Seeking Alpha
Long only, economy, behavioral finance
Profile| Send Message|
( followers)  

The Turnkey Analyst loves the smell of bargains in the morning, so after breakfast I decided to run our Magic Score screen, which generates cheap stocks with strong returns on capital. Screening aficianados and other finance geeks will recognize this screen as the one popularized by Joel Greenblatt in his "Little Book that Beats the Market," and recall that it ranks stocks on two dimensions: 1) cheapest stocks based on EBIT/EV, and 2) firms with highest returns of EBIT/Tangible Book Value. Tangible Book Value (PP&E - Accumulated Depreciation, plus Net Working Capital) is a nice denominator metric, as it can be used as a crude measure of the liquidation value of assets owned by the firm, and if the firm is earning a nice EBIT return on those assets, then the company won't require a lot of that cash flow to maintain earnings power, and can either reinvest its cash flows in new high-return projects, or return them to shareholders. Because the Magic Score focuses on returns on Tangible Book, it tends to avoid capital intensive business, such as, say, mining or oil refining, and focuses more on asset-light firms such as software and service businesses, which don't generate cash based on an expensive asset. When the returns on Tangible Book are high, you know the firm is doing something special. Running the screen, we saw up near the top of our Magic Score list a for-profit education company that could be worth a closer look.

ITT Educational Services, Inc. (NYSE:ESI) is a provider of technology-oriented undergraduate and graduate programs across a variety of fields through its ITT Technical Institutes and Daniel Webster College. Turning to our screen output, we see the following:

Turnkey Analyst's Economic Moat score for ESI is a strong 89%. As you might expect, it scored exceptionally well -- in the 99%ile -- for 8yr Free Cash Flow/Assets, 8yr Return on Assets, and 8yr return on capital. This means that ESI has some of the highest returns, by several measures, to be found anywhere. Additionally, the company had no negative earnings over the past eight years, and its Margin Strength was in the top 12% of the universe. Even with few operating assets, ESI is a cash flow machine.

Moving on to Turnkey's Shareholder Yields output, as noted earlier we see a strong aggregate Valuation score of 84%, based on double digit yields across our screening metrics. 8yr EBIT and FCF to EV yields are in the 19% range, placing the company in top 5% of companies in the universe, while TTM EBIT and FCF to EV also score very highly, with yields even higher at 20%. Normalized (8yr average) Net Income to Market Cap is at 11%, so the company's equity also looks cheap versus its long run average after-tax earnings. Just take a look at this attractive and stable spread between 8yr Net Income and Unlevered FCF: When FCF exceeds NI for long periods of time, that can be a good sign.

As you might expect from the Magic Score screen, you find here a very cheap stock that offers excellent returns, consistent with firms that have a wide economic moat. While the forward-looking prospects of for-profit education appear bleak, on a statistical basis, this stock merits some additional scrutiny.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Source: ITT Educational Services Is Inexpensive, With Strong Returns