The First Cut: Using Enterprise Value to Locate Bargains

by John Bajkowski

The First Cut: Using Enterprise Value To Locate Bargains Splash image

Using Enterprise Value to Locate Bargains

The First Cut is designed as a starting point for investors. Each issue we list the top 30 stocks that pass relatively simple screens of interest to individual stock pickers. AAII’s Stock Investor Pro screening software is used to generate the First Cut listing.

 

While market capitalization (stock price times number of outstanding shares) reflects the overall trading value of a company, it does not fully capture the cost of acquiring a firm. Instead, investors turn to the “enterprise value” to help measure the overall outlay of buying out a company. The enterprise value is calculated by adding market capitalization, preferred stock, and total debt and reducing this total by the amount of cash held by the firm. Debt and preferred stock is added because the acquirer must shoulder the cost of assuming the obligations of the firm. Cash is subtracted because once you acquire the firm, it becomes yours.

To gauge the worth of a company, the enterprise value is normally related to earnings before interest, taxes, depreciation and amortization (EBITDA). EBITDA ignores non-cash expenses such as depreciation of already paid for fixed assets and amortization of intangibles because they do not impact pretax cash flow. EBITDA ignores taxes and interest payments, which will likely change after an acquisition or merger. The enterprise value to EBITDA ratio relates a firm’s takeover cost to its earnings potential. The lower the ratio, the more attractive the firm.

The stocks that made this issue’s First Cut are domestic, exchange-listed stocks with a minimum share price of $5.00. Financials were excluded because their unique financial structure cannot be directly compared to firms in other industries. As a test for minimum financial strength, stocks were required to have a debt-to-equity level below 50% as well as positive free cash flow. The 30 stocks with the lowest enterprise value to EBITDA made the First Cut. The historical growth rates in the table help to bring to light past top and bottom-line company performance. The 52-week price change highlights the weak stock price performance of most of these stocks. Value screens such as this often turn up out-of-favor companies and industries. Keep in mind that all screens are starting points; the goal of the EV/EBITDA screen is to create a list of attractively priced stocks.

Using the Ratio of Enterprise Value to EBITDA to Locate Bargains

Company
(Exchange: Ticker)
Enterprise Val to EBITDA
(X)
P/E Ratio
(X)
Enterprise Value
($ Mil)
Market Cap
($ Mil)
Historical Ann'l Growth Rate LT Debt to Equity
(%)
52-Wk Price Change
(%)
Description
Sales 3 Yr
(%)
EPS 3 Yr
(%)
Imperial Sugar Co. (M: IPSU) 1.3 4.5 85 178 3.7 75.2 0.8 (50) proc & mkts refined sugar
PeopleSupport, Inc. (M: PSPT) 2.4 40.3 92 196 46.7 35.6 0.0 (23) offshore business outsource
KSW, Inc. (M: KSW) 2.5 8.6 17 33 43.2 67.3 0.0 (23) heat, vent, & air cond sys
CSP Inc. (M: CSPI) 2.7 8.6 13 23 22.3 44.7 0.0 (35) IT solutions
Stone Energy Corp. (N: SGY) 2.8 8.3 1,903 1,978 11.4 13.7 45.2 104 oil & natural gas
KapStone Paper & Packaging (M: KPPC) 2.9 9.2 165 177 na na 20.7 1 kraft paper & linerboard
Barrett Business Services (M: BBSI) 3.2 9.4 80 135 14.0 22.2 0.0 (51) HR mgmt servs
Mediware Info. Systems (M: MEDW) 3.3 58.5 24 45 3.9 (14.0) 0.0 (22) clinical mgmt info software
Horsehead Holding (M: ZINC) 3.4 6.9 441 520 36.2 267.2 0.0   zinc-based prods
Barnes & Noble, Inc. (N: BKS) 3.4 14.7 1,332 1,693 3.5 6.5 0.0 (23) bookseller
American Biltrite Inc. (A: ABL) 3.6 nmf 30 21 (1.0) (41.6) 33.7 (34) floor, tape & rubber prods
Atlantic Tele-Network, Inc. (M: ATNI) 3.6 10.5 381 406 27.9 35.8 23.3 3 telecom servs
JAKKS Pacific, Inc. (M: JAKK) 3.6 8.5 514 654 14.3 23.0 14.1 (6) toys & related prods
Novatel Wireless, Inc. (M: NVTL) 3.8 9.1 192 291 60.6 36.1 0.1 (57) wireless broadband sols
VAALCO Energy, Inc. (N: EGY) 3.9 27.9 375 446 30.3 (9.4) 3.5 46 oil & natural gas
North American Galvanizing (M: NGA) 3.9 8.6 77 81 35.2 162.1 0.0 (34) coatings holding co
Air T, Inc. (M: AIRT) 3.9 7.0 21 22 6.3 6.0 4.2 14 air cargo servs
Dynacq Healthcare, Inc. (M: DYII) 3.9 8.5 71 95 3.0 40.9 0.7 216 hospital holding co
AutoNation, Inc. (N: AN) 3.9 7.5 4,603 2,939 (1.3) 0.0 47.7 (22) auto retailer
Cal-Maine Foods, Inc. (M: CALM) 4.0 6.0 814 798 1.5 (17.2) 36.1 175 prods & mkts shell eggs
LoJack Corporation (M: LOJN) 4.0 11.3 136 170 15.2 20.9 20.8 (53) recovers stolen vehicles
SL Industries, Inc. (A: SLI) 4.0 7.2 79 74 19.1 17.8 9.7 (24) power electronics
Grey Wolf, Inc. (A: GW) 4.0 11.6 1,380 1,391 28.8 170.3 39.8 1 land drilling servs
Sears Holdings Corp. (M: SHLD) 4.0 16.2 13,952 12,564 36.7 (19.7) 24.4 (47) department store holding co
RadioShack Corp. (N: RSH) 4.1 9.1 1,988 2,077 (4.2) (5.8) 43.6 (48) retail consumer electronics
ViroPharma Inc. (M: VPHM) 4.1 8.1 557 632 108.8 54.1 48.3 (39) biopharmaceuticals
Valero Energy Corp. (N: VLO) 4.1 7.4 30,638 25,595 20.4 33.2 35.5 (34) gas & fuel refiner
Canterbury Park Holding (A: ECP) 4.2 13.4 27 34 (0.9) (12.3) 0.0 (42) pari-mutuel wagering oper
Build-A-Bear Workshop (N: BBW) 4.3 8.7 137 178 16.3 35.7 0.0 (69) interactive retail experience
Werner Enterprises, Inc. (M: WERN) 4.3 20.2 1,243 1,321 7.3 (1.9) 0.0 0 truckload transportation
Exchange Key: A=American Stock Exchange; M=NASDAQ; N=New York Stock Exchange.
Source: AAII's
Stock Investor Pro, Reuters Research, Inc., and I/B/E/S. Data as of 5/16/2008.


John Bajkowski is president of AAII.


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