by Marc Lichtenfeld, Chief Income Strategist, The Oxford Club
Thursday, December 27, 2012: Issue #1935
So, we have a new President/four more years. Last night’s results were totally unexpected/predictable. I’m glad it was wrapped up before midnight/I can’t believe this will go on for weeks.
My deadline for Wednesday’s column is Tuesday afternoon. So as I write this, I have no idea which candidate has won the election, or if a winner has even been named.
From a stock market perspective, it really doesn’t matter.
In an earlier article, I showed you stock market performance under both parties for the last 111 years. It was pretty close to even. Over the long term, the market goes up, no matter who is in office, whether there is war or peace, high taxes or low taxes. Over 100 years of stock market history proves this to be true.
So rather than get all riled up over the election, I’m focusing on finding great stocks for the next year…
Why Cash is Still King
One of the most important variables to consider when analyzing a stock is cash flow.
It’s how much cash a company has left over after it’s paid its bills and operated its business.
The same is true for your personal finances. It doesn’t matter what your salary is, it matters how much cash you’re generating from your job, investments, tax credits, etc.
Investors tend to focus on earnings. But earnings have all kinds of non-cash items in the calculation. Things like depreciation and amortization are factored into earnings. Those are expenses that reduce earnings, but did not cause the company to lay out any cash.
When investing, I like to find companies that have earnings growth, but also are growing cash flow. If earnings are consistently going higher, but cash flow is not, that tells me that something isn’t quite right. That scenario can even be a sign that a company is cooking the books to appease Wall Street.
A company that’s well managed will not only increase its earnings, but will generate more cash year after year. That’s cash that can be used to buy back shares, pay shareholders a dividend and make acquisitions. Activities that, if done correctly, enhance shareholder value.
Earnings are nice. But, as they say, cash is king.
The “Cash is King” Stock Screen
So I decided to run a screen for stocks that are growing cash flow from operations by a robust 15% or more on average over five years. I also screened for companies whose earnings were growing at a 15% per year clip. Although I love cash flow, investors do pay close attention to earnings. Additionally, I looked for companies that grew their sales by 15%. I didn’t want higher earnings due simply to cost cutting. I wanted to see revenue growth fuel the earnings growth.
With a minimum market cap of $1 billion, I generated a list of 217 stocks. Here are some of the highlights:
Atwood Oceanics (NYSE: ATW) is an offshore drilling contractor that grew cash flow at an annual 23% pace over the past five years while earnings and sales rose 25% and 18%, respectively.
Additionally, the stock trades at just 12 times earnings and below 10 times forward earnings.
Iron ore miner Cliffs Natural Resources (NYSE: CLF) grew its cash flow by a whopping 45% annually over the past five years. During that period, earnings climbed 35% and revenue grew 29%. Cliffs also has a forward P/E ratio below 10.
Digital Realty Trust (NYSE: DLR) is a real estate investment trust (REIT) whose business has been booming. It owns real estate focused on technology. For example, its properties include data storage centers, IT departments of Fortune 1000 companies, manufacturing facilities, etc.
REITs typically don’t have rapid growth, but considering the strength of technology over the past few years, it’s not a shock that Digital Realty is growing by huge amounts every year.
Cash flow grew 33%, earnings 47% and sales 31% over the past five years. And the stock pays a nice 4.9% dividend yield.
Gilead Sciences (Nasdaq: GILD) is one of the most successful biotech companies in history. Its medicines dominate the HIV space. It also has drugs for hepatitis B, angina and cystic fibrosis, to name just a few.
Gilead’s cash flow and earnings both grew at an impressive 36% rate over the past five years, while sales rose 22%.
Fertilizer company Intrepid Potash (NYSE: IPI) saw its cash flow grow by 43% over the past five years. At the same time earnings swelled 35% while sales increased 24%.
Last week, the company reported better-than-expected third quarter earnings and sales. It trades at less than 10 times its operating cash flow, which is inexpensive.
You can see that strong cash flow performance can occur in a variety of sectors. Above, we have an oil driller, a metal miner, a technology REIT, a biotech and a fertilizer company.
Companies with five-year annualized growth in cash flow, earnings and sales at or above 15% widely outperformed the market over the past 10 years. These stocks gained 195% while the S&P 500 climbed 54%. Annualized, the screened group gained over 11%, while the S&P rose 4%. That’s significant outperformance.
Screening for stocks with strong cash flow is an excellent way to start your research when looking for new positions to add to your portfolio. Earnings are great, but I need to see some cash flow growth to make me interested.
Companies with all three growth attributes should outperform no matter who is in the White House or Congress.
MarcForget Obama – It’s All About the King,