Unilever Analysis — Warren Buffett Valuation
Introduction
I want to start out with a very appropriate quote from Warren Buffett, the Oracle of Omaha. It comes from his 2008 letter to shareholders in the Berkshire Hathaway (BRK.A, BRK.B) annual report:
Price is what you pay. Value is what you get — Warren Buffett
This quote is especially important today considering the high valuations of most stocks traded on U.S. exchanges. I believe Unilever (NYSE:UN) is a great company paying a secure, above-average dividend. But is it a good value at its current valuation? There are many ways to value a company, so let us choose one that is not so well known, but very consistent with the methodology employed by the Oracle himself.
In his letter to shareholders from the 1958 annual report of his partnership, Mr. Buffett speaks to how he looks for “undervalued securities”:
“To the extent possible, therefore, I am attempting to create my own work-outs by acquiring large positions in several undervalued securities. Such a policy should lead to the fulfillment of my earlier forecast-an above average performance in a bear market, and a normal performance in a bull market. It is on this basis that I hope to be judged.”
Judging by his compounded annual return over the 50 years from 1965 to 2015 of 21.6 percent, I would have to say he and his investors are pretty happy. Consistent returns of that magnitude are getting harder to achieve, but the principle is still rock-solid, in my humble opinion.
Finding value requires patience, and lots of it. You will find that theme in many of my articles. Cash is not trash; it is an option on finding value in the future. I tend to invest for dividends. I want to keep adding consistently rising streams of income for future use. I keep collecting those dividends and letting the cash pile up until I find something that I consider to be a good value. How do I define a good value?
I use three methods primarily: the DDM (dividend discount model), the simple P/E (price/earnings) relative to the historical P/E and the Friedrich method using the FROIC (free cash flow return on invested capital). In this article, I will focus on the FROIC method.
Valuing Unilever
Unilever pays a decent dividend yielding about 2.75 percent. The dividend is declared in euros and then translated to USD (U.S. dollars) to be paid on the ADR units. While the dividend rises consistently in euros, due to deviations in currency exchange rates it is more erratic in USD. But over the long term, it continues to rise. If the USD weakens against the euro in the future, the dividend will rise faster. Conversely, if the USD continues to strengthen against the euro, the dividend paid in USD will continue to rise less than in euro terms. By the way, when I use the term “long term,” I mean at least five years, but preferably much longer (as in decades).
Now, I want to explain how to analyze a stock using free cash flow return on investment. We will take a deep look into the numbers for Unilever, and at the same time explain the methodology involved in this analysis.
Main Street (the real world) is where Unilever operates, and Wall Street (the hype casino) is where its shares trade. Unilever shares available for purchase on Wall Street are in the public domain, and the company has little control over the price at which each share will trade. Unilever is required to release its earnings reports annually and semi-annually (as a Dutch company), and from time to time, it also provides press releases to its shareholders (and the general public), giving updates on how its operations are doing on Main Street.
As an ADR traded on an U.S. exchange, it is only required to report to the SEC once per year. I do not like waiting a full year to reassess my foreign equity holdings based solely on SEC filings. I also do not like to rely on company press releases during the interim. Fortunately, I am able to evaluate Unilever (and other foreign stock around the globe) using our Friedrich Global Research database, which updates monthly (to recalculate ratios based upon the current share price) and includes a TTM (trailing twelve months) column that picks up the semi-annual reports in local currencies.
Main Street is where Unilever invests in its own operations and creates products that its customers can purchase. How well company management does in pricing and selling those products determines the profitability. Wall Street then reacts based on the success or failure of management to meet goals, set by analysts with guidance from corporate management. Main Street and Wall Street thus have a seemingly symbiotic relationship. The disconnect that often occurs between the two is the result of perceptions and the ability of almost anyone to buy or sell any stock at any time. Expert analysis is not required to invest on Wall Street. The rise of such competitive forces such as hedge funds, dark pools and HFTs (high frequency traders — using algorithms) that account for the majority of trading volume most days has created a far different investing environment than that which existed 30 or more years ago when I got started as an investor.
It seems to me that we are subject to much more of a herd mentality and momentum investing than ever before. Fundamental analysis and investing for the long term have become unfashionable on Wall Street. That is probably because it does not produce as much revenue for the powers that be on Wall Street. They need ever-rising volumes to keep respective revenues and profits rising.
This results in advice coming from Wall Street to be very dangerous for individual investors. Many individual investors experience emotional swings about individual stocks and tend to follow the herd in and out, creating more volume and revenue for Wall Street and often more taxable revenue for the government. During bull markets, investors experience euphoria as “the rising tide lifts all boats.” But when a bear market suddenly shows up, these same investors tend to panic and stampede over the cliff like lemmings. Thus, we have the classic case of “greed vs. panic.” It is the game that Wall Street plays to its advantage, not ours.
I am a fan and student of both Benjamin Graham and Warren Buffett. Our Friedrich algorithm was designed to assist all investors (both pro and novice alike) and give them the ability to quickly compare a company’s Main Street operations to its Wall Street valuation. Friedrich can do this on an individual company basis or assist users in analyzing an entire index like the S&P 500, an ETF, mutual fund or individual portfolio.
Berkshire Hathaway’s 1986 letter to shareholders contains a ratio which Mr. Buffett entitled “Owner Earnings.” It is what we would consider to be a version of “Free Cash Flow.” This is one of the many gems hidden throughout the letters and footnotes, where one can find explanations from Mr. Buffett on the key ratios that he and Charlie Munger used in analyzing stocks. In that letter, he defined the term “owner earnings” as the cash that is generated by the company’s business operations.
“[Owner earnings] represent A) reported earnings plus B) depreciation, depletion, amortization, and certain other non-cash charges… less C) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume.”
I like this free cash flow ratio, as I believe earnings can be manipulated, but a company’s ability to create cash flow is more representative of its underlying operational efficiencies and financial well-being. Arnold Bernhard, the founder of Value Line Investment Survey, was a big fan of free cash flow and probably introduced it sooner than Mr. Buffett did. Our 60-year backtest of the DJIA from 1950–2009 used data from Value Line.
In the backtest mentioned above, we demonstrated that if one can purchase a company whose shares are selling for 15 times or less its Price-to-Free Cash Flow ratio, the probability of success will dramatically increase in most cases. We have renamed the ratio the Bernhard Buffett Free Cash Flow ratio in honor of both men. The following is how that ratio below is calculated.
Price-to-Bernhard Buffett Free Cash Flow Ratio = Sherlock Debt Divisor/ [(net income per share + depreciation per share) — (capital spending per diluted share)]
Sherlock Debt Divisor = Market Price Per Share — ((Working Capital — Long-Term Debt)/Diluted Shares Outstanding))
The above are the ratios to use when analyzing a stock on Wall Street, and below are the ratios we use when analyzing a stock on Main Street.
FROIC means “Free Cash Flow Return on Invested Capital”
Forward Free Cash Flow = [((Net Income + Depreciation) (1+ % Revenue Growth rate)) — (Capital Spending)]
FROIC = (Forward Free Cash Flow)/ (Long-Term Debt + Shareholders’ Equity)
What the FROIC ratio does is tell us how much forward free cash flow the company is generating on Main Street relative to how much total capital it has employed. So, if a company invests $100 in total capital on Main Street and generates $20 in forward free cash flow, it therefore has an FROIC of 20%, which we consider excellent. This is just one of the key ratios (66 in total) that we use to identify how a company is performing on Main Street, as it is our belief that if it is making a killing on Main Street, this news will eventually show up on Wall Street’s radar.
So, let us begin our analysis and, at the same time, try to teach everyone how to do a similar analysis on one’s own portfolio. In analyzing Unilever’s Price-to-Bernhard Buffett FCF ratio, we must first analyze Unilever’s Sherlock Debt Divisor. Here is a detailed definition of what that ratio is:
Sherlock Debt Divisor = A major concern that we have these days in analyzing companies is the amount of debt relative to its operating cash flow, and whether management is abusing this situation by taking on more debt than it requires. Debt can be used wisely to create leverage, and leverage can be extremely beneficial within certain parameters. On the other side of the coin, too much reliance on debt can be unsustainable and put a company’s future in jeopardy. So, what we have done to determine if a company’s debt policy is beneficial or abusive is to create the Sherlock Debt Divisor.
What the Divisor does is punish companies that rely too heavily on debt and reward those who successfully use debt as leverage. To do this, we take a company’s working capital and subtract its long-term debt. If the company has a lot more working capital than long-term debt, we reward it. Conversely, we punish those whose long-term debt exceeds their working capital. If this result of this calculation is higher than the current stock market price, then leverage is being employed. A company with too much leverage will generate a result of this ratio that will adjust our other ratios, making the stock less attractive as an investment.
Having successfully defined the Sherlock Debt Divisor, we now need the following four bits of financial data in order to calculate it for Unilever. We last updated the reports on Unilever on March 22, 2017, and the company last reported results as of December 31, 2016.
Instead of going through all the calculations, I will now provide my shortcut from our Friedrich Global Research database with five years of ratios for Unilever where we have done all the calculations for you.

The market share price (Wall Street price) in local currency is €46.52. The Sherlock Debt Divisor is €52.76. This means Unilever has more debt than working capital, so we increase the price. We feel accounting for the debt this way keeps up from stumbling into a company that carries too much debt.
Price-to-Bernhard Buffett FCF Ratio = Sherlock Debt Divisor/ [(net income per share + depreciation per share) — (capital spending per diluted share)]
Price-to-Bernhard Buffett Free Cash Flow Ratio = 32.65
Now, if you goes to our Friedrich Legend (on what is considered a good or bad result), you will notice that our result of 32.65 is considered BAD.
We last ran our datafile for Unilever on March 22, 2017, and our Friedrich algorithm gave a recommendation to our subscribers that Unilever is a “Sell” as our Friedrich datafile above and our Friedrich chart below show.

Now that we have shown everyone how to use our Price-to-Bernhard Buffett Free Cash Flow ratio, let us now move on and explain how to calculate our FROIC ratio.
This is how we calculate it:
FROIC means “Free Cash Flow Return on Invested Capital”
Forward Free Cash Flow = [((Net Income + Depreciation) (1+ % Revenue Growth rate)) — (Capital Spending)]
FROIC = (Forward Free Cash Flow)/ (Long-Term Debt + Shareholders’ Equity)
If you will scroll back up to the Friedrich datafile table shown earlier in this article, you will see that we have done the calculations for you and determined that the Unilever FROIC = 17%
Now if one goes to our Friedrich Legend again (on what is considered a good or bad result), you will notice that our result of 17% is a good result and tells us that Unilever generates €17 in forward free cash flow for every €100 it invests in total capital employed. Better yet, if we scroll back up to the datafile table, we see that Unilever has been churning out free cash flow like this for at least the last five years. This is a very good showing!
On Main Street, Unilever is doing great, while on Wall Street, it is extremely overbought. Now, if you can build a portfolio containing companies with similar results on Main Street and buy all at attractive Price-to-Bernhard Buffett Free Cash Flow ratio results, then your portfolio should be a star on both Main Street and Wall Street. Unfortunately, Unilever does not meet both criteria at the current share price. It may be a great company, but does not, in our opinion, represent a good value.
Finding companies that have excellent results on Main Street and Wall Street (simultaneously) these days is, unfortunately, like trying to find a needle in a haystack. In order to prove this point, we recently analyzed the S&P 500 Index using the exact same methodology and produced final Main Street (FROIC) and Wall Street (Price-to-Bernhard Buffett FCF) results for the entire index.
The final results for the S&P 500 Index are:
FROIC = 12%
Price-to-Bernhard Buffett FCF = 38.34
For FROIC, we consider any result above 20% to be excellent and any result above 10% to be good, so the S&P 500 index, in having a FROIC of 12%, can be considered good and tells us (that as a group on Main Street) the components of the index are doing well.
The problem is that Wall Street has “overbought” the index, giving it a score of 38.34 for our Price-to-Bernhard Buffett FCF ratio. That ratio considers a stock a bargain when it trades under 15 times and overbought when it trades over 30 times. Therefore, the S&P 500 index is some 8.34 points, or about 28%, in “overbought” territory. This is just one more indication of a stock market that is highly overvalued.
When analyzing the S&P 500 Index components, we set up certain rules to use when analyzing any group of stocks, such as one’s own portfolio:
- If a stock has a negative FROIC result, we automatically assign it a score of 100 for its Price-to-Bernhard Buffett FCF ratio, in order to keep everything consistent and logical, as you can’t have a negative Price-to-Bernhard Buffett FCF ratio when analyzing portfolios.
- Then, at the same time, the maximum FROIC allowed is 100%, so we can keep everything consistent and logical as well, as anything higher distorts the results for the group.
- We also give a zero result for FROIC for any “cash position” in the portfolio and a 22.50 result for the Price-to-Buffett Free Cash Flow (which is 15 (buy) + 30 (sell) = 45/2 = 22.50). This was done to force one never to feel comfortable in cash, unless one has no choice in the matter, like we are now. Our real-time research clearly shows that the markets are overvalued, as measured by our analysis of the S&P 500 index.
Conclusion
It is my belief that free cash flow analysis is the ultimate tool when analyzing companies, and my hope is that you may add these ratios to your own investor tool box in order to help you in your own due diligence. If you have any questions, please feel free to ask them in the comment section below, and don’t forget to hit the “Follow” button next to my name at the top of this article. Now that we are able to analyze indices, we will begin the process of analyzing ETFs, mutual funds and certain popular portfolio managers’ (gurus’) portfolios in a series of articles here on Seeking Alpha. That effort will, of course, be in addition to providing analysis on individual stocks. Since most use the S&P 500 Index as the comparative benchmark, we can see how each is doing in a side-by-side comparison.
