NEW YORK (CNN/Money) -
My colleague Adam Lashinsky raised an interesting question in a CNN/Money column he wrote on Blockbuster last week. He noted that a private-equity group was thinking about buying Blockbuster by borrowing heavily and then paying off the debt with Blockbuster's own ample cash flow.
Then Lashinsky asks, "If this formula is so easy, why doesn't Blockbuster just do it itself?" (see the column here)
That's a good question. And more to the point, why don't investors zero in on stocks trading at low price/cash-flow ratios? Even if those companies don't literally repurchase all their stock and recapitalize, they have other ways they can use their cash flow to accelerate their growth.
With interest rates so low today, any price/cash-flow ratio below 12 could indicate that a stock is a bargain. There doesn't even have to be an actual acquirer in the wings.
The company itself can use its surplus cash flow to steadily buy back stock, make selective acquisitions aimed at speeding up its earnings growth or simply raise the dividend.
There are a few things to watch out for, however. The company shouldn't have so much debt already that it can't borrow further. Its cash flow should come from continuing operations -- not one-time gains -- and be highly predictable. There should be no accounting questions. Nor should the company's profits be vulnerable to some single adverse event.
With those caveats in mind, I've examined the companies I track (see the Sivy 70) to see how they measure up against a cash-flow benchmark.
Of the nine stocks with cash-flow multiples below 11, three are financials -- Washington Mutual (WM), J.P. Morgan Chase (JPM) and Bank of America (BAC). And MBNA (KRB) just misses the cutoff. These depressed valuations stand to reason: all these stocks are vulnerable to a rise in interest rates and their low prices reflect that risk. Even so, they look undervalued by many measures.
Two energy stocks make the list -- Anadarko Petroleum (APC) and Exxon Mobil (XOM). They both are exposed to swings in oil prices. But as I noted two weeks ago, Anadarko looks like a great value (see 'Growth stocks on the cheap'). And some analysts believe the company will begin buying back stock. Exxon is a perfectly fine mainstream holding, although the company's production trends are unimpressive.
The four other stocks that look cheap by cash-flow measures are Union Pacific, Johnson Controls, Time Warner and FedEx.
Time Warner (TWX), owner of this Web site, has faced questions about its accounting. Were those questions resolved, the company's assets would be worth more than the current share price.
Auto parts maker Johnson Controls (JCI) and express shipper FedEx (FDX) both stand to be beneficiaries of an improving economy -- auto sales will likely increase and shipping this Christmas season will probably set a record. But neither stock is generating a lot of enthusiasm among analysts right now.
Union Pacific (UNP), by contrast, gets better ratings for timeliness as well as value. The largest railroad in North America is a straight play on Dow Theory -- in a recovery, an upturn in manufacturing is supposed to be quickly followed by an upturn in transportation stocks as newly made goods are shipped to customers. A few analysts have recently upgraded Union Pacific to outperform and the company recently raised its dividend 30 percent.
Michael Sivy is an editor-at-large for Money magazine. Sign up for free e-mail delivery of Sivy on Stocks every Tuesday and Thursday.