2 Stock Value Metrics That Make Sense

07/24/2012 10:00 am EST

Focus: STOCKS

Intrepid fund manager Greg Estes tells MoneyShow.com about his method for identifying stocks with long-term potential, using metrics such as enterprise value and earnings before interest and taxes.

Kate Stalter: Today, our guest is Greg Estes, Vice President and Portfolio Manager at the Intrepid All-Cap Fund (ICMCX). So Greg, set the stage for us today by giving us the fund’s objective and your investment philosophy.

Greg Estes: The fund’s objective is to seek long-term capital appreciation, and we do that by buying stocks. And the way that we approach stock purchasing is, basically, an intrinsic value approach, where you’re looking at the value of a business and comparing it with today’s stock price. And if you can buy it in the market for a cheaper price than what you believe it’s worth, then that’s something we would want to own.

So it’s another way of saying we’re value investors, but we’re heavily focused on knowing what the value is of what we’re buying.

Kate Stalter: Let’s talk a little bit about some of the holdings. I noticed, looking at some of the most recent data, you’re pretty heavily weighted in US stocks. What’s the reason for that?

Greg Estes: Well, I think our typical approach is to be in securities that are based in the US. If you get into emerging markets, you’re kind of dealing with a bit of a different skill set. Our investments are predominantly in US businesses—some that are global in nature. It’s not really a geographic call, so much as that’s where we think we can add value: By looking at companies that are primarily US-based.

Kate Stalter: Let me come back to something you said a minute ago, which was looking for value. You said that a couple of times. In these stocks, what are some of the fundamental metrics that you look at to make a determination about a buy?

Greg Estes: Well, we tend to look at things such as enterprise value, where you’re really accounting for the capital structure of a business. Not only are you looking at the sizes of the market cap, but how much debt and cash are on the books.

So, if you look at—for example, what we like to look at a lot of times is earnings before interest and taxes, and look at enterprise value as a multiple of that. So enterprise value over EBIT, as we would call it, that multiple can kind of give you an idea of the cash flow generation power of that business, and how cheap or expensive that business is today.

Kate Stalter: One thing that I was looking at, in some of the Morningstar data about the fund: A large percentage of the fund was in cash. Tell us about that, Greg.

Greg Estes: Yeah, I could tell you today, it’s almost 28% of the fund. A lot of this has to do with the fact that our approach is a bit unconventional. Number one, we’re bottom-up stock selectors, so we’re not really making top-down calls on the market. What we’re trying to do is buy individual businesses and build out a portfolio that way.

In markets like today’s, where we think there’s a lot of things out there that are at fair value, we can’t find a lot of securities to purchase and we don’t necessarily have to hold a fully invested portfolio. We think our clients prefer us to try to protect capital where we can, and if we can’t find anything compelling, our default is to go to cash. So that’s why the cash level is where it is today.

Kate Stalter: So, it sounds like it’s dependent upon, maybe, market conditions...that would be the driver of that decision?

Greg Estes: There are two ways, I think, that one can find value. One of them is if a security is really overlooked. And so, for us, we tend to look for smaller companies a lot of times.

On the other hand, another way to find value is potentially through a larger company. And it’s a contrarian call where you think that the market is missing something or misunderstanding something about the business. And those tend to be more one-off. You can find them even when values are somewhat high, but you better do a good job of vetting that security.

And today, in the environment that we’re in, like I said, I think a lot of things out there are fairly valued. So that kind of leaves you less with being able to find a lot of different opportunities, and more spending your time on vetting things that might have some sort of issue in determining whether or not you’re going to be compensated for that, based on the kind of risk you’re taking with that business.

Kate Stalter: I wanted to segue a bit into the sector weightings. The most recent data that I was seeing, it was showing that you were most heavily weighted in technology and consumer. Can you say a little about that?

Greg Estes: Well, you know again, I’ll hark back to what I said previously, and that not necessarily that we’re making a top-down call that we think techs and consumer are the place to be.

But I would say that the kind of technology companies and the kind of consumer businesses that we’re looking at, we believe, number one, have decent balance sheets. And there are a lot of tech companies out there that do have pretty good balance sheets with a lot of cash. And in the case of consumers, consumer businesses tend to have a more stable cash flow profile.

Those are two things that we really look for in a lot of business. And sit’s just a matter of circumstance, actually, that at the time that we purchased these items, that they were at the right price for us.

So, those sector weightings can kind of fluctuate. We’re definitely not managing towards some sort of sector target or comparing it against an index when we do that.

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