reasonable if the business has a wide enough moat. As for further research, I would like to know more about the business model, the competitive landscape and structural trends in U.S. retail to assess whether ROST's improved profitability is sustainable.

Based on the screen, FOSL looks like an above average consumer goods company at a reasonable valuation. I would start by researching the business strategy and potential brand strength to assess its moat. In addition, FOSL has a very low leverage currently, so I would also check up the main owners' and management's M&A track record and risk attitude to assess the likelihood and success potential of coming acquisitions and/or refinancing actions.

In the complete screen, INGR was the only "Growth Firm" identified; no other firm in the database could match both the business performance and current valuation criteria set up for that category. This means that 5-year growth and profitability has been respectable rather than stellar, but also that the valuation allowed was stricter than for the other firms. A slowdown in growth has occurred during the most recent twelve months, limiting upside potential if it is not due to temporary developments. INGR's moderate Debt-to-Capital (~0.4) would suggest that the firm is already appropriately levered, if INGR is considered a low risk business in a low risk industry, that is. In that case, the P/E and PEG multiples are not rich and the EV/EBIT and EV/FCFF multiples are not prohibitive either.

Above Average Performing U.S. Listed Businesses Selling at Bargain to Reasonable Valuations

PART 1 of 4
Firm Ross Stores Inc. Fossil Group Inc. Ingredion Inc.
Category* HG HG G
Industry Retail (Apparel) Jewelry & Silverware Food Processing
Business Performance ROST FOSL INGR
5 yr Revenue CAGR 10.2% 14.8% 14.0%
TTM Revenue growth 12.9% 11.3% 5.0%
5 yr Net Income CAGR 24.7% 22.7% 16.7%
TTM Net Income growth 19.7% 16.5% 2.9%
5 yr EPS CAGR 30.0% 26.1% 16.2%
5 yr Capex CAGR 12.4% 22.8% 12.1%
5 yr average Net Profit Margin 6.9% 11.5% 5.5%
TTM Net Profit Margin 8.2% 12.5% 6.9%
TTM Operating Margin 13.2% 17.0% 10.4%
5 yr average ROA 18.9% 17.4% 6.5%
TTM ROA 22.3% 21.4% 8.2%
5 yr average ROE 43.3% 23.8% 14.4%
TTM ROE 46.6% 30.3% 18.9%
Debt-to-Capital 0.07 0.11 0.42
Interest Cover 268.4 89.6 11.4
Valuation Metrics ROST FOSL INGR
P/E 17.58 18.01 12.26
PEG** 0.71 0.79 0.74
EV/EBIT** 10.84 12.28 9.77
EV/FCFF** 8.92 9.87 7.63
P/B 7.59 5.09 2.16
Dividend Yield (%) 1.05% 0.00% 2.19%
Enterprise Value, USD bn 13.71 6.14 6.67
Market Cap, USD bn 14.21 6.23 5.38

Source: All data from Thomson-Reuters/Financial Times Equity Screener as of June 1, 2013. Definitions from Thomson-Reuters/Financial Times unless otherwise stated.

"CAGR" = Compound Annual Growth Rate (in percentage points), "TTM" refers to most recent Trailing Twelve Months.

*Category refers to firm classification discussed in article; "HG" = High Growth Firm, "G" = Growth Firm.

** Calculations by author. PEG = [P/E] / [5 yr Net Income CAGR]; EV/EBIT = [Market capitalization of equity + Interest-bearing debt - Cash]/[TTM Operating result]; EV/FCFF = [Market capitalization of equity + Interest-bearing debt - Cash]/[TTM Cash from Operations - TTM Net Capex].

ROST Total Return Price Chart

ROST Total Return Price data by YCharts

Group 2: CF Industries Holdings (NYSE:CF), HollyFrontier (NYSE:HFC) and RPC (NYSE:RES)

Then we move over to three firms active in commodities production and related areas; the fertilizer producer CF Industries Holdings, the oil refiner HollyFrontier and RPC, active in oilfield services and equipment.

CF shows respectable growth in revenues at an increasing profitability. Margins are currently extremely high. A bit worrying, though, is that capex has expanded at about the same rate as profits and far above revenue growth over the past 5 years, indicating heavy reinvestment needs. Industry and business model research could quickly sort out whether this is temporary or a structural issue that limits valuation upside. CF's shares trade at bargain levels on historical data, with PEG of 0.2, P/E under 7 and EV/FCFF at 2.1. This is a clear sign that the market is discounting significant long-term setbacks for CF and/or for the fertilizer industry as a whole. If such scenarios do not fully materialize, CF would be an interesting investment.

HFC has even more impressive growth metrics and trades at similar seemingly bargain multiples as CF. Since the growth here did not occur with a matching capex expansion, I would start out by analyzing the growth strategy, including analyzing organic versus acquired growth. Then I would move over to examining whether HFC has got any type of moat that could protect its high gear performance and how it is positioned against major trends in its industry. If no potential disasters are around the corner HFC's multiples look very attractive.

Finally, concerning RPC, it has managed to grow its top-line respectfully at good profitability that has been slightly improving over the past 5 years. However, over the past twelve-month period, revenue growth is stalling. Valuation seems to be in the low end if there is a recognizable moat in RPC's business.

Above Average Performing U.S. Listed Businesses Selling at Bargain to Reasonable Valuations
PART 2 of 4
Firm CF Industries Holdings Inc. HollyFrontier Corp. RPC Inc.
Category HG HG HG
Industry Chemical Manufacturing Oil & Gas Operations Oil Well Services & Equipment
Business Performance CF HFC RES
5 yr Revenue CAGR 17.2% 33.2% 23.0%
TTM Revenue growth 0.1% 30.1% 7.5%
5 yr Net Income CAGR 37.8% 38.9% 25.8%
TTM Net Income growth 20.1% 68.8% -7.4%
5 yr EPS CAGR 34.2% 22.9% 26.3%
5 yr Capex CAGR 37.9% 15.8% 5.8%
5 yr average Net Profit Margin 23.1% 5.7% 12.3%
TTM Net Profit Margin 31.5% 9.3% 12.2%
TTM Operating Margin 49.3% 15.2% 19.7%
5 yr average ROA 18.3% 12.8% 16.6%
TTM ROA 18.6% 18.1% 16.8%
5 yr average ROE 31.5% 28.6% 27.7%
TTM ROE 35.4% 31.8% 26.7%
Debt-to-Capital 0.21 0.16 0.09
Interest Cover 42.5 24.1 222.5
Valuation Metrics CF HFC RES
P/E 6.59 5.64 12.23
PEG 0.17 0.15 0.47
EV/EBIT 3.75 2.99 7.96
EV/FCFF 2.10 3.21 5.02
P/B 2.06 1.62 3.12
Dividend Yield (%) 0.82% 2.40% 3.10%
Enterprise Value, USD bn 10.94 8.91 2.93
Market Cap, USD bn 11.54 10.16 2.85

Source: All data from Thomson-Reuters/Financial Times Equity Screener as of June 1, 2013. Definitions from Thomson-Reuters/Financial Times unless otherwise stated.

"CAGR" = Compound Annual Growth Rate (in percentage points), "TTM" refers to most recent Trailing Twelve Months.

*Category refers to firm classification discussed in article; "HG" = High Growth Firm, "G" = Growth Firm.

** Calculations by author. PEG = [P/E] / [5 yr Net Income CAGR]; EV/EBIT = [Market capitalization of equity + Interest-bearing debt - Cash]/[TTM Operating result]; EV/FCFF = [Market capitalization of equity + Interest-bearing debt - Cash]/[TTM Cash from Operations - TTM Net Capex].

CF Total Return Price Chart

CF Total Return Price data by YCharts

Group 3: Oracle (NASDAQ:ORCL), Western Digital (NYSE:WDC) and Kulicke and Soffa Industries (NASDAQ:KLIC)

The next group is technology-centered with the software, hardware and services giant Oracle, the computer storage maker Western Digital and the semiconductor manufacturing equipment maker Kulicke and Soffa Industries.

ORCL is by far the largest firm found in the screen. In light of its massive market capitalization, it managed to eke out very respectable revenue growth over the past 5 years while improving its already impressive profitability. Given that the current size of the firm is a longer-term growth constraint and that top line growth has slowed in the past twelve months, the current valuation could be interpreted as reasonable, but not in any way stretched. Industry insights added may materially change the investment case potential, but as for myself, I will not spend time on research here, since this is a very well-researched mega cap firm.

WDC offers impressive historical growth at improving profitability, a trend that seems to have accelerated in the past 12 months. At the same time, the shares trade at a historical valuation that seems very low in aggregate. An overview of WDC's competitive landscape and any moats in its business model or products would make the room for upside potential clearer. Knowing nothing about this firm or the industry, I would want to rule out a value-trap situation the first thing I do.

KLIC has got respectable top-line growth at a significantly improving profitability over the past 5 years, indicating improvements in execution and/or the help from some beneficial trend(s). At the same time, capex growth has been limited, and the firm has a large net cash position. A question mark is the slight decrease in revenues over the past twelve months. If KLIC's track record is not the result of non-recurring effects, and if short-term developments have not turned very sour, the bargain multiples placed on this firm make no sense to me. I would start researching by learning more about the business model, the industry and the track record of the main owners and management. Note that KLIC is the smallest firm passing the screen, ceteris paribus placing it among the more interesting ones to research further.

Above Average Performing U.S. Listed Businesses Selling at Bargain to Reasonable Valuations
PART 3 of 4
Firm Oracle Corp. Western Digital Corp. Kulicke and Soffa Industries Inc.
Category HG HG HG
Industry Software & Programming Computer Storage Devices Semiconductors
Business Performance ORCL WDC KLIC
5 yr Revenue CAGR 15.6% 17.9% 16.4%
TTM Revenue growth 4.2% 31.0% -4.7%
5 yr Net Income CAGR 18.5% 23.4% 56.3%
TTM Net Income growth 16.8% 122.0% 26.5%
5 yr EPS CAGR 19.3% 21.4% 51.0%
5 yr Capex CAGR 15.2% 17.2% 4.4%
5 yr average Net Profit Margin 24.6% 10.7% 11.6%
TTM Net Profit Margin 28.5% 12.2% 19.7%
TTM Operating Margin 38.4% 14.0% 21.4%
5 yr average ROA 12.5% 14.8% 11.9%
TTM ROA 13.7% 14.0% 19.2%
5 yr average ROE 24.0% 24.3% 23.8%
TTM ROE 24.5% 25.1% 25.2%
Debt-to-Capital 0.31 0.19 0.00
Interest Cover 16.0 60.5 226.7
Valuation Metrics ORCL WDC KLIC
P/E 15.98 8.09 6.43
PEG 0.86 0.35 0.11
EV/EBIT 10.37 5.68 2.57
EV/FCFF 4.36 2.30 1.09
P/B 3.74 1.8 1.41
Dividend Yield (%) 0.00% 1.57% 0.00%
Enterprise Value, USD bn 148.11 13.03 0.44
Market Cap, USD bn 161.76 15.08 0.93

Source: All data from Thomson-Reuters/Financial Times Equity Screener as of June 1, 2013. Definitions from Thomson-Reuters/Financial Times unless otherwise stated.

"CAGR" = Compound Annual Growth Rate (in percentage points), "TTM" refers to most recent Trailing Twelve Months.

*Category refers to firm classification discussed in article; "HG" = High Growth Firm, "G" = Growth Firm.

** Calculations by author. PEG = [P/E] / [5 yr Net Income CAGR]; EV/EBIT = [Market capitalization of equity + Interest-bearing debt - Cash]/[TTM Operating result]; EV/FCFF = [Market capitalization of equity + Interest-bearing debt - Cash]/[TTM Cash from Operations - TTM Net Capex].

ORCL Total Return Price Chart

ORCL Total Return Price data by YCharts

Group 4: United Therapeutics (NASDAQ:UTHR), Questcor Pharmaceuticals (QCOR) and AZZ (NYSE:AZZ)

The next group is mixed, with the two biotechnology firms (drug makers) United Therapeutics and Questcor Pharmaceuticals, plus AZZ, an electrical equipment manufacturer.

Regarding both UTHR and QCOR, it should be noted that biotechnology/pharmaceuticals is a very complex industry to analyze, with a large set of industry specific and R&D project-related risks. Overlooking this, both these firms have extremely strong [UTHR] to amazing [QCOR] 5-year growth, and show great profitability. The valuations of both firms are very low in relation to past growth, indicating that the market sees their current level of sales and/or profitability as unsustainable or that there are some major problems or uncertainties surrounding these two firms.

Finally, the last firm covered is AZZ, the second smallest firm in the screen. Five-year growth is respectable with a significant improvement in profitability, a trend that seems to have accelerated (both the revenue growth rate and the improvement in profitability) in the last 12 months. However, with the 5-year capex growth exceeding revenue growth and EV/FCFF being almost twice EV/EBIT I would want to further analyze the reinvestment needs for sustained growth and profitability. Current valuation of AZZ in relation to its historical performance looks reasonable.

Above Average Performing U.S. Listed Businesses Selling at Bargain to Reasonable Valuations
PART 4 of 4
Firm United Therapeutics Corp. Questcor Pharmaceuticals Inc. AZZ Inc.
Category HG HG HG
Industry Biotechnology & Drugs Biotechnology & Drugs Electronic Instr. & Controls
Business Performance UTHR QCOR AZZ
5 yr Revenue CAGR 34.1% 59.2% 12.3%
TTM Revenue growth 23.3% 133.4% 21.6%
5 yr Net Income CAGR 89.8% 40.2% 16.9%
TTM Net Income growth 40.1% 148.4% 48.4%
5 yr EPS CAGR 83.4% 43.6% 15.9%
5 yr Capex CAGR 23.7% 23.6% 20.2%
5 yr average Net Profit Margin 20.8% 37.0% 9.9%
TTM Net Profit Margin 30.9% 36.1% 10.6%
TTM Operating Margin 42.7% 54.3% 16.5%
5 yr average ROA 10.1% 47.8% 9.2%
TTM ROA 18.2% 61.1% 9.3%
5 yr average ROE 15.9% 62.9% 18.0%
TTM ROE 27.0% 92.2% 19.5%
Debt-to-Capital 0.19 0.08 0.39
Interest Cover 32.5 873.0 7.6
Valuation Metrics UTHR QCOR AZZ
P/E 12.30 10.91 17.75
PEG 0.14 0.27 1.05
EV/EBIT 7.43 6.62 4.49
EV/FCFF 6.43 4.13 8.48
P/B 3 10.73 3.19
Dividend Yield (%) 0.00% 2.84% 1.33%
Enterprise Value, USD bn 3.05 1.97 1.23
Market Cap, USD bn 3.44 2.10 1.07

Source: All data from Thomson-Reuters/Financial Times Equity Screener as of June 1, 2013. Definitions from Thomson-Reuters/Financial Times unless otherwise stated.

"CAGR" = Compound Annual Growth Rate (in percentage points), "TTM" refers to most recent Trailing Twelve Months.

*Category refers to firm classification discussed in article; "HG" = High Growth Firm, "G" = Growth Firm.

** Calculations by author. PEG = [P/E] / [5 yr Net Income CAGR]; EV/EBIT = [Market capitalization of equity + Interest-bearing debt - Cash]/[TTM Operating result]; EV/FCFF = [Market capitalization of equity + Interest-bearing debt - Cash]/[TTM Cash from Operations - TTM Net Capex].

UTHR Total Return Price Chart

UTHR Total Return Price data by YCharts


The screens in this article were done in Financial Times' free-to-use online equity screener on June 1, 2013 (based on the closing prices of May 31). At the time, the screener listed 6,666 U.S. firms in total. The author assumes no responsibility for the accurateness of the information provided.

This article is not a recommendation to buy any of the stocks mentioned, but a mere suggestion to consider them for further research. Any investments in these stocks should be based on the reader's own analysis and/or recommendations from his/her professional advisor.

Screening Details: Business Performance Criteria

1) Annual growth of revenues, net income and EPS: The Financial Times screener can screen for the last 5 fiscal years' average annual growth in revenues, net income and adjusted EPS (Earnings per Share). I set the revenue growth limit somewhat lower than for net income to account for firms that are operationally and financially executing improved or maintained profitability. This includes the few firms that are actually successful at acquisitions. EPS growth should ideally be in line with or better than net income growth, indicating among other things, that the firm is not diluting existing shareholders with excessive share issues (including stock-for-stock acquisitions) and/or that the firm is actively repurchasing its shares.

The 5-year growth criteria are particularly interesting, since the historical period encompasses 2008-2012, the blowup and aftermath of the recent financial crisis. Thus passing the screen means the firm's business held up well, or even prospered, during very challenging economic times with high levels of financial stress. The criteria also remove newly listed firms without a 5-year track record.

I also require that trailing twelve month ("TTM") growth in revenue and/or net income has not entered a sharp plunge. Other criteria below will exclude fast-growers with excessive leverage, high reinvestment needs and/or cash-flow problems.

- Growth Firms:

5-year revenue growth > 5% per annum

5-year net income growth > 10% per annum

5-year EPS growth > 10% per annum

TTM revenue growth > -10% year-on-year

TTM net income growth > -20% year-on-year

- High Growth Firms:

5-year revenue growth > 10% per annum

5-year net income growth > 15% per annum

5-year EPS growth > 15% per annum

TTM revenue growth > -10% year-on-year

TTM net income growth > -20% year-on-year

2) Operating margin and net margin: After filtering out the firms that had grown through the crisis years, we want to exclude firms, which operate with low profit margins. The rationale for this is that low profit margins usually, but not always, indicate the lack of a "moat" in the firm's business, poor management/execution and/or that the industry itself is very competitive with possible structural issues such as overcapacity. Ideally this screen would be done employing the long-term average operating [EBIT] margin, but the chosen screener data only offers 5-year average annual net margins, so that will somewhat crudely be used as a proxy. Some ultra-efficient high asset turnover low-margin firms will be lost here [think Wal-Mart (NYSE:WMT)].

- Growth Firms and High Growth Firms:

5-year average net profit margin > 5%

TTM net profit margin > 5%

TTM operating (EBIT) margin > 7%

3) ROA, ROE: All firms screened for should generate at least decent returns on their equity holders' capital but also on their total assets. We want the High Growth firms to generate even better returns than the Growth ones, the rationale being to compensate for paying higher multiples and for the risk that growth abates.

- Growth Firms:

5-year average ROA > 5%

TTM ROA > 5%

5-year average ROE > 10%

TTM ROE > 10%

- High Growth Firms:

5-year average ROA > 7.5%

TTM ROA > 7.5%

5-year average ROE > 15%

TTM ROE > 15%

4) Debt-to-capital: In this screen, we also want the firms with above average business performance not to be financially levered. The rationale is that these firms are more robust during economic cycle downturns, financial market turbulence etc. In addition, these firms are likely to be candidates for refinancing, unlocking short-term payoff potential to their shareholders. You want to be an owner before potential refinancing and/or buyout attempts occur.

The above reasoning contradicts the so called Modigliani-Miller Theorem, which I sloppily summarize as the concept that in a world of efficient markets, capital structure should not affect firm value. In practice, potential capital structure changes are not easy to discount, and thus market valuations commonly extrapolate the current capital structure rather than a radically changed (and perhaps more optimal) one. There are often forces in play that can make capital structures in public firms become quite inefficient, at least from the point of view of external investors with no personal interests involved other than their shareholding. The ability of private equity buyout funds to outbid institutional and retail investors is not only a product of their governance model, trusting general partners and/or offshore tax advantages, it is as well an arbitrage of unlocking value potential by changing the target firm's capital structure.

Practically, there will at all times be a small number of firms that could service very high debt loads over the nearest business cycle. The problem from the perspective of a conservative value investor is just that which business sectors and business characteristics will prove robust will vary over time, and not in a particularly predictable way.

- Growth Firms and High Growth Firms:

Debt-to-capital < 0.6

5) Annual growth of capex (capital expenditure): Most firms need to reinvest some of their continuous cash flows into tangible fixed assets, in order to maintain their current capabilities and to stay competitive relative to their peers. Some of the downsides with tangible fixed assets is that they consume cash (in investment outlay and in future maintenance costs), they tend to become technologically obsolete quickly (e.g. unattractive on the secondary market) and they make an organization less flexible. The need for fixed tangible asset reinvestment of course varies between sectors and firms and can seldom be avoided completely.

A trend of drastically increasing capex over the last 5 years suggests the not-so-light-reinvestment need of a commoditized or highly competitive low-margin industry and/or business model. This despite that some such firms manages to match the high profitability we simultaneously screen for. The ideal sort of business we are looking for is one that has a business model where its competitive advantage can be converted into profitability and possibly strong growth, but without having to reinvest a large portion of cash flows in maintenance capex. Instead the reinvestment need should ideally be so light that capital allocation becomes a matter of choosing to reinvest in improved profitability and/or high return growth opportunities or to just distribute the excess cash to shareholders.

- Growth Firms:

5-year capex growth < +35 % per annum

- High Growth Firms:

5-year capex growth < +50 % per annum

Screening Details: Valuation Criteria

1) P/E: The net income and EPS of U.S. firms tend to be easy to manipulate (usually upwards) using liberal accounting techniques. Thus P/E's based on U.S. GAAP or firm's own non-GAAP EPS can at best serve as a crude guide to the market's perception of current firm profits.

My complementary screening criteria improve the odds that these profits have been generated at a low to moderate financial leverage, with high business margins, with growth and that an attractive to fair accounting profit valuation is matched by an attractive to fair free cash flow valuation.

- Growth Firms:

TTM P/E < 15

- High Growth Firms:

TTM P/E < 20

2) EV/EBIT and EV/FCFF: Though not included in the Financial Times equity screener, I manually use their data to estimate the current TTM Enterprise Value/EBIT and Enterprise Value/Free Cash Flow-to-Firm-multiples and exclude firms that have rich net debt-adjusted valuations on current performance. EV/EBIT and EV/FCFF are quite versatile firm valuation metrics that relate the current operating profit [EBIT] or cash flow [FCFF] level from the entire firm's asset side to the firm's capital owners, i.e. its shareholders as well as its debt-holders.

I define FCFF as [Cash from Operating Activities] - [Capex]; a simplification that involves the assumption that all capex is replacement oriented (some is probably used for growth) while none of the M&A activity would be considered replacement reinvestment. Firms that are successful in M&A will over time generate part of their profit and FCFF growth from these activities, while unsuccessful M&A activities will over time put a drag on profits and FCFF.

- Growth Firms:

TTM EV/EBIT < 12.5

TTM EV/FCFF < 12.5

- High Growth Firms:



Comment: As a simplified example a FCFF that corresponds to at least 8% of the firm's capital implies an EV/FCFF of below 12.5. A non-growing all-equity financed firm at EV/FCFF of 12.5 would thus have a 8% cost of equity. In most cases, that would be too low for conservative investors, but keep in mind that we are actively scanning for growing firms with above-average profitability. The same non-growing firm with a 50% debt-to-capital financing could support a 12% cost of equity and a pre-tax 6% cost of debt (making the liberal assumption that interest is fully deductible at a 35% corporate tax rate).

Screening Details: Additional Criteria

Stock must trade in U.S. markets: For most investors this is just a limitation but given that the focus of Seeking Alpha is actionable ideas in U.S. markets I have added this limitation. This eliminates most but the largest international firms when using Financial Times' screener.

Stock must have a market capitalization of equity of at least 100 million USD: In line with Seeking Alpha policy, I will focus on stocks above this threshold. I would not feel comfortable to publish a prospective stock screen with small/micro capitalization components when I have not manually checked up all the underlying data, main owners and firm management.

Stock must not be in Financial Industry: This screen focuses on finding businesses with strong operating performance. Well-performing Financials can also be distinguished by a set a characteristics, only that many of the relevant metrics are industry specific so I leave Financials out of this exercise.

A Note on the Concept of Value Investing

"Price is what you pay. Value is what you get." - Warren Buffett, Berkshire Hathaway's 2008 Chairman's Letter

"Value investing" can seem like a deceivingly simple concept; you assess the intrinsic longer-term value of some asset or business and try to guesstimate some reasonable price or price range at which this asset or business could be acquired in order to constitute an attractive holding from a risk/reward perspective. Yet value investing requires extensive and original research and over long periods of time it requires you to be positioned against the prevailing market consensus, which can be quite a psychological challenge.

My own conviction from studying the literature and human behavior in markets is that any market based valuation is very susceptible to human behavioral patterns over the short to medium term, including the mass psychology driving manias and panics. Market history tells us how over the longer run common sense tends to bring markets back in line with their ever-changing fundamentals, in a sort of mean-reverting pattern (no, I am not talking about mathematically precise or predictable mean-reversion). Longer term this is an opportunity for a prudent value-oriented investor and a potential death trap for the momentum crowd (at least for those who are overly aggressive buyers at stretched valuations or overly aggressive short-sellers in firms with sound fundamentals and low valuations).

From a more practical and non-scientific perspective, there are a good handful of well-known investors who have built successful long-term track records around value-investing strategies, track-records that would be hard to replicate by naive chance. Incorporating a value-investing mindset can be as easy as to just start questioning and scrutinizing the current valuation the market has put on any stock, business or asset that you feel that you yourself, or some partner you trust, could perform a reasonable risk/reward analysis on.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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