The most important component of the value of a company is its ability to generate cash year after year. So one metric that can be used as a rough guide to whether a company is undervalued is the Price/Free Cash Flow. I've fould six companies with market caps above $2 billion and Price/FCF below 5 that may warrant further research.
- R.R. Donnelley & Sons Company (RRD): Provides printing and media solutions globally for large corporations. The Price/FCF is 2.6, and revenue grew by 6% in 2011. This company is a good example of why it is better to look at FCF rather than EPS. The EPS for the company in 2011 was negative, but the FCF was positive and actually grew from the previous year. So the company is profitable, even though the earnings numbers say otherwise. The stock trades at $12.70 with a 52-week range of $11.25-21.34.
- Gamestop Corp. (GME): World's largest retailer of video game products with over 6,600 stores. The Price/FCF is 3.9, and revenue grew by 4.4% in 2010. Gamestop faces the problem of increased digital distribution of video games which may render it's business model obsolete sooner rather than later. The stock trades at $23.62, with a 52-week range of $18.34-$28.66.
- Best Buy (BBY): Best Buy is the world's largest consumer electronics retailer. I wrote recently about Best Buy and believe it is undervalued. The Price/FCF is 3.3, and revenue grew by 1.2% in 2010. Best Buy faces competition from stores like Wal-Mart (WMT) and Costco (COST), but the biggest threat is from online retailer Amazon (AMZN). The stock trades at $27.51, with a 52-week range of $21.79-$32.98.
- Hertz Global Holdings (HTZ): Hertz is the third largest car rental company in the US and also has an equipment rental business. The Price/FCF is 3.0 and revenue grew by 9.7% in 2011. Hertz does have a considerable amount of debt, about $11.3 billion, but thier strong cashflow should allow them to reduce this debt over time. The stock trades at $15.19, with a 52-week range of $7.80-$17.64.
- United Continental Holdings (UAL): United is the largest airline in the United States, with 5,600 daily flights. The Price/FCF is 3.4 and revenue grew 60% in 2011. The airline industry is generally a poor investment, with low profit margins tied to fuel prices. The stock trades at $20.55, with a 52-week range of $15.51-$26.84.
- HCA Holdings (HCA): HCA is the largest private hospital operator in the United States, representing 4% of all hospital admissions. The Price/FCF is 3.2 and revenue shrunk by 3.3% in 2011. HCA has over $25 billion dollars in debt, and pays over $2 billion in interest each year. This compares to a FCF of $2.2 billion. The stock trades at $25.05, with a 52-week range of $17.03-$35.37.
Price/FCF is a useful metric that may point towards a stock being undervalued, but many times a stock has a low Price/FCF for a reason. It is just one part of the valuation process.