5 Innovative U.S. Companies Leading The Way - Part 1

by: Jae Jun

Throughout the year, Forbes provides a list of companies based on its own ranking systems.

In their latest edition, Forbes has a list of 50 companies ranked by a metric it calls "Innovation Premium." Similar to the way I give Premium or Discount points based on Business, Financial and Earnings Predictability in the PE valuation model you can find in the OSV Stock Valuation Spreadsheets.

Here is how Forbes describes its Innovation Premium.

We use something called the Innovation Premium to compile our lists of the World's Most Innovative Companies. It is calculated first by projecting a company's income (cash flows, in this case) from existing businesses, plus anticipated growth from those businesses, and look at the net present value (NPV) of those cash flows. We compare the NPV of cash flows from existing businesses with a current market capitalization: Companies with a current market cap above the NPV of cash flows have an innovation premium built into their stock.

The U.S. is filled with innovation and the culture inspires and encourages people to be innovative.

Innovation also leads to growth and market returns. Although the innovation premium is not perfect and the lofty expectation can actually lead to diminished returns, here is a more detailed look at the top 10 innovative U.S. companies identified by Forbes in their list of 50 from their September issue.

#1 Salesforce.com (CRM)

Innovation Premium: 73%

LTM Sales Growth: 37.7%

5-Yr Annualized Return: 29.7%

What It Does:

Provides a customer and collaboration relationship management application through the cloud.

Added Thoughts and Details:

Salesforce.com continues to outperform the market but warning signs are appearing in terms of not being able to generate returns from capital.

Although CRM's ROE was never high, it is now officially in negative territory at -2% TTM as the company continues to post losses this year.

Return on Invested Capital has always been volatile, but it too has fallen to -2.4% and shows currently, CRM is actually destroying value.

Salesforce.com is continuing to spend on R&D, which is now 13% of revenue and continues to increase as the company continues to focus on growth and maintaining market leadership.

According to my valuation models, even with a lofty growth rate, CRM is worth approximately $110-$130.

#2 Alexion Pharmaceuticals (ALXN)

Innovation Premium: 72.3%

LTM Sales Growth: 46.5%

5-Yr Annualized Return: 47.6%

What It Does:

Its anemmia drug Soliris costs over $400k and will gross $1.1 billion in revenue this year.

Added Thoughts and Details:

Interestingly, ALXN shares have outperformed AAPL since 2007 and is still relatively unknown.

Unless you are growth investor, current expectations are extremely high.

  • PE of 113
  • EV/EBITDA of 69
  • EV/FCF of 70
  • TTM ROE at 11%
  • TTM ROIC at 15.6%

Looking at these numbers, it is going to take strong conviction to buy at these levels but ALXN is also growing that asset base to go along with the hyper growth it is exhibiting.

The valuation range looks to be around the $110 to $130 range. Not much margin of safety but an interesting name and great innovator in the pharma industry none the less.

#3 Amazon (AMZN)

Innovation Premium: 58.3%

LTM Sales Growth: 34.9%

5-Yr Annualized Return: 26.3%

What It Does:

Worlds largest ecommerce store

Added Thoughts and Details:

First off, Amazon has an amazing CEO. Having the founder as the CEO is a recipe for success as a founding CEO's focus is on innovation and growth compared with heir CEO's who are better at cost cutting and making the company leaner.

Back to the point.

Looking at the valuation multiples, it scares me more than Alexion.

  • PE of 315
  • EV/EBITDA of 50
  • EV/FCF of 105
  • TTM ROE at 5%
  • TTM ROIC at 5.8%

If Amazon can continue this torrid growth the valuation looks to be around $230 to $260.

Note that these valuation ranges are based on the growth rates analysts are predicting.

#4 Red Hat (RHT)

Innovation Premium: 58.1%

LTM Sales Growth: 22.6%

5-Yr Annualized Return: 23.9%

What It Does:

Provider of open source software solutions such as linux

Added Thoughts and Details:

A great success story in the open source software world.

RHT has been seeing great top line growth with healthy gross margins at 84%. RHT continues to be consistent with its R&D efforts at 18-19% of revenue.

Red Hat has minimal debt and continues to grow its FCF.

I still don't consider Red Hat's valuation multiples to be in the cheap or buyable range.

In a no growth scenario, I've valued RHT to be around $23, which means that the remaining $24 of the stock price can be attributed to growth.

When I quickly check on my DCF model, I get a value of $57, which is what Red Hat is trading for now.

#5 Intuitive Surgical (ISRG)

Innovation Premium: 54%

LTM Sales Growth: 27.6%

5-Yr Annualized Return: 20.8%

What It Does:

Maker of the da Vinci Surgical Systems and related instruments and accessories. The da Vinci Surgical System translates a surgeon's natural hand movements, which are performed on instrument controls at a console, into corresponding micro-movements of instruments positioned inside the patient through small incisions, or ports.

Added Thoughts and Details:

As the innovation premium goes down, so do the valuation multiples.

  • PE of 37
  • EV/EBITDA of 24
  • EV/FCF of 31
  • TTM ROE at 18%
  • TTM ROIC at 27%

Being in the medical equipment industry, Intuitive Surgical enjoys huge margins and returns compared with its cost of capital.

Gross margins are 72% and net margins are in the high 20% range.

Balance sheet is solid, days' sales outstanding is decreasing. ISRG is a cash generating machine as it is able to turn 30% of sales into FCF.

Performing a reverse DCF shows the expected growth rate is around 19%. Analysts are predicting 20% so the current market price seems to be a fair value for ISRG.

Based on the quality of the business however, the upper valuation range is at $622.

Continue to Part 2 >>

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.