Matt Krantz called Gilead Sciences, Freeport-McMoRan, and Delta Airlines the cheapest stocks of 2015 by price-to-earnings ratio. But P/E is distorted by accounting tricks. Using price-to-economic-book-value instead, Gilead Sciences is the real bargain at 1.3, meaning the market expects only a 30% profit increase.
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Following up on Matt Krantz's article, Which Are the Cheapest Stocks of the 9 Best Stocks for 2015? I wanted to follow up on what he wrote in that because he pointed out 3 stocks as the cheapest as being Gilead Sciences, Freeport-McMoRan, and Delta Airlines. His main metric for measuring what was cheapest was PE. We did a whole Danger Zone article and podcast on why PE is not a good metric. PEs are unreliable. The first and biggest reason is that that E, completely unreliable. Maybe 50 years ago when my grandfather was in the business, you could trust the earnings on an income statement. These days you can't. We've done white papers and studies. There's over 30 white papers on my blog identifying all the loopholes in accounting earnings that can make them unreliable. This is a big part of what the work I do for the Financial Accounting Standards Board and helping them identify loopholes And make sure new loopholes don't get created when they create new rules. Now, the stock that I believe to be the best of those 3, or the cheapest, is Gilead Sciences. It gets an attractive rating, it's got a low growth appreciation period, and a decently low price-to-economic book value. The price-to-economic book value is 1.3. Now, the economic book value of a business is the cash value of the business, the no-growth cash value, that is. Or the value of the business if it never grows profits again. That's what's equal to the economic book value. The definition is on our blog. Right? And we calculate that by effectively looking at the perpetuity value of the company's current NOPAT. We adjust for debt, off-balance sheet debt, preferred stock, pensions, option liabilities, non-operating assets, all the things you need to do to get to the true shareholder value related to or Derived from the current cash flows. Right? And so when we assume a perpetuity value on those cash flows, that's a no-growth value. That assumes the business never grows again. So 1.3 effectively is saying that the market price is 1.3 times the economic book value, which means the market believes the company's profits will be no more than 30% greater than what they are today. So that's a conservative expectation for a business like Gilead Sciences, which has been growing profits significantly over the last several years. The other 2 stocks, Freeport-McMoRan and Delta Airlines, cheap on a PE basis again, but not so cheap on a discounted cash flow or price-to-economic book value basis. Thank you.
