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The best time to buy stocks is often when they trade at unusually low valuations. But investors still need to be careful to take a proper look at the underlying business.
For example, shares in Pinterest (NYSE:PINS) currently trade at a price-to-earnings (P/E) ratio of 14 and I think the firm has some good growth prospects. But I’m not in a rush to buy this one.
Growth
Pinterest currently generates $1.52 in revenues per user, which translates into around 7.6c in operating income. But I think there’s scope for this to increase significantly in the future.
Meta Platforms, for example, achieves $13.65 in sales for each person on Facebook, Instagram, and WhatsApp. And with around seven times as many users, it should generate better returns.
Pinterest, however, might have something unique. It has unusually good data about its users and their interests and there might even be a class of people who are on Pinterest but not Instagram. If it can achieve $2 in revenues per user – well below what Meta achieves – its operating profits could more than double. And at first sight, the share price doesn’t seem to reflect this possibility.
Earnings
Officially, Pinterest shares trade at a P/E multiple of 14. But there’s a reason investors shouldn’t just look at one ratio to work out whether or not a stock is cheap. In this case, the company’s earnings over the last 12 months were boosted by a one-off tax benefit.
The value of this was around $1.6bn, which accounts for around 90% of its net income. Adjusting for this, the stock currently trades at a P/E ratio of around 97. That’s much less attractive, but it’s not the only way of valuing the business.
One-off tax gains aside, Pinterest’s free cash flows are actually much higher than official net income. So does the stock look more attractive from this perspective?
Free cash flows
Over the last 12 months, Pinterest has generated $952m in free cash. A market value of $26.5bn means this implies a multiple of around 28, which is high but not outrageous.
The trouble is, the company also issued $791 in stock-based compensation. And this almost entirely offsets the cash generated by the social media business.
In order to avoid diluting shareholders, Pinterest has to buy back the shares it has issued to employees. But once it has finished doing this, the free cash remaining is around $150m. That implies a multiple of 177, which is high by any standard. So while the company might have some strong growth prospects, its shares are a lot more expensive than they look at first sight.
Final Foolish thoughts
As a business, I quite like Pinterest. But I’m not convinced the stock’s the bargain it looks like at first sight – either on an earnings basis, or in terms of free cash.
A one-off tax benefit means earnings per share are higher than they might otherwise be. And high stock-based compensation offsets a lot of the firm’s cash generation.
As a result, I don’t think the current share price is the bargain it appears to be at first sight. So I don’t see the stock as an obvious opportunity for me at the moment.
