Masco (MAS)...The Obvious Should not be an Impediment!

How much time do we as value investors waste looking for tiny companies as potential un-discovered jewels when companies with well-established franchises and brand names continue to earn superior returns on their capital, but also treat shareholders like partners. Most of us have a real weakness for trying to find a cheap version of a great company in the hopes that it may turn into something. Yet such tiny companies often face a perilous future. High current returns invite competition and over time, excess returns over the cost of capital diminish.

Masco (MAS) is a mature business that most of us should recognize. In an announcement this morning, they are once again completing two divestitures to maintain their record of solid returns on capital. As well, the company announced that as a result of this action, they were lowering earnings guidance.

This prompted me to have another look at their cash flow and returns history over the last several years. It truly is impeccable.

Free cash flow generation over the last five years (incorporating TTM results from Q3 2005) has been about $4.8 billion. Compare this with CFFO which has totalled about $6.3 billion. Non nonsense here in terms of quality of earnings...free cash flow approximates about 75% of CFFO.

Share buybacks have also been an important part of Masco's partnership with its shareholders. These have been effective share buybacks, not merely the sopping up of executive stock options. The fully diluted sharecount as of Sept 2005 was 427 million shares compared to December of 2003 at 491 million shares, a full 13% reduction in share count.

At current prices, the shares are yielding 2.63%, well above the S&P's 2.08%. Dividends have grown at about 8.6%, slightly behind the S&P's 9.1%. However, share buybacks have represented a significant return of capital to shareholders.

The FCF yield is about 4.6%, well above that of the S&P which has a 3.3% FCF yield but still a little expensive for what I would like to pay. On an EV/EBIT basis, the company is trading for 11.2 times, again not quite a bargain in my opinion.

Returns on capital have been solid recently at 12%, improved from 2004's 11.40%, 2003's 8.70%, 2002's 8.50%, and 2001's 9.40%.

Much like a good portfolio manager, MAS management continuously oversees its portfolio of businesses with an eye to pruning the weeds and letting the flowers thrive.

Keeping an eye on this for a better entry point. Hopefully, we get it.