Monday, October 15, 2001

The Meaning of "Cheap"

The economy is struggling and the stock market is a mess. If you are looking for bargains churned up in the turmoil, you may have to set your computer to screen for companies trading at low multiples of their earnings.

That's not a bad way to look for cheap stocks, but it's not the only way. Here are two other approaches to the notion of low-multiple investing: price to cash flow and enterprise multiple.

The "cash flow" we are talking about here (be careful-the phrase has three entirely different meanings on Wall Street) is earnings plus depreciation and amortization. In some industries, like newspaper publishing, it is perhaps a better measure of profitability than net income; in many others, like cement making and railroads, it is merely a supplemental measure. (Although amortization may be nothing but a bookkeeping entry related to goodwill, depreciation tends to reflect real wear and tear on equipment and buildings. As investor Warren Buffett likes to say, capital expenditures are not paid for by the tooth fairy.) In the table we picked out companies trading at cash flow multiples that are low in relation to historical norms.

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