Instead of equity, total assets, or “invested capital”, I use PPE as a yardstick for the company’s capital base. The amount of free cash flow earned per unit of PPE is my measure of the company’s return on investment. I use “Return on PPE” as a substitute for return on equity, return on assets, and “return on invested capital”. A high-quality company will generate lots of free cash flow per unit of PPE while a low-quality company will generate little or no free cash flow (or even negative free cash flow) per unit of PPE. The formula is:
RET_PPE(Y)=FCF(Y)/PPE(Y-1)
where RET_PPE (Y) is this year’s return on PPE, FCF (Y) is this year’s free cash flow, and PPE (Y-1) is the plant/property/equipment at cost at the end of last year (the beginning of this year).
Fastenal started 2010 (ended 2009) with $571.467 million in PPE and generated $287.857 million in free cash flow. The return on PPE is 50.4%, which is excellent. (Think of the return on PPE as the Doppler Return on Equity.) This shows that Fastenal is a high-quality company that can generate a substantial amount of free cash flow per unit of PPE.
The next step is to count up the number of shares. At the end of 2010, there were 147,430,712 shares outstanding and 2,660,000 options outstanding for a total of 150,090,712 shares. I include options, because a rising stock price would lead to exercised options and thus dilute the per-share intrinsic value by increasing the number of shares outstanding. It’s good to see that the potential for dilution is modest.
That said, Fastenal had a 2-for-1 stock split in 2011, which means that there were twice as many shares at the end of 2010 as originally stated in the report. So this brings the number of shares to 300,181,424. There were also 2-for-1 splits in 2005 and 2002, so the number of shares originally reported from 2002-2004 must be multiplied by 4, and the number of shares originally reported from 2001 and earlier must be multiplied by 8.
At the start of 2011 (end of 2010), the PPE was $632.332 million. Assuming a return on PPE of 50.4%, projected free cash flow for 2011 is $318.695 million, or $1.062/share. The net liquidity of -$10.859 million is -$0.04/share.
To get the intrinsic business value, mutliply the free cash flow by 10 and then add the net liquidity. The formula is:
EST_VAL(Y)=10*FCF_SM_SH(Y)+NETLIQ_SH(Y)
The instrinsic value of Fastenal at the end of 2010 was 10*$1.062 – -$.04, or $10.58/share. Given that Fastenal currently sells for over $40/share, this stock isn’t a screaming buy at the moment.
That said, we’re not finished yet. The intrinsic business value calculation is based on only one year’s worth of return on PPE data. Part 6 will consist of repeating this analysis with financial data from previous years and using averaged return on PPE figures to smooth out fluctuations. Yes, even a company as ultra-conservative as Fastenal can have fluctuations in performance. Yes, the companies that show smooth earnings growth year after year have ways of manipulating their numbers to brown-nose Wall Street.
