Article Excerpt:
TWST: Do you use any particular approach in terms of looking at industrial companies?Mr. Langenberg: I take a unique approach to the sector that involves breaking down and analyzing, on an unrestated basis, the returns on invested capital starting from 1989 to capture two full economic cycles in order to develop an understanding of earnings power. In a world where good sellside content is shrinking, understanding earnings power is of increasing value on both the long and short side. Second, valuation work factors in three strata ' strategic buyer value, cash flow and enterprise multiple relationships versus interest rates, and intra-group valuation. And I take into account the entire capital structure. For example, my January analysis of Tyco (TYC) broke the company into 13 pieces, not just the four segments. The second thing I evaluate is free cash flow relative to interest rates, because stocks are financial assets, and this has a major bearing on multiples. Third is to compare companies within the space by reviewing EBITDA multiples versus returns on net assets, because there is a strong relationship between returns and multiples within a given sector. While the 'sector multiple' will fluctuate with investor sentiment, the next derivative call is relative valuations within the sector.
TWST: So you've got a multi-point look at what is going on out there?
Mr. Langenberg: Actually, it's not throwing a lot of spaghetti at the
wall to see which valuation sticks. I want to understand the company's
earnings power through its cycle better than anybody else, and I think I
do that. The second thing I am going to do then is value it
intelligently as a business not by saying, 'Oh, the p/e is 14, we think
it ought to be 16,' but by evaluating the entire company and subtracting
out non equity pieces of the capital structure. Then I ask myself what
should the stock trade at, given its relationship and returns relative
to interest rates, and then I am going to compare that stock to other
stocks within its universe and within the particular sector.
Tickers included in this excerpt: A, ABB, ATU, D, DHR, DOV, GE, HON, HUBB, ITT, ITW, MYE, PHG, PNR, ROK, SI, TXT, TYC, WCC, ZNEVF
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