I have spent a lot of time considering various valuation ratios this week. I even went back and reconsidered my notion that PE ratios are pretty much worthless. I found nothing to change my mind about that particular tool, as earnings are too easily manipulated.
However, I did find lots of information to confirm that both price to free cash flow and Enterprise Value to EBITDA ratio have a lot of value as stock selection criteria. They are both popular with the private equity and leveraged buyout (LBO) types, so it makes sense to me that they would be useful in finding long-term bargain issues with the potential for large profits. I have them in my valuable tool box along with my favored metric of price to book value.
I decided to search for stocks that are cheap on all three measures and I ran a screen for those that traded in the bottom based on all three metrics. It is a very short list of stocks, but there are some interesting names worth consideration.
While much of the market's attention has been focused on the refinancing and restructuring efforts at Global Ship Lease (GSL), a deeper look shows there are a lot of good things going on at the containership charter company. The business is generating substantial free cash flow and the fleet utilization rate is 97%. The average age of the fleet is 10.3 years out of an economic life of 30 years and the average remaining contracted term is 7.3 years. That long contracted time span keeps Global Ship Lease form dealing with the high volatility of shipping rates that many competitors are seeing right now.
Management is committed to growing the company by the disciplined acquisition of new vessels that can add to cash flow right out of the gate. The company is in an excellent positon to take advantage of weak shipping prices right now. The stock trades at about 3x free cash flow, has an enterprise value to EBITDA ratio of 6 and fetches about half of book value at the current price. Value firm DePrince, Race & Zollo has a big position in the stock and has been buying more recently.
I keep coming back and circling around another company on the list. I own a little bit of hhgregg (HGG) and it has not treated me well so far. I don't consider that a problem, as most of my stocks go down before they go up and I have a much longer time frame than many investors. As it drops, I consider adding more shares, but the fact that I really hate the big box electronics and appliance stores has kept me from pulling the trigger for a scale buy.
Appliance and home good sales are holding up OK at retailers but the same-store comps on consumer electronics and computing are horrific with declines around 20% in sales, year over year. On the positive side, the company is debt free and is actively buying back stock at depressed prices. The stock is trading at 6x free cash flow and an EV/EBITDA ratio. The price-to-book ratio is 70%, so the stock is cheap at this level. However, I do not see any inside buying or traditional smart value types buying the stock at these depressed levels. Those events would likely be my trigger to add to my stake.
Other stocks on the list that might be worth consideration and investigation are AU Optronics (AUO), Renewable Energy Group (REGI) and Armour Residential REIT (ARR).
There are not a lot of combination bargains right now when using all three metrics at once. That's not really a surprise since the market has moved straight up for the past five years. I own both of the stocks that I discussed but would only be willing to buy more of Global Ship Leasing at the current price.