Lexmark International (LXK, Financial) has a P/E of just 9. In addition, the company has more cash than it does debt by about $600 million. If you back out the net cash position from the company's market cap, the company's P/E falls to just 7! In addition, the company produces returns on equity that are well above its cost of capital. So is this an obvious value buy? Not so fast.
First of all, it's important to consider more than one year's worth of earnings. Last year just happened to be one of Lexmark's better years, as profits more than doubled over the year before, and were even 10% higher than they were in 2007. So how sustainable are these newfound profits? This brings us to an important point regarding the company's competitive position.
Lexmark has had a great year because customers are buying again, and because its recent slate of products is outperforming those of the competition. But in the highly competitive industry of printing solutions, Lexmark is unlikely to always outshine the competition. The company has to continuously innovate just to maintain its market share. Therefore, the risk is ever-present that the company will be bested by competitor products.
This illustrates the idea that just because two companies trade at the same P/E, they are not necessarily similarly priced. One company may have to be both good and lucky to generate its earnings, while another can still profit strongly even if it has an off-year. For example, if Microsoft comes out with a sub-par version of Windows, there is little change to the company's finances; competitors may make some inroads, but customers will largely eagerly await future upgrades. Lexmark, on the other hand, has to keep inventing a better mousetrap in order to stay competitive. This kind of fast-changing industry evolution is the major reason why value investors prefer to stay away from technology companies. When you're trying to predict a company's earnings power, more predictability is better.
Of course, that doesn't mean Lexmark can't pull it off. The company may have excellent internal processes that lead to innovation, marketing and manufacturing prowess that is superior to the competition. But because of the nature of this industry, value investors should be able to confidently assert that these advantages are present before plunging in.
Disclosure: None
First of all, it's important to consider more than one year's worth of earnings. Last year just happened to be one of Lexmark's better years, as profits more than doubled over the year before, and were even 10% higher than they were in 2007. So how sustainable are these newfound profits? This brings us to an important point regarding the company's competitive position.
Lexmark has had a great year because customers are buying again, and because its recent slate of products is outperforming those of the competition. But in the highly competitive industry of printing solutions, Lexmark is unlikely to always outshine the competition. The company has to continuously innovate just to maintain its market share. Therefore, the risk is ever-present that the company will be bested by competitor products.
This illustrates the idea that just because two companies trade at the same P/E, they are not necessarily similarly priced. One company may have to be both good and lucky to generate its earnings, while another can still profit strongly even if it has an off-year. For example, if Microsoft comes out with a sub-par version of Windows, there is little change to the company's finances; competitors may make some inroads, but customers will largely eagerly await future upgrades. Lexmark, on the other hand, has to keep inventing a better mousetrap in order to stay competitive. This kind of fast-changing industry evolution is the major reason why value investors prefer to stay away from technology companies. When you're trying to predict a company's earnings power, more predictability is better.
Of course, that doesn't mean Lexmark can't pull it off. The company may have excellent internal processes that lead to innovation, marketing and manufacturing prowess that is superior to the competition. But because of the nature of this industry, value investors should be able to confidently assert that these advantages are present before plunging in.
Disclosure: None
