Investing these days for most people is like riding a roller coaster. You get on the ride, go way up and way down numerous times and at the end of the ride you find yourself back where you started and in some cases worse off, because you are sick to your stomach.
Investing does not have to be that way if you try to achieve "capital appreciation through capital preservation."
Since most investors put little research into their investments, they tend to buy at the wrong time and sell at the wrong time. These roller coaster swings in the markets are caused by millions of such investors selling and buying at the wrong times. I am not complaining, as such actions create opportunities for those who do their research and understand that they are making investments in companies that operate on Main Street, and that are not just a ticker on Yahoo Finance.
During high growth periods, when the economy is booming and we are near full employment, it is a lot easier to invest as a rising tide lifts all boats. But unfortunately we are currently in a period where the macroeconomic picture is not bright at all, as governments of the world are in serious trouble economically. Whether it is at the local, state or federal level, most government entities are struggling.
Unfortunately, market participants as a group are in denial and can’t break the cycle of feeling that they always have to be fully invested or must be “in it, to win it.” Millions of investors are still fully invested in Index funds and are taking on a great risk. Stocks are by no means expensive when one compares our current period to that of the dot com boom and bust period of 1998-2001 for example, but what people are missing these days is the macroeconomic picture is ten time more bleak then it was then.
No matter how good of a stock picker you are, when the markets go down you are going to go down as well. This happens because most of the market participants (who also own your stocks) don’t understand what they are doing and will sell stocks randomly when they panic and start running for the exits.
The best way to handle the current environment as an investor is to be in as much cash as possible, create a database or list of stocks with your buy prices ready and wait for them to hit those prices. By doing this you are taking the emotion out of the game and end up buying stocks that are selling at incredible discounts to their free cash flow.
The way to do this is to buy unpopular and boring companies that are beaten up by Wall Street. These stocks have already had most of their fall and most traders or momentum players are avoiding them like the plague. In the majority of cases many stocks that crater, deserve to do so, but then again, every once and a while bargains spring up that are too incredibly priced to ignore.
That is the point where you are forced to buy and thus use some of your cash. Cash is the greatest hedge around as it stays where it is, if you go short at the wrong time or buy treasuries and interest rates go up then you can get hurt just as bad as you can with stocks going long. Cash allows you to be totally agnostic to the market and only act when you have done your research.
Roller Coasters are for kids and not for adults preparing for their retirement. Investing for your retirement is not a game, but is serious business and unless you are willing to take the time to do the work, you are taking a big risk in just letting it ride in an Index fund or Mutual Fund where you never met or even taked to the portfolio manager.
The following is how I pick investments during these difficult Macro-economic times to protect my clients and preserve their capital.
The five stocks I would like to discuss now that meet my criteria as free cash flow bargains are as follows:
1. Nokia (NOK)
2. American Greetings (AM-OLD)
3. Pitney Bowes (PBI)
4. Eli Lilly (LLY)
5. Xerox (XRX)
When I analyze stocks using free cash flow I come at it from two directions. One is using the standard method of free cash flow, which is basically = cash flow from operations-capital expenditures. The second method is what is called Levered Free Cash Flow and it is a little more complicated.
Levered Free Cash Flow = the amount of cash available to stockholders after interest payments on debt are made. A company with a large amount of debt will have to spend more money on interest payments, which in turn will limit the amount of money that can be sent to stockholders in the form of dividends. The way to calculate it is = Net Income + Depreciation and Amortization - Principal Repayment of Debt - Preferred Dividends + Proceeds from New Debt and Preferred - Capital Expenditures - Changes in Working Capital.
Luckily for us I have found some websites where both Levered and Regular Free Cash Flow are calculated for us and even better the information is free. I will use (TTM) for all my examples, which simply means “trailing twelve months”.
First, Regular Free Cash Flow can be found by going to Morningstar.
As you can see in the Key Ratios section that the Free Cash Flow for Nokia comes in at 3.591 billion euros, and if we look a little bit up the page we can also get the Shares outstanding, which come out to 3.718 billion shares. So now the calculation is an easy one. 3.591/3.718 = .96 euro’s per share. To get the dollars per share we just multiply the .96 euro’s by today’s exchange rate of 1.2681 and we get $1.21 per share in free cash flow TTM.
As I write this Nokia’s stock price $8.97 so if we take $8.97/$1.21 = PFCF of 7.41.
Now this low result could be a fluke or a onetime event, but as you can see Nokia has been extremely free cash flow positive over the last decade. If you add their free cash flow up from 2000-2010TTM, Nokia has generated 44.132 billion Euros in free cash flow or $55.963 billion over the last decade.
When you see that Nokia has a market capitalization of just $33.34 billion on Revenues TTM of 41.323 billion then you can see why I call it a bargain, as it only sells for a price to sales of .80. Now this has occurred because companies like Apple (AAPL) and Research In Motion (RIMM) have eaten Nokia’s lunch for the last few years and for the last decade Nokia’s management has made many mistakes, but when stocks get this low in valuation to their free cash flow, it is my opinion that all the bad news is already priced in and there are not many sellers left.
Now to analyze the levered free cash flow for Nokia we can find it by going here.
If we go to the bottom of the first column we get a number of $4.72 billion which we then divide by 3.718 billion shares and we get $1.27 in levered free cash flow. Now this number is from data from June 30, 2010, so it may be a little less now.
So we take our price of $8.97 and we divide it by $1.27 and we get 7.06 times its levered free cash flow. So as you can see Nokia requires little in debt to operate and in fact has total debt of $6.83 billion or $1.83 of total debt per share which equals 20% of its market capitalization. With $41 billion in revenue and $4.5 billion in free cash flow we can assume that Nokia will not be going out of business any time soon, despite what Wall Street thinks. As for competing with Apple and RIM in the smart phone area they need a tremendous amount of catching up to do but this smart phone, coming out this September, should take them a long way forward from where they are now.
Remember when stocks are selling at such low valuations all that is needed is for the stock to rocket forward is just one or two pieces of good news. When a stock is overvalued many pieces of good news are required to keep it at its current level and blow out numbers are needed to move it higher. In a bad economy that gets more difficult to achieve as everyone is invested in the stock, but when you are in stocks like Nokia or the next four I will mention, you are protected by the low valuation and the lack of sellers(traders and momentum players) still in the stock.
So I don’t end up writing a book here, I have explained how to find the data to make the calculations to find Levered and Regular free cash flow and I will just list the remaining data for the other four stocks I believe to be bargains. It is important for everyone to do a qualitative analysis as well on each stock to find out why each stock is selling at such low valuations. To do so I use the methods of Philip Fisher which you can find by going here.
Here is the rest of my bargain list analyzed.
American Greetings (AM-OLD) = Market Price = $19.38 or $775.93 Million
Free Cash Flow TTM = $198 Million
Price to Free Cash Flow TTM = 3.91
Levered FCF TTM = $171.98 Million
Price to Levered FCF TTM = 4.51
Free Cash Flow Generation 2000-2010 TTM =$1.681 Billion
Pitney Bowes (PBI) = Market Price = $19.74 or $4.09 billion
Free Cash Flow TTM = $629 million
Price to Free Cash Flow TTM = 6.50
Levered FCF TTM =$639.8 Million
Price to Levered FCF TTM = 6.39
Free Cash Flow Generation 2000-2010 TTM =$5.325 Billion
Eli Lilly (LLY) = Market Price = $34.36 or $37.99 Billion
Free Cash Flow TTM = $5.484 Billion
Price to Free Cash Flow TTM = 6.92
Levered FCF TTM = $4.54 Billion
Price to Levered FCF TTM = 8.36
Free Cash Flow Generation 2000-2010 TTM =$32.672 Billion
Xerox (XRX) = Market Price = $8.80 or $12.19 Billion
Free Cash Flow TTM = $2.449 Billion
Price to Free Cash Flow TTM = 4.97
Levered FCF TTM = $1.34 Billion
Price to Levered FCF TTM = 9.09
Free Cash Flow Generation 2000-2010 TTM =$14.430 Billion
In closing I prefer levered over regular FCF, just like I prefer Return on Invested Capital (ROIC) over Return on Equity (ROE) as Debt is a big problem for companies (and for our government as well) and the more debt you take on the harder it is to dig yourself out of the hole. These companies are clearly turnaround plays and have below average management, otherwise they would have never gotten to this point in the first place, but that is not a bad thing.
In buying these I am trying to think like Mr. Buffett, when he bought American Express (AXP) 30+ years ago, or Geico when it was close to bankruptcy due to one-time events. I firmly believe these companies will pull through and when they do my clients will be well rewarded. I like to invest no more than 1% of my assets in any one of these when I find them. Currently I am 73% in cash as I am having great difficulty finding such companies to buy (so that should tell you something), so I have my list and waiting for the macroeconomic correction that in my opinion is coming.
Disclosure: Long AM, LLY, NOK, XRX, PBI No Positions in AAPL, RIMM
As Registered Investment Advisors, we see it as our responsibility to advise the following: We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about. Please note investments involve risk and unless otherwise stated, are not guaranteed. Past performance cannot be used as an indicator to determine future results. Strategies mentioned may not be suitable for everyone. We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter “Mycroft” Psaras, and should not be construed as personalized investment advice. Information expressed does not take into account your specific situation or objectives, and is not intended as recommendations appropriate for you. Before acting on any information mentioned, it is recommended to seek advice from a qualified tax or investment adviser to determine whether it is suitable for your specific situation.