Numbers can lie -- but they’re the best first step in determining whether a stock is a buy. In this series, we use some carefully chosen metrics to size up a stock’s true value based on the following clues:
The current price multiples
- The consistency of past earnings and cash flow
- How much growth we can expect
Let’s see what those numbers can tell us about how cheap Northgate Minerals (AMEX:NXG) might be.
The current price multiples
First, we'll look at most investors' favorite metric: the P/E ratio. It divides the company's share price by its earnings per share (EPS) -- the lower, the better.
Then, we'll take things up a notch with a more advanced metric: enterprise value to unlevered free cash flow. This divides the company's enterprise value (basically, its market cap plus its debt, minus its cash) by its unlevered free cash flow (its free cash flow, adding back the interest payments on its debt). Like the P/E, the lower this number is, the better.
Analysts argue about which is more important -- earnings or cash flow. Who cares? A good buy ideally has low multiples on both.
Northgate Minerals has a negative P/E ratio and an EV/FCF ratio of 60.4 over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, Northgate Minerals has a P/E ratio of 24.2 and a five-year EV/FCF ratio of 9.2.
A one-year ratio under 10 for both metrics is ideal. For a five-year metric, under 20 is ideal.
Northgate Minerals has a mixed performance in hitting the ideal targets, but let’s see how it compares against some competitors and industry mates.
|Goldcorp (NYSE: GG)|
|Kinross Gold (NYSE: KGC)|
|Agnico-Eagle Mines (NYSE:AEM)|
Source: Capital IQ, a division of Standard & Poor’s; NM = not meaningful.
Numerically, we’ve seen how Northgate Minerals’ valuation rates on both an absolute and relative basis. Next, let's examine…
The consistency of past earnings and cash flow
An ideal company will be consistently strong in its earnings and cash flow generation.
In the past five years, Northgate Minerals’ net income margin has ranged from -14.0% to 35.7%. In that same time frame, unlevered free cash flow margin has ranged from 2.3% to 40.9%.
How do those figures compare with those of the company's peers? See for yourself:
Additionally, over the past five years, Northgate Minerals has tallied up four years of positive earnings and five years of positive free cash flow.
Next, let’s figure out…
How much growth we can expect
Analysts tend to comically overstate their five-year growth estimates. If you accept them at face value, you will overpay for stocks. But while you should definitely take the analysts' prognostications with a grain of salt, they can still provide a useful starting point when compared to similar numbers from a company's closest rivals.
Let's start by seeing what this company's done over the past five years. Northgate’s losses make the trailing growth rate meaningless, but Wall Street’s analysts expect negative future growth rates of negative 6.0%.
Here's how Northgate Minerals compares to its peers for trailing five-year growth (Kinross’s growth is also meaningless):
And here's how it measures up with regard to the growth analysts expect over the next five years:
The bottom line
The pile of numbers we've plowed through has shown us how cheap shares of Northgate Minerals are trading, how consistent its performance has been, and what kind of growth profile it has -- both on an absolute and a relative basis.
The more consistent a company’s performance has been and the more growth we can expect, the more we should be willing to pay. We’ve gone well beyond looking at a negative P/E ratio.
The future of commodities prices -- gold and copper in this case -- is another key consideration. For more on some “golden opportunities,” click here for analysis from my Foolish colleague, Andrew Sullivan.
If you find Northgate Minerals’ numbers compelling, don’t stop. Continue your due diligence process until you’re confident that the initial numbers aren't lying to you.
© 2010 UCLICK L.L.C.