Traditionally, however, OMC’s share price has been much, much more volatile than their actual profits and business performance. Take the 2008/2009 time period. The stock declined from a peak over $50 in 2007 to a bottom around $23 at the end of 2008 and beginning of 2009, a drop of more than 50%. Its profits, in contrast, barely budged: They actually rose slightly in 2008 (from $1.66 billion in 2007 to $1.69 billion) and only dropped less than 20% from 2008 to 2009.
That type of volatility, where a high quality company’s stock value moves much, much more than its intrinsic value, is exactly the type of thing value investors dream of. It’s what the magic formula was designed to take advantage of. It’s what we look for here at Gurufocus’ own Micro-Cap Magic Formula newsletter.
OMC’s management is also looking to take advantage of that volatility — they’ve repurchased $1.4 billion worth of shares in the past 12 months, more than 10% of today’s market cap! Returns on Capital
Let’s start by taking a look at OMC’s returns on capital.
At first glance, they don’t look that outstanding. OMC currently employs $10.2B in assets and has earned $1.6B in EBIT in the past twelve months, for a pretax return on assets of just under 16%. That’s not terrible — it’s a bit above the average return on assets of 14% for the S&P 500 — but it’s by no means outstanding.
However, the beauty of OMC’s model is that almost all of their operations are funded by their customers. OMC is hired and paid by their customers before they ever have to pay suppliers or pay their employees’ salaries. This effectively represents an interest-free loan that OMC can use to run their operations, and OMC takes full advantage of this “loan.” As a matter of fact, OMC funds all of their tangible assets with their customers’ money. In other words, OMC doesn’t invest a dime to fund any of their tangible assets; their customers do that for them! Once you look at OMC from the perspective that their customers basically pay for all of their invested capital, the perception of the business changes. They’re no longer earning “just” 16% returns on assets; they’re earning near infinite returns on their invested capital.
So what are you paying for OMC?
Let’s take a look. Over the past 12 months, OMC has earned $1.6 billion in operating income. At today’s enterprise value of $12.5 billion, you’re paying about 8 times EV / EBIT for OMC.
However, today’s economy is still pretty weak, and that weakness is a huge drag on OMC’s top and bottom line. Considering the company earned more than $1.6 billion in both 2007 and 2008 and they’ve completed a couple of small acquisitions since then, there’s reason to believe OMC’s earnings can increase significantly from today’s levels as the economy continues to gain strength.
In other words, at today’s prices, you’re buying into OMC at a very reasonable valuation with a free option on any increase in earnings as the economy gains some steam.