Smith International, Inc. (SII)

SII (Smith International) Free Cash Flows have hovered just above and just below zero for the past decade. While this has resulted in a median shareholder's equity growth rate of 14.9 percent, I tend to look for, both, predictable (low variance) FCF growth that reliably equates to shareholders equity growth. Otherwise, I'm relying on a model of valuation that is more complex than discounted cash flow and the stock goes into my "too hard" pile. With more than 6000 stocks to chose from, worthy and viable firms may miss the cut because they require too much work. Is this laziness on my part? No. Like most non-institutional investors, I have a full-time job and investing is a part-time pleasure.

None of this, however, warrants giving SII a thumbs down. I could, after all, simply take an agnostic position on the stock. Instead, the thumbs down follows from a weighted average cost of capital (8.28 percent) that exceeds the cash return on invested capital (-0.5 percent), free cash flows that fails to cover any portion of current liabilities (-1.5 percent), and a discounted cash flow valuation that puts the value of the stock at $9.14. With the stock currently selling for $67.84, the company may be wonderful but the stock is over-valued -- by more than 600 percent. There times when stocks are significantly undervalued and times when the stock is significantly overvalued and, in both cases, when the stock's value has no relation to the company and its performance. When undervalued, it is time to buy. When overvalued to this extent, it is time to let the experts figure out why and, more importantly, for the non-expert (i.e., me) to deploy his hard-earned money elsewhere.