This Screen Killed the S&P Over the Last Year

• ByJonathan Heller, RealMoney Contributor
• On 1:00 pm EDT, Wednesday October 7, 2009

Investors measure value in many different ways, and in many cases it is indeed in the eye of the beholder. One concept I believe in is enterprise value (EV), which I use as the starting point to measure the value of a company.

Let me explain. Enterprise value, which measures the value of the entire firm (in terms of capital structure), is more encompassing than market cap, which simply measures the market value of a firm's equity but ignores the fact that debtholders have also provided capital to companies. Enterprise value considers debt along with equity market cap and preferred stock, and subtracts out cash, the result of which is sometimes used as a proxy for the takeover value of a given firm.

When used with EBITDA (earnings before interest, taxes, depreciation and amortization) as the denominator, EV-to-EBITDA can act as a better indicator of a firm's profitability than a P/E ratio alone -- especially for companies whose capital structure includes debt. All else being equal, of course, the lower EV/EBITDA, the better.

This time last year, I wrote an EV/EBITDA story based on a stock screen with the following criteria:

• market caps greater than $250 million
• trading at less than 10 times EV-to-EBITDA, in the latest fiscal year, as well as on a trailing-12-month basis
• price-to-book ratio less than 1
• total debt-to-equity of less than 50%

While the resulting list was just 20 companies, the returns of these companies over the past year have exceeded even my expectations. During that time, the S&P 500 is down 6%, Nasdaq down 4.3%, and Russell 2000 off 10.1%. Yet the list of 20 was up an average of 12.3%. In fact, all but six names were in positive territory, and 14 still trade at less than 10 times EV/EBITDA.

As you might expect, there were some big winners, and big losers.

EV/EBITDA Screen Source: Yahoo! Finance

The Winners

Communication technology company Arris Group was the best performer, up 74% through Oct. 5. Currently trading at less than 7 times EV/EBITDA, Arris changes hands for about 13 times 2010 consensus earnings estimates.

Business solution company First Advantage was up nearly 50%, and it still trades at less than 9 times EV/EBITDA. The company is looking pricey here, though, trading at 20 times 2010 consensus earnings estimates.

The Losers

MedCath Corp. , which operates nine hospitals in seven states, fell more than 50% and is trading at just over 4 times EV/EBITDA and about 11 times 2010 consensus earnings estimates. MedCath is also changing hands at just 0.47 times book value, or 0.55 times tangible book value.

Shares of IT consulting company Ciber fell more than 42% and sell for about 6.5 times EV/EBITDA, 10 times trailing earnings and 13 times 2010 consensus earnings estimates. I typically shun IT companies if for no other reason than that I don't understand them. This one has remained profitable throughout the recession, so perhaps I need to expand my horizons a bit.

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Please note that due to factors including low market capitalization and/or insufficient public float, we consider Ciber, MedCath, Methode Electronics, Olympic Steel, Journal Communications and Core-Mark Holding to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Buzz up!