Another process I undertake in my financial analysis is to calculate the cash profits of a company, which in City speak is known as earnings before interest, taxation, depreciation and amortisation (Ebitda). I then work out the company's enterprise value (EV), which is the sum of its market value and net debt or market value less net cash, and then work out the ratio of EV to Ebitda.
This multiple is far more relevant to companies that are in recovery mode and have high cash balances yielding very little in the way of interest income, so may look ludicrously priced on a simple earnings multiple of basic EPS when, in fact, they offer great value.
A good example of this was my call to buy shares in Moss Bros (MOSB) at 39.5p ('Dressed for success', 20 February 2012) when I spotted that the sale of the company's Hugo Boss franchise had left the balance sheet in a very cash-rich position. Management also had a plan to spruce up the estate of stores and invest heavily in a new internet offering. This was going to be funded by recycling operating cash flow from the business in order to upgrade 90 stores over the next three to five years at a cost of around £11m. On inspection, I realised just how cash-generative Moss Bros's underlying business is, so much so that the company's cash pile has actually grown by £3m to £26.3m this year alone and that's after making significant investments. Moreover, this capital expenditure in store refits is having an immediate impact by raising like-for-like sales and, importantly, is entirely funded from cash flow.
So although on the face of it Moss Bros's shares, at 55p, look ridiculously priced on 45 times January 2013 EPS estimates of 1.2p, this is misleading. That's because, once you strip out the £26.3m cash pile from the market value of £55m, the company's enterprise value of £28.7m is only 4.2 times cash profit estimates of £6.8m for the current financial year, falling to 3.3 times the year after. This is why I continue to rate them a buy even after a 40 per cent rerating.
