Stocks which are selling at a deep discount to their fair values can be detected by comparing the enterprise value of the company to its market cap. Enterprise value represents the theoretical cost of a company if someone were to acquire it. Enterprise value is calculated as market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents. When the enterprise value of a company is significantly lower than its market cap, the conclusion to be reached is that the stock of the company is relatively cheap, especially if other valuation factors contribute to this conclusion.
I searched for very profitable large cap companies where enterprise value is significantly lower than their market cap. Those stocks also had to show very little debt and to pay relatively high dividends.
I have elaborated a screening method, which shows stock candidates following these lines. Nonetheless, the screening method should only serve as a basis for further research.
The screen's formula requires all stocks to comply with all following demands:
1. The stock is included in the S&P 500 index. S&P Custom Indices Fact Sheet explanation:
Widely regarded as the best single gauge of the U.S. equities market, this world-renowned index includes 500 leading companies in leading industries of the U.S. economy. Although the S&P 500® focuses on the large cap segment of the market, with approximately 75% coverage of U.S. equities, it is also an ideal proxy for the total market. S&P 500 is part of a series of S&P U.S. indices that can be used as building blocks for portfolio construction.
2. The forward P/E is less than 15.
3. The annual dividend yield is greater than 3.0%.
4. Total debt to equity is less than 0.40.
5. The enterprise value is lower than the market cap by at least 12%.
After running this screen on November 07, 2012, before the market open, I obtained as results the 5 following stocks:
Cisco Systems, Inc. (NASDAQ:CSCO)
Cisco Systems, Inc. designs, manufactures, and sells Internet protocol based networking and other products related to the communications and information technology industries worldwide.
Cisco Systems has a low debt (total debt to equity is only 0.32) and it has a very low trailing P/E of 11.73 and a low forward P/E of 8.36. The PEG ratio is 1.35 and the price to free cash flow for the trailing 12 months is very low at 10.46. The forward annual dividend yield is very high at 3.20% and the payout ratio is quite low at 37.6%. The company is trading 16.6% below its 52-week high and has 25% upside potential based on the consensus mean target price of $21.79. Cisco Systems is scheduled to report its FYQ1 2013 financial results on November 13, and the results would probably affect the short-term stock price.
KLA-Tencor Corporation (NASDAQ:KLAC)
KLA-Tencor Corporation designs, manufactures, and markets process control and yield management solutions for the semiconductor and related nanoelectronics industries.
KLA-Tencor has a very low debt (total debt to equity is only 0.22) and it has a low trailing P/E of 11.87 and a low forward P/E of 12.04. The PEG ratio is also quite low at 1.19 and the price to free cash flow for the trailing 12 months is very low at 12.33. The average annual earnings growth estimates for the next 5 years is 10%. The forward annual dividend yield is very high at 3.27% and the payout ratio is quite low at 38.8%. The company is trading 10.5% below its 52-week high and has 8.4% upside potential based on the consensus mean target price of $53.00. Although KLA-Tencor reported, on October 25, weaker than expected Q1 results and provided weaker than expected Q2 guidance, I still think that the stock is quite attractive due to the very low multiples and the very high dividend yield.
Microchip Technology Inc. (NASDAQ:MCHP)
Microchip Technology Incorporated engages in the development, manufacture, and sale of semiconductor products for embedded control applications.
Microchip has a very low debt (total debt to equity is only 0.18) and it has a low forward P/E of 14.73. The forward annual dividend yield is very high at 4.24% and the payout ratio is quite high at 89.7%. Microchip will unveil its latest earnings on Thursday, November 8, 2012 and the results would probably affect the short-term stock price.
Molex Incorporated (NASDAQ:MOLX)
Molex Incorporated, together with its subsidiaries, engages in the design, manufacture, and sale of electronic components worldwide.
Molex has a very low debt (total debt to equity is only 0.09) and it has a low forward P/E of 14.71. The forward annual dividend yield is very high at 3.27% and the payout ratio is 57.5%. On October 23, Molex reported its FYQ1 2013 financial results, on that occasion the company said that its backlog was $445.3 million, an increase of 6.9% from the June 2012 quarter and 15.0% from the September 2011 quarter. These increases are the result of orders for new products that were launched in the September 2012 quarter. All these factors make the stock quite attractive.
Microsoft Corporation (NASDAQ:MSFT)
Microsoft Corporation develops, licenses, and supports software products and services; and designs and sells hardware world wide.
Microsoft has a very low debt (total debt to equity is only 0.17) and it has a trailing P/E of 16.14 and a very low forward P/E of 9.22. The PEG ratio is 1.68 and the price to free cash flow for the trailing 12 months is very low at 11.21. The forward annual dividend yield is very high at 3.08% and the payout ratio is 49.7%. The company is trading 8.2% below its 52-week high and has 18.7% upside potential based on the consensus mean target price of $35.44. Analysts recommend the stock; among the 40 analysts covering the stock, 27 rate it a strong buy or a buy. Microsoft is not anymore the fast-growing company it used to be, but with such a low forward P/E and such a high dividend yield the MSFT stock is a safe bet.
Disclosure: I am long MSFT. 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.