In my last article, I used the Stockopedia screening tools to generate value investing ideas based on their earnings. I chose to use EV/EBIT, also known as Earnings Yield, since an exhaustive study by Wes Gray and Toby Carlisle showed that this was the best-performing value metric on a quantitative basis. This screen generated 29 initial ideas that I hadn't looked at in previous Screening for Value articles. As usual, I have created a Stockopedia portfolio to allow me to scroll through the Stockreports rapidly:
Before drilling down into the details of these companies, I wanted to take time to consider some of the factors that may not be captured by a simple analysis of EV/EBIT: pension deficits, working capital, provisions, deferred consideration, and lease liabilities.
Pension Deficits
In my previous articles, I mentioned that investors would be wise to adjust their valuations for the presence of any Pension Deficits. After all, most pension deficits require the company to make recovery payments, which are real cash that leaves the business that isn't available for dividends, buybacks or re-investment into future growth. The simplest way is to exclude any companies with significant deficits. However, this may miss companies that are cheap despite this extra consideration.
Another way would be to consider the deficit as debt and add it to the EV. However, there are many valuations investors could choose: the IAS19 accounting deficit, the actuarial deficit or even the net present value of the agreed recovery payments. Making the correct choice here is difficult and then may not be straightforward to calculate. Therefore, when a deficit is likely to remain for some time, the easiest way is to adjust the EBIT, not the EV. Comparing this adjusted Earnings Yield to other companies will give a fairer comparison.
One of the companies from my screen results, Renold (LON:RNO) , is a company with long-term agreed recovery payments and provides the ideal example for this adjustment. Our screen gives a TTM Earnings Yield of 19.8%. This comes from a TTM EBIT of £16.2m, which can be seen on the Accounts tab on the Stockreport, as Operating Profit. The company has an EV of £81.7m, consisting of a market cap of £55.9m and net debt of £25.8m.
To get a good view of the pension situation, I turn to the latest Annual Report. This…
