After yesterday's column on companies buying back stock below book value appeared, I was gently reminded that price-to-book value is not the only measure that has proven to be of great merit in the search for undervalued stocks. Enterprise value-to-earnings before interest and taxes (EV/EBIT) has also been a useful tool in the search for value.
While the EV/EBIT measure has long been used by private equity and LBO investors to find likely candidates, it was the extensive work of Tobias Carlisle in his two books "Quantitative Value" and "Deep Value" that led me to explore the ratio further. What I discovered verified Carlisle's finding that stocks that trade at low EV/EBIT ratios do almost as well as those priced below book value.
So last night I sat down and ran some tests of names that either trade below book value or have low EV/EBIT ratios and have decreased their share count by at least 5% over the past year. Using a one-year holding period, the performance of the two groups over one, three, five, 10 and 15-year periods was comparable. Both absolutely crushed the market over all time periods, too, so the two value measures combined with active buyback activity appear to be a strong addition to the value-investing toolbox.
I ran the screens for stocks with low EV/EBIT ratios and active buybacks this morning and came up with some interesting stocks worth considering.
Fluor (FLR) is one of the stocks on my infrastructure list. The Texas-based company provides engineering, procurement, construction, operations, maintenance and project management services around the world. It operates five divisions, including oil and gas, industrial and infrastructure, government, global services and power, all areas that will likely see increased spending in the years and even decades to come.
The company has a lot of oil and gas related businesses but not have much exposure to the exploration and production segment that is seeing spending reductions. Like so many infrastructure companies, Fluor is facing some near-term uncertainty but once the U.S. gets a solid long term plan in place for infrastructure upgrades the company should see a pretty large revenue and profit surge. In the meantime, FLR stock is cheap, with an EV/EBIT ratio of just 4.94 and it has reduced the share count by about 6% over the past year. The stock is yielding about 1.8% and, as a bonus for patient investors, I believe the payout will grow at a decent pace going forward.
I don't wear a watch for the same reason I won't own expensive ink pens anymore. However, I am told many others do not consistently lose things like I do and do wear watches. That bodes well for the long-term prospects of watch marker Fossil (FOSL).
Fossil has been pressured by the strong dollar this year, as it does about half its business outside the U.S., but long-term prospects look pretty good. The company is expanding its list of brands, adding Kate Spade, Tory Burch and Chaps to the catalog. My "in-house research department" would wear a burlap bag with the Kate Spade tag on it so this should help Fossil sell more watches to fashion- and brand-conscious consumers. Fossil has decreased its share count by around 10% over the past year and the shares currently trade with an EV/EBIT ratio of just 5.4.
Also taking a few hits this year from the strong dollar, Dana Holding (DAN) provides drive shafts, axles, and differentials to the auto manufacturing industry around the world. But the Ohio-based company's longer term outlook appears pretty good as sales volumes for light vehicles have been strong and most analysts expect them to stay that way for the next several years.
Dana's EV/EBIT ratio is 10, which is two-thirds of the median S&P 500 company, so it is reasonably inexpensive at these levels. In the past year, the company has reduced its share count by about 7% and it still has plenty left to repurchase under the current buyback authorization. What's more, it just raised the dividend and the shares are yielding about 1.45%. I expect the payout a steady, but unspectacular increase in the payout over the next several years.
Companies that are trading at low valuations and buying back stock are proven performers for patient investors. Checking the buyback rate when picking undervalued stocks can help you raise your win rate and over all returns.